Unassociated Document
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-Q
x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF
THE
SECURITIES EXCHANGE ACT OF 1934
For
the
quarterly period ended April 30, 2008
OR
¨
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
(Exact
name of registrant 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, 14th
floor, New York, NY 10005
(Address
of principal executive offices)
Registrant’s
telephone number, including area code: (212)
344-2785
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 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 large accelerated filer, an
accelerated filer, or a non-accelerated filer or a smaller reporting company.
See the definitions of “large accelerated filer,” “accelerated filer” and
“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large
accelerated filer o
|
Accelerated
filer o
|
|
|
Non-accelerated
filer x
|
Smaller
reporting company 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.
|
|
Outstanding at June 1, 2008
|
|
|
|
|
|
Common
Stock, par value $.0001 per share
|
|
|
176,214,898
|
|
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 and
nine months ended April 30, 2008.
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, 2007.
The
results reflected for the three and nine months ended April 30, 2008 are not
necessarily indicative of the results for the entire fiscal
year.
CAPITAL
GOLD CORPORATION
CONDENSED
CONSOLIDATED BALANCE SHEET
(in
thousands, except for share and per share amounts)
|
|
(Unaudited)
|
|
|
|
|
|
April 30,
2008
|
|
July 31,
2007
|
|
ASSETS
|
|
|
|
|
|
|
|
Current
Assets:
|
|
|
|
|
|
|
|
Cash
and Cash Equivalents
|
|
$
|
4,936
|
|
$
|
2,225
|
|
Accounts
Receivable
|
|
|
1,143
|
|
|
-
|
|
Stockpiles
and Ore on Leach Pads (Note 4)
|
|
|
9,371
|
|
|
2,997
|
|
Material
and Supply Inventories
|
|
|
818
|
|
|
174
|
|
Deposits
(Note 5)
|
|
|
46
|
|
|
879
|
|
Marketable
Securities (Note 3)
|
|
|
50
|
|
|
90
|
|
Prepaid
Expenses (Note 18)
|
|
|
1,009
|
|
|
72
|
|
Loans
Receivable – Affiliate (Note 10 and 13)
|
|
|
40
|
|
|
47
|
|
Other
Current Assets (Note 6)
|
|
|
1,242
|
|
|
1,675
|
|
Total
Current Assets
|
|
|
18,655
|
|
|
8,159
|
|
|
|
|
|
|
|
|
|
Mining
Concessions (Note 9)
|
|
|
61
|
|
|
68
|
|
Property
& Equipment – net (Note 7)
|
|
|
20,619
|
|
|
18,000
|
|
Intangible
Assets – net (Note 8)
|
|
|
193
|
|
|
577
|
|
|
|
|
|
|
|
|
|
Other
Assets:
|
|
|
|
|
|
|
|
Other
Investments
|
|
|
28
|
|
|
28
|
|
Deferred
Financing Costs
|
|
|
463
|
|
|
581
|
|
Mining
Reclamation Bonds
|
|
|
82
|
|
|
36
|
|
Other
|
|
|
-
|
|
|
42
|
|
Security
Deposits
|
|
|
61
|
|
|
60
|
|
Total
Other Assets
|
|
|
634
|
|
|
747
|
|
Total
Assets
|
|
$
|
40,162
|
|
$
|
27,551
|
|
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
Current
Liabilities:
|
|
|
|
|
|
|
|
Accounts
Payable
|
|
$
|
609
|
|
$
|
617
|
|
Accrued
Expenses
|
|
|
1,713
|
|
|
603
|
|
Derivative
Contracts (Note 16)
|
|
|
976
|
|
|
596
|
|
Income
Taxes Payable (Note 18)
|
|
|
834
|
|
|
-
|
|
Current
Portion of Long-term Debt (Note 15)
|
|
|
4,125
|
|
|
-
|
|
Total
Current Liabilities
|
|
|
8,257
|
|
|
1,816
|
|
|
|
|
|
|
|
|
|
Reclamation
and Remediation Liabilities (Note 11)
|
|
|
1,370
|
|
|
1,249
|
|
Long-term
Debt (Note 15)
|
|
|
8,375
|
|
|
12,500
|
|
Total
Long-term Liabilities
|
|
|
9,745
|
|
|
13,749
|
|
Commitments
and Contingencies
|
|
|
-
|
|
|
-
|
|
Stockholders’
Equity:
|
|
|
|
|
|
|
|
Common
Stock, Par Value $.0001 Per Share;
|
|
|
|
|
|
|
|
Authorized
300,000,000 shares; Issued and
|
|
|
|
|
|
|
|
Outstanding
175,914,898 and 168,173,148 shares, respectively
|
|
|
18
|
|
|
17
|
|
Additional
Paid-In Capital
|
|
|
57,348
|
|
|
54,016
|
|
Accumulated
Deficit
|
|
|
(32,248
|
)
|
|
(38,861
|
)
|
Deferred
Financing Costs (Note 15)
|
|
|
(2,740
|
)
|
|
(3,438
|
)
|
Deferred
Compensation
|
|
|
(573
|
)
|
|
(52
|
)
|
Accumulated
Other Comprehensive Income (Note 12)
|
|
|
355
|
|
|
304
|
|
Total
Stockholders’ Equity
|
|
|
22,160
|
|
|
11,986
|
|
Total
Liabilities and Stockholders’ Equity
|
|
$
|
40,162
|
|
$
|
27,551
|
|
The
accompanying notes are an integral part of the financial
statements.
|
|
|
|
|
|
|
|
CAPITAL
GOLD CORPORATION
CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(in
thousands, except for share and per share amounts)
|
|
For The Three Months Ended
|
|
|
|
April 30,
|
|
|
|
2008
|
|
2007
|
|
Revenues
|
|
|
|
|
|
|
|
Sales
– Gold, net
|
|
$
|
8,730
|
|
$
|
-
|
|
Costs
and Expenses:
|
|
|
|
|
|
|
|
Costs
Applicable to Sales
|
|
|
2,717
|
|
|
-
|
|
Depreciation
and Amortization
|
|
|
800
|
|
|
286
|
|
General
and Administrative
|
|
|
1,072
|
|
|
970
|
|
Exploration
|
|
|
19
|
|
|
811
|
|
Equity
Based Compensation
|
|
|
14
|
|
|
52
|
|
Total
Costs and Expenses
|
|
|
4,622
|
|
|
2,119
|
|
Income
(Loss) from Operations
|
|
|
4,108
|
|
|
(2,119
|
)
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
Interest
Income
|
|
|
12
|
|
|
64
|
|
Interest
Expense
|
|
|
(377
|
)
|
|
(275
|
)
|
Other
Income (Expense)
|
|
|
(25
|
)
|
|
-
|
|
Loss
on change in fair value of derivative
|
|
|
(337
|
)
|
|
(319
|
)
|
Total
Other Income (Expense)
|
|
|
(727
|
)
|
|
(530
|
)
|
|
|
|
|
|
|
|
|
Income
(Loss) before Income Taxes
|
|
|
3,381
|
|
|
(2,649
|
)
|
|
|
|
|
|
|
|
|
Income
Tax Expense
|
|
|
(641
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
Net
Income (Loss)
|
|
$
|
2,740
|
|
$
|
(2,649
|
)
|
|
|
|
|
|
|
|
|
Income
(Loss) Per Common Share
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.02
|
|
$
|
(0.02
|
)
|
Diluted
|
|
$
|
0.01
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
Basic
Weighted Average Common Shares Outstanding
|
|
|
175,645,465
|
|
|
164,581,950
|
|
Diluted
Weighted Average Common Shares Outstanding
|
|
|
197,238,688
|
|
|
-
|
|
The
accompanying notes are an integral part of the financial
statements.
CAPITAL
GOLD CORPORATION
CONDENSED
CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
(in
thousands, except for share and per share amounts)
|
|
For
The Nine Months Ended
|
|
|
|
April
30,
|
|
|
|
2008
|
|
2007
|
|
Revenues
|
|
|
|
|
|
|
|
Sales
– Gold, net
|
|
$
|
23,299
|
|
$
|
-
|
|
Costs
and Expenses:
|
|
|
|
|
|
|
|
Costs
Applicable to Sales
|
|
|
7,343
|
|
|
-
|
|
Depreciation
and Amortization
|
|
|
2,630
|
|
|
632
|
|
General
and Administrative
|
|
|
3,186
|
|
|
2,151
|
|
Exploration
|
|
|
650
|
|
|
1,325
|
|
Equity
Based Compensation
|
|
|
122
|
|
|
153
|
|
Total
Costs and Expenses
|
|
|
13,931
|
|
|
4,261
|
|
Income
(Loss) from Operations
|
|
|
9,368
|
|
|
(4,261
|
)
|
|
|
|
|
|
|
|
|
Other
Income (Expense):
|
|
|
|
|
|
|
|
Interest
Income
|
|
|
63
|
|
|
98
|
|
Interest
Expense
|
|
|
(945
|
)
|
|
(474
|
)
|
Other
Income (Expense)
|
|
|
(30
|
)
|
|
-
|
|
Loss
on change in fair value of derivative
|
|
|
(1,037
|
)
|
|
(847
|
)
|
Total
Other Income (Expense)
|
|
|
(1,949
|
)
|
|
(1,223
|
)
|
|
|
|
|
|
|
|
|
Income
(Loss) before Income Taxes
|
|
|
7,419
|
|
|
(5,484
|
)
|
|
|
|
|
|
|
|
|
Income
Tax Expense
|
|
|
(806
|
)
|
|
-
|
|
|
|
|
|
|
|
|
|
Net
Income (Loss)
|
|
$
|
6,613
|
|
$
|
(5,484
|
)
|
|
|
|
|
|
|
|
|
Income
(Loss) Per Common Share
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.04
|
|
$
|
(0.04
|
)
|
Diluted
|
|
$
|
0.03
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
Basic
Weighted Average Common Shares Outstanding
|
|
|
173,722,564
|
|
|
143,842,574
|
|
Diluted
Weighted Average Common Shares Outstanding
|
|
|
194,869,746
|
|
|
-
|
|
The
accompanying notes are an integral part of the financial
statements.
CAPITAL
GOLD CORPORATION
CONDENSED
CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(UNAUDITED)
(in
thousands, except for share and per share amounts)
|
|
|
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Additional
|
|
|
|
Other
|
|
Deferred
|
|
|
|
Total
|
|
|
|
Common
Stock
|
|
paid-in-
|
|
Accumulated |
|
Comprehensive
|
|
Financing
|
|
Deferred
|
|
Stockholders’
|
|
|
|
Shares
|
|
Amount
|
|
capital
|
|
Deficit
|
|
Income/(Loss)
|
|
Costs
|
|
Compensation
|
|
Equity
|
|
Balance
at July 31, 2007
|
|
|
168,173,148
|
|
$
|
17
|
|
$
|
54,016
|
|
$
|
(38,861
|
)
|
$
|
304
|
|
$
|
(3,438
|
)
|
$
|
(52
|
)
|
$
|
11,986
|
|
Amortization
of deferred finance costs
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
698
|
|
|
-
|
|
|
698
|
|
Equity
based compensation
|
|
|
-
|
|
|
-
|
|
|
366
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
169
|
|
|
535
|
|
Common
stock issued upon the exercising of options and warrants
|
|
|
6,646,750
|
|
|
1
|
|
|
2,276
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2,277
|
|
Issuance
of restricted common stock
|
|
|
1,095,000
|
|
|
-
|
|
|
690
|
|
|
|
|
|
|
|
|
|
|
|
(690
|
)
|
|
-
|
|
Change
in fair value on interest rate swaps
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(209
|
)
|
|
-
|
|
|
-
|
|
|
(209
|
)
|
Unrealized
loss on marketable securities
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
(40
|
)
|
|
-
|
|
|
-
|
|
|
(40
|
)
|
Equity
adjustment from foreign currency translation
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
300
|
|
|
-
|
|
|
-
|
|
|
300
|
|
Net
income for the nine months ended April 30, 2008
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
6,613
|
|
|
-
|
|
|
|
|
|
-
|
|
|
6,613
|
|
Balance
at April 30, 2008
|
|
|
175,914,898
|
|
$
|
18
|
|
$
|
57,348
|
|
$
|
(32,248
|
)
|
$
|
355
|
|
$
|
(2,740
|
)
|
$
|
(573
|
)
|
$
|
22,160
|
|
The
accompanying notes are an integral part of the financial statements.
CAPITAL
GOLD CORPORATION
CONDENSED
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
(in
thousands, except for share and per share amounts)
|
|
For
The
|
|
|
|
Nine
Months Ended
|
|
|
|
April
30,
|
|
|
|
2008
|
|
2007
|
|
Cash
Flow From Operating Activities:
|
|
|
|
|
|
|
|
Net
Income (Loss)
|
|
$
|
6,613
|
|
$
|
(5,484
|
)
|
Adjustments
to Reconcile Net Loss to
|
|
|
|
|
|
|
|
Net
Cash Provided by (Used in) Operating Activities:
|
|
|
|
|
|
|
|
Depreciation
and Amortization
|
|
|
2,611
|
|
|
632
|
|
Accretion
of Reclamation and Remediation
|
|
|
121
|
|
|
-
|
|
Loss
on change in fair value of derivative, net
|
|
|
1,040
|
|
|
662
|
|
Equity
Based Compensation
|
|
|
535
|
|
|
472
|
|
Changes
in Operating Assets and Liabilities:
|
|
|
|
|
|
|
|
Increase
in Accounts Receivable
|
|
|
(1,143
|
)
|
|
-
|
|
Increase
in Prepaid Expenses
|
|
|
(937
|
)
|
|
(289
|
)
|
Increase
in Inventory
|
|
|
(6,309
|
)
|
|
(446
|
)
|
Decrease
in Other Current Assets
|
|
|
433
|
|
|
3,366
|
|
Decrease
(Increase) in Other Deposits
|
|
|
832
|
|
|
(610
|
)
|
Decrease
in Other Assets
|
|
|
1
|
|
|
1
|
|
Increase
in Mining Reclamation Bond
|
|
|
(46
|
)
|
|
-
|
|
Decrease
in Accounts Payable
|
|
|
(8
|
)
|
|
(20
|
)
|
Decrease
in Derivative Liability
|
|
|
(869
|
)
|
|
-
|
|
Increase
in Reclamation and Remediation
|
|
|
-
|
|
|
1,228
|
|
Increase
in Accrued Expenses
|
|
|
1,944
|
|
|
244
|
|
Net
Cash Provided By (Used in) Operating Activities
|
|
|
4,818
|
|
|
(244
|
)
|
|
|
|
|
|
|
|
|
Cash
Flow From Investing Activities:
|
|
|
|
|
|
|
|
(Increase)
in Other Investments
|
|
|
-
|
|
|
(6
|
)
|
Purchase
of Mining, Milling and Other Property and
|
|
|
|
|
|
|
|
Equipment
|
|
|
(4,601
|
)
|
|
(15,032
|
)
|
Purchase
of Intangibles
|
|
|
(90
|
)
|
|
(570
|
)
|
Net
Cash Used in Investing Activities
|
|
|
(4,691
|
)
|
|
(15,608
|
)
|
The
accompanying notes are an integral part of the financial
statements.
CAPITAL
GOLD CORPORATION
CONDENSED
CONSOLIDATED STATEMENT OF CASH FLOWS – CONTINUED
(UNAUDITED)
(in
thousands, except for share and per share amounts)
|
|
For
The
|
|
|
|
Nine
Months Ended
|
|
|
|
April
30,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
Cash
Flow From Financing Activities:
|
|
|
|
|
|
|
|
Advances
to Affiliate
|
|
|
7
|
|
|
(4
|
)
|
Proceeds
from Borrowing on Credit Facility
|
|
|
-
|
|
|
12,000
|
|
Proceeds
From Issuance of Common Stock
|
|
|
2,277
|
|
|
8,655
|
|
Deferred
Finance Costs
|
|
|
-
|
|
|
(257
|
)
|
Net
Cash Provided By Financing Activities
|
|
|
2,284
|
|
|
20,394
|
|
Effect
of Exchange Rate Changes
|
|
|
300
|
|
|
262
|
|
Increase
(Decrease) In Cash and Cash Equivalents
|
|
|
2,711
|
|
|
4,804
|
|
Cash
and Cash Equivalents - Beginning
|
|
|
2,225
|
|
|
2,741
|
|
Cash
and Cash Equivalents – Ending
|
|
$
|
4,936
|
|
$
|
7,545
|
|
|
|
|
|
|
|
|
|
Supplemental
Cash Flow Information:
|
|
|
|
|
|
|
|
Cash
Paid For Interest
|
|
$
|
973
|
|
$
|
686
|
|
Cash
Paid For Income Taxes
|
|
$
|
806
|
|
$
|
21
|
|
Non-Cash
Financing Activities:
|
|
|
|
|
|
|
|
Issuance
of common stock and warrants as payment of financing costs
|
|
$
|
-
|
|
$
|
3,665
|
|
Change
in Fair Value of Derivative Instrument
|
|
$
|
209
|
|
$
|
76
|
|
The
accompanying notes are an integral part of the financial
statements.
CAPITAL
GOLD CORPORATION
NOTES
TO
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE
1 -
Basis of Presentation
Capital
Gold Corporation ("Capital Gold", "the Company", "we" or "us") owns rights
to
property located in the State of Sonora, Mexico and the California Mining
District, Lake County, Colorado. The Company is engaged in the production of
gold and other minerals from its properties in Mexico as well as exploration
for
additional mineral properties. All of the Company's mining activities are being
performed in Mexico.
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. These concessions are sometimes referred to 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 is 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, the Company 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 (the
“Option”) to purchase 51% of Minera Chanate (or such entity that owns the Minera
Chanate concessions at the time of option exercise) (the “Back-In Right”). 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.
In
January 2008, pursuant to the terms of the agreement, the Company made a good
faith determination and notified AngloGold that the drill indicated resources
at
the El Chanate gold mine exceeded two million ounces of contained gold. The
term
"drill indicated resources" is defined in the agreement. A drill indicated
resource number does not rise to the level of, and should not be considered
proven and probable reserves as those terms are defined under SEC guidelines.
AngloGold has 180 days from the date of notification, or July 28, 2008, to
determine whether or not it will choose to exercise the Option for the Back-In
Right.
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-Q. 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. They include the accounts of Capital Gold Corporation and its wholly
owned and majority owned subsidiaries, Leadville Mining and Milling Holding
Corporation, Minera Santa Rita, S.A de R.L. de C.V.(“MSR”) and Oro de Altar S.
de R. L. de C.V. (“Oro”) as well as the accounts within Caborca Industrial S.A.
de C.V. (“Caborca Industriale”), a Mexican corporation 100% owned by two of the
Company’s officers and directors for mining support services. These services
include, but are not limited to, the payment of mining salaries and related
costs. Caborca Industrial bills the Company for these services at slightly
above
cost. This entity is considered a variable interest entity under accounting
rules provided under FIN 46, “Consolidation of Variable Interest Entities”. All
significant intercompany accounts and transactions are eliminated in
consolidation. Certain items in these financial statements have been
reclassified to conform to the current period presentation. These
reclassifications had no impact on the Company’s results of operations,
stockholders’ equity or cash flows
Results
of operations for interim periods are not necessarily indicative of the results
of operations for a full year.
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 at the discretion of the Board of Directors.
Such
options and warrants may be exercisable at varying exercise prices currently
ranging from $0.24 to $0.63 per share of common stock with certain of these
grants becoming exercisable immediately upon grant. Certain grants vested or
are
vesting for a period of five years, respectively. Also, 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 option 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
nine months ended April 30, 2008 and 2007, were $0.60 and $0.32, respectively.
The fair values of the options and warrants granted were estimated based on
the
following weighted average assumptions:
|
|
Nine months ended April 30,
|
|
|
|
2008
|
|
2007
|
|
Expected volatility
|
|
|
47.60 – 58.69%
|
|
|
82%
|
|
Risk-free
interest rate
|
|
|
3.74%
|
|
|
6.24%
|
|
Expected
dividend yield
|
|
|
-
|
|
|
-
|
|
Expected
life
|
|
|
6.3
years
|
|
|
4.2
years
|
|
Stock
option and warrant activity for employees during the nine months ended April
30,
2008 is as follows:
|
|
Number
of
Options
|
|
Weighted
Average
exercise
price
|
|
Weighted
average
remaining
contracted
term
(years)
|
|
Aggregate
intrinsic
value
|
|
Outstanding
at July 31, 2006
|
|
|
5,570,454
|
|
$
|
.16
|
|
|
1.17
|
|
$
|
702,250
|
|
Options
granted
|
|
|
1,050,000
|
|
|
.36
|
|
|
|
|
|
|
|
Options
exercised
|
|
|
(3,570,909
|
)
|
|
.08
|
|
|
-
|
|
|
-
|
|
Options
expired
|
|
|
(549,545
|
)
|
|
.22
|
|
|
-
|
|
|
-
|
|
Warrants
and options outstanding at July 31, 2007
|
|
|
2,500,000
|
|
$
|
.34
|
|
|
1.20
|
|
$
|
255,000
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options
granted*
|
|
|
2,500,000
|
|
|
.63
|
|
|
-
|
|
|
-
|
|
Options
exercised
|
|
|
(250,000
|
)
|
|
.32
|
|
|
-
|
|
|
-
|
|
Options
expired
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Warrants
and options outstanding at April 30, 2008
|
|
|
4,750,000
|
|
$
|
.49
|
|
|
2.90
|
|
$
|
748,000
|
|
Warrants
and options exercisable at April 30, 2008
|
|
|
2,916,750
|
|
$
|
.41
|
|
|
2.90
|
|
$
|
711,000
|
|
*
Issuances under 2006 Equity Incentive Plan.
Unvested
stock option and warrant balances for employees at April 30, 2008
are as
follows:
|
|
|
Number of
Options
|
|
Weighted
Average
Exercise
price
|
|
Weighted
average
remaining
contracted
term (years)
|
|
Aggregate
Intrinsic
value
|
|
Outstanding at August 1, 2007
|
|
|
150,000
|
|
$
|
.32
|
|
|
0.67
|
|
$
|
18,000
|
|
Options
granted
|
|
|
2,500,000
|
|
$
|
.63
|
|
|
-
|
|
|
-
|
|
Options
vested
|
|
|
(816,750
|
)
|
$
|
.57
|
|
|
-
|
|
|
-
|
|
Unvested
Options outstanding at April 30, 2008
|
|
|
1,833,250
|
|
$
|
.63
|
|
|
5.89
|
|
$
|
86,000
|
|
Stock
option and warrant activity for non-employees during the nine months
ended
April 30, 2008 is as follows:
|
|
|
Number
of
Options
|
|
Weighted
Average
Exercise
price
|
|
Weighted
average
remaining
contracted
term
(years)
|
|
Aggregate
Intrinsic
value
|
|
Warrants
and options outstanding at July 31, 2006
|
|
|
25,561,000
|
|
$
|
.29
|
|
|
1.33
|
|
$
|
1,939,530
|
|
Options
granted
|
|
|
16,982,542
|
|
|
.33
|
|
|
|
|
|
|
|
Options
exercised
|
|
|
(18,633,000
|
)
|
|
.29
|
|
|
-
|
|
|
-
|
|
Options
expired
|
|
|
(1,375,000
|
)
|
|
.31
|
|
|
-
|
|
|
-
|
|
Warrants
and options outstanding at July 31, 2007
|
|
|
22,535,542
|
|
$
|
.33
|
|
|
1.48
|
|
$
|
2,577,734
|
|
Options
granted*
|
|
|
1,115,000
|
|
$
|
.55
|
|
|
-
|
|
|
-
|
|
Options
exercised
|
|
|
(6,396,750
|
)
|
|
.34
|
|
|
-
|
|
|
-
|
|
Options
expired
|
|
|
(680,000
|
)
|
|
.30
|
|
|
-
|
|
|
-
|
|
Warrants
and options outstanding at April 30, 2008
|
|
|
16,573,792
|
|
$
|
.34
|
|
|
2.40
|
|
$
|
5,218,000
|
|
Warrants
and options exercisable at April 30, 2008
|
|
|
16,380,042
|
|
$
|
.33
|
|
|
2.40
|
|
$
|
5,209,000
|
|
*
Issuances under 2006 Equity Incentive Plan.
Unvested
stock option and warrant balances for non-employees at April 30,
2008 are
as follows:
|
|
|
Number of
Options
|
|
Weighted
Average
Exercise
price
|
|
Weighted
average
remaining
contracted
term (years)
|
|
Aggregate
Intrinsic
value
|
|
Outstanding at
August 1, 2007
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
-
|
|
Options
granted
|
|
|
650,000
|
|
$
|
.63
|
|
|
-
|
|
|
-
|
|
Options
vested
|
|
|
(173,355
|
)
|
$
|
.63
|
|
|
-
|
|
|
-
|
|
Unvested
Options outstanding at April 30, 2008
|
|
|
476,645
|
|
$
|
.63
|
|
|
6.74
|
|
$
|
10,000
|
|
The
impact on the Company’s results of operations of recording equity based
compensation for the nine months ended April 30, 2008, for employees and
non-employees was approximately $535,000 and reduced earnings per share by
$0.00
per basic and diluted share.
As
of
April 30, 2008, there was approximately $752,000 of unrecognized equity based
compensation cost related to options granted to executives and employees which
have not yet vested.
NOTE
3 -
Marketable Securities
Marketable
securities are classified as current assets and are summarized as
follows:
|
|
(in
thousands)
|
|
|
|
April 30,
2008
|
|
July 31,
2007
|
|
Marketable
equity securities, at cost
|
|
$
|
50
|
|
$
|
50
|
|
Marketable
equity securities, at fair value (See Notes 10 & 13)
|
|
$
|
50
|
|
$
|
90
|
|
NOTE
4 -
Stockpiles, Ore on Leach Pads and Inventories (“In-Process
Inventory”)
|
|
(in thousands)
|
|
|
|
April 30,
2008
|
|
July 31,
2007
|
|
Current:
|
|
|
Stockpiles
& Ore on leach pads
|
|
$
|
9,371
|
|
$
|
2,997
|
|
Total
|
|
$
|
9,371
|
|
$
|
2,997
|
|
Costs
that are incurred in or benefit the productive process are accumulated and
allocated to ore on leach pads and inventories. Stockpiles, ore on leach pads
and inventories are carried at the lower of average cost or net realizable
value. Net realizable value represents the estimated future sales price of
the
product based on current and long-term metals prices, less the estimated costs
to complete production and bring the product to sale. Write-downs of stockpiles,
ore on leach pads and inventories, resulting from net realizable value
impairments, will be reported as a component of Costs
applicable to sales.
The
current portion of stockpiles, ore on leach pads and inventories is determined
based on the expected amounts to be processed within the next 12 months.
NOTE
5 – Deposits
Deposits
are classified as current assets and represent advance payments made on the
Company’s mining contract and on mining equipment regarding the El Chanate
Project in Sonora, Mexico. Deposits are summarized as follows:
|
|
(in thousands)
|
|
|
|
April 30,
2008
|
|
July 31,
2007
|
|
Advance
payments on mining contract
|
|
$
|
-
|
|
$
|
684
|
|
Equipment
deposits
|
|
|
46
|
|
|
193
|
|
Other
|
|
|
-
|
|
|
2
|
|
Total
Deposits
|
|
$
|
46
|
|
$
|
879
|
|
NOTE
6 – Other Current Assets
Other
current assets consist of the following:
|
|
(in thousands)
|
|
|
|
April 30,
2008
|
|
July 31,
2007
|
|
Value added
tax to be refunded
|
|
$
|
1,072
|
|
$
|
1,475
|
|
Asset
held for resale
|
|
|
-
|
|
|
166
|
|
Other
|
|
|
170
|
|
|
34
|
|
Total
Other Current Assets
|
|
$
|
1,242
|
|
$
|
1,675
|
|
NOTE
7 – Property and Equipment
Property
and Equipment consist of the following:
|
|
(in thousands)
|
|
|
|
April 30,
2008
|
|
July 31,
2007
|
|
Process
equipment and facilities
|
|
$
|
17,682
|
|
$
|
16,285
|
|
Asset
retirement obligation
|
|
|
1,218
|
|
|
1,218
|
|
Mining
equipment
|
|
|
973
|
|
|
863
|
|
Mineral properties
|
|
|
141
|
|
|
141
|
|
Construction
in progress
|
|
|
2,986
|
|
|
-
|
|
Computer
and office equipment
|
|
|
307
|
|
|
212
|
|
Improvements
|
|
|
16
|
|
|
16
|
|
Furniture
|
|
|
36
|
|
|
23
|
|
Total
|
|
|
23,
359
|
|
|
18,758
|
|
Less:
accumulated depreciation
|
|
|
(2,740
|
)
|
|
(758
|
)
|
Property
and equipment, net
|
|
$
|
20,619
|
|
$
|
18,000
|
|
Expenditures
for new facilities or equipment and expenditures that extend the useful lives
of
existing facilities or equipment are capitalized and depreciated using the
Units
of Production (“UOP”) and straight-line method at rates sufficient to depreciate
such costs over the estimated productive lives, which do not exceed the related
estimated mine lives, of such facilities based on proven and probable reserves.
Mineral
exploration costs are expensed as incurred. When it has been determined that
a
mineral property can be economically developed as a result of establishing
proven and probable reserves, costs incurred prospectively to develop the
property are capitalized as incurred and are amortized using the UOP method
over
the estimated life of the ore body based on estimated recoverable ounces or
pounds in proven and probable reserves.
Depreciation
expense for the nine months ended April 30, 2008 and 2007 was approximately
$1,983,000 and $131,000, respectively.
NOTE
8 -
Intangible Assets
Intangible
assets consist of the following:
|
|
(in thousands)
|
|
|
|
April 30,
2008
|
|
July31,
2007
|
|
Repurchase of
Net Profits Interest
|
|
$
|
500
|
|
$
|
500
|
|
Water
Rights
|
|
|
134
|
|
|
-
|
|
Mobilization
Payment to Mineral Contractor
|
|
|
70
|
|
|
70
|
|
Investment
in Right of Way
|
|
|
18
|
|
|
18
|
|
Total
|
|
|
722
|
|
|
588
|
|
Accumulated
Amortization
|
|
|
(529
|
)
|
|
(11
|
)
|
Intangible
assets, net
|
|
$
|
193
|
|
$
|
577
|
|
Purchased
intangible assets consisting of rights of way, water rights, easements and
net
profit interests are carried at cost less accumulated amortization. Amortization
is computed using the straight-line method over the economic lives of the
respective assets, generally five years or using the UOP method. It is the
Company’s policy to assess periodically the carrying amount of its purchased
intangible assets to determine if there has been an impairment to their carrying
value. Impairments of other intangible assets are determined in accordance
with
SFAS 144. There was no impairment at April 30, 2008.
Amortization
expense for the nine months ended April 30, 2008 and 2007 was approximately
$521,000 and $4,000, respectively. The Repurchase of Net Profits Interest from
FG was fully amortized as of April 30, 2008.
NOTE
9 -
Mining Concessions
Mining
concessions consist of the following:
|
|
(in thousands)
|
|
|
|
April 30,
2008
|
|
July 31,
2007
|
|
El
Chanate
|
|
$
|
45
|
|
$
|
45
|
|
El
Charro
|
|
|
25
|
|
|
25
|
|
Total
|
|
|
70
|
|
|
70
|
|
Less:
accumulated amortization
|
|
|
(9
|
)
|
|
(3
|
)
|
Total
|
|
$
|
61
|
|
$
|
67
|
|
The
El
Chanate concessions are carried at historical cost and are being amortized
using
the UOP method. They were acquired in connection with the purchase of the stock
of Minera Chanate (see Note 1).
MSR
acquired an additional mining concession – El Charro. El Charro lies within
the current El Chanate property boundaries. MSR is required to pay 1 1/2% net
smelter royalty in connection with the El Charro concession.
Amortization
expense for the nine months ended April 30, 2008 and 2007 was approximately
$6,000 and $0, respectively.
NOTE
10 -
Loans Receivable - Affiliate
Loans
receivable - affiliate consist of expense reimbursements due from a
publicly-owned corporation in which the Company has an investment. The Company's
president and chairman of the board of directors was an officer and director
of
that corporation. On March 10, 2008, the Company’s president and chairman of the
board of directors resigned as both an officer and director of this corporation.
These loans are non-interest bearing and due on demand (see Notes 3 &
13).
NOTE
11 -
Reclamations and Remediation Liabilities (“Asset Retirement
Obligations”)
In
accordance with SFAS No. 143, Accounting for Asset Retirement Obligations,
reclamation costs are allocated to expense over the life of the related assets
and are periodically adjusted to reflect changes in the estimated present value
resulting from the passage of time and revisions to the estimates of either
the
timing or amount of the reclamation and abandonment costs. The Asset Retirement
Obligation is based on when the spending for an existing environmental
disturbance and activity to date is expected to occur. The Company reviews,
on
an annual basis, unless otherwise deemed necessary, the Asset Retirement
Obligation at each mine site.
The
following is a reconciliation of the liability for long-term Asset Retirement
Obligation:
|
|
(in thousands)
|
|
Balance
at July 31, 2007
|
|
$
|
1,249
|
|
Additions,
changes in estimates and other
|
|
|
-
|
|
Liabilities
settled
|
|
|
-
|
|
Accretion
expense
|
|
|
121
|
|
Balance
at April 30, 2008
|
|
$
|
1,370
|
|
NOTE
12 -
Other Comprehensive Income (Loss)-Supplemental Non-Cash Investing
Activities
Other
comprehensive income (loss) consists of changes in the fair value of
derivatives, accumulated foreign translation gains and losses and unrealized
gains and losses on marketable securities and is summarized as
follows:
|
|
(in thousands)
|
|
Balance
at July 31, 2007
|
|
$
|
304
|
|
Equity
Adjustments from Foreign Currency Translation
|
|
|
300
|
|
Change
in fair value of derivative instrument
|
|
|
(209
|
)
|
Unrealized
Gains (loss) on Marketable Securities
|
|
|
(40
|
)
|
Balance
at April 30, 2008
|
|
$
|
355
|
|
NOTE
13 -
Related Party Transactions
In
August
2002, the Company purchased marketable equity securities of a related company
(see Note 3). The Company recorded approximately $4,750 and $6,750,
respectively, in expense reimbursements including office rent from this entity
for the nine months ended April 30, 2008 and 2007, respectively (see Notes
10).
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 slightly above
cost.
Mining expenses charged by the Mexican Corporation and eliminated upon
consolidation amounted to approximately $2,525,000 and $240,000 for the nine
months ended April 30, 2008 and 2007, respectively.
NOTE
14 -
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 nine months ended April 30, 2008, the Company received proceeds of
approximately $2,277,000 from the exercising of an aggregate of 6,646,750
warrants issued in past private placements.
On
January 25, 2008, the Company amended its Certificate of Incorporation to
increase the Company’s authorized shares of capital stock from 250,000,000 to
300,000,000 shares.
2006
Equity Incentive Plan
The
2006
Equity Incentive Plan (the “Plan”), approved by stockholders on February 21,
2007, is intended to attract and retain individuals of experience and ability,
to provide incentive to the Company’s employees, consultants, and non-employee
directors, to encourage employee and director proprietary interests in the
Company, and to encourage employees to remain in the Company’s employ.
The
Plan
authorizes the grant of non-qualified and incentive stock options, stock
appreciation rights and restricted stock awards (each, an “Award”). A maximum of
10,000,000 shares of common stock are reserved for potential issuance pursuant
to Awards under the Plan. Unless sooner terminated, the Plan will continue
in
effect for a period of 10 years from its effective date.
The
Plan
is administered by the Company’s Board of Directors which has delegated the
administration to the Company’s Compensation Committee. The Plan provides for
Awards to be made to such of the Company’s employees, directors and consultants
and its affiliates as the Board may select. As of April 30, 2008, 6,260,000
options and shares have been granted under the Plan leaving 3,740,000 available
for issuance.
In
August
2007, the Company issued two year options to purchase the Company’s common stock
at exercise prices ranging from $0.38 to $0.50 per share for professional
services rendered. These options are for the purchase of 465,000 shares and
were
issued under the Plan. The Company utilized the Black-Scholes Method to fair
value these options and recorded approximately $58,000 as equity based
compensation expense.
On
December 20 2007, the Company’s executive officers and directors were granted
stock options and restricted stock under the Plan. Executive officers and
directors were granted an aggregate of 3,000,000 stock options and executive
officers were granted an aggregate 1,075,000 shares of restricted stock. All
of
the stock options have a term of seven years and vest as follows: 20% vested
upon issuance and the balance vest 20% annually thereafter. The exercise price
of the stock options is $0.63 per share (per the Plan, the closing price on
the
Toronto Stock Exchange on the trading day immediately prior to the day of
determination converted to U.S. Dollars). The restricted shares granted vest
equally over three years from the date of grant. In the event of a termination
of continuous service (other than as a result of a change of control), as
defined in the Plan, unvested stock options and unvested restricted stock grants
shall terminate and, with regard to vested stock options, the exercise period
shall be the lesser of the original expiration date or one year from the date
continuous service terminates. Upon the happening of a change of control, all
unvested stock options and unvested restricted stock grants immediately vest.
The Company utilized the Black-Scholes Pricing Model to fair value the stock
options and recorded approximately $231,000 as Equity Based Compensation during
the period. The Company also recorded approximately $690,000 as deferred
compensation expense within the Company’s statement of stockholders equity upon
the issuance of the restricted stock. Approximately $116,000 of this restricted
stock vested during the nine months ended April 30, 2008.
NOTE
15 -
Debt
Long
term
debt consists of the following:
|
|
(in thousands)
|
|
|
|
April 30,
2008
|
|
July 31,
2007
|
|
|
|
|
|
|
|
Total
long-term debt
|
|
$
|
12,500
|
|
$
|
12,500
|
|
|
|
|
|
|
|
|
|
Less
current portion
|
|
|
4,125
|
|
|
-
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
$
|
8,375
|
|
$
|
12,500
|
|
The
Company entered into a credit facility (the “Credit Facility”) in 2006 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 Facility, MSR and Oro borrowed money in an aggregate
principal amount of US$12,500,000 (the “Loan”) for the purpose of constructing,
developing and operating the Company’s El Chanate Project (the “Mine”). The
Company guaranteed the repayment of the loan and the performance of the
obligations under the Credit Facility. 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 occurred during the current quarter. Our first principal
payment is anticipated to be due June 30, 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. As of April 30, 2008,
the
outstanding amount on the credit facility was $12,500,000 and accrued interest
on this facility was approximately $72,000 (see Note 21)
The
Credit Facility 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
will be required to meet and maintain certain financial covenants once repayment
begins, scheduled to initiate June 30, 2008, 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 also is required to maintain a
certain minimum level of unrestricted cash and maintain a specified amount
of
cash ($1,800,000) 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.
As
part
of the fee for entering into and closing the Credit Facility, 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 its 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 Facility. 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 Facility. The Company recorded
the issuance of the shares of common stock and warrants as deferred financing
costs 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 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.
Amortization
of deferred financing costs related to these issuances was $698,000 and $517,000
for the nine months ended April 30, 2008 and 2007, respectively.
The
Company received a mandate letter, dated February 27, 2008, from Standard Bank
to refinance the existing project finance facility on the El Chanate mine.
The
key anticipated amendments to the refinance include: 1) removal of cash
restrictions and covenants, 2) reduction of the finance interest rate by 1.5%,
3) addition of a five million dollar line of credit at an interest rate of
LIBOR
+ 2%, and 4) exercise of a portion of the warrants currently held by Standard
Bank to provide additional support for El Chanate expansion plans and to fully
fund the debt service reserve account. The Company anticipates a closing date
for this refinance by the end of our fiscal year end, July 31, 2008.
NOTE
16 -
Sales Contracts, Commodity and Financial Instruments
In
March
2006, in conjunction with the Company’s credit facility, the Company entered
into two identically structured derivative contracts with Standard Bank (See
Note 15). 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 purchase a gold cap, enabling the company to buy gold 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, together, served to put a floor on the sales price
of
gold for the above stated volume of gold sales, however, the contracts were
not
designated as hedging derivatives, and therefore special hedge accounting does
not apply.
The
following is a reconciliation of the derivative contracts regarding the
Company’s Gold Price Protection agreement:
|
|
(in thousands)
|
|
Balance as
of July 31, 2007
|
|
$
|
548
|
|
Loss
on change in fair value of derivative
|
|
|
1,040
|
|
Net
cash settlements
|
|
|
(886
|
)
|
Balance
as of April 30, 2008
|
|
$
|
702
|
|
Rather
than modifying the original Gold Price Protection agreement with Standard Bank
to satisfy these forward sale obligations, the Company has opted for a net
cash
settlement between the call option purchase price of $535 and the forward sale
price of $500, or $35.00 per oz. The Company has paid Standard Bank
approximately $1,346,000 on the settlement of 38,455 ounces with corresponding
reductions in the Company’s derivative liability ($886,000 or 25,329 ounces of
gold during the nine months ended April 30, 2008). These expenses were incurred
concurrently with sales revenues that reflected actual sales of physical gold
at
market prices well above the option strike price of $535 per ounce. The
remaining ounces to settle with regard to this agreement amounted to 83,472
as
of April 30, 2008.
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 terminated on
March
31, 2007 and the second covering the period from March 30, 2007 with 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
other comprehensive income to earnings during the year ending July 31, 2008
from
these two swaps was determined to be immaterial.
The
following is a reconciliation of the derivative contract regarding the Company’s
Interest Rate Swap agreement:
|
|
(in thousands)
|
|
Balance as
of July 31, 2007
|
|
$
|
48
|
|
Change
in fair value of swap agreement
|
|
|
209
|
|
Interest
expense (income)
|
|
|
28
|
|
Net
cash settlements
|
|
|
(11
|
)
|
Balance
as of April 30, 2008
|
|
$
|
274
|
|
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 monitors
the
market position with each counterparty as required by
SFAS 133.
NOTE
17 -
Employee and Consulting Agreements
On
August
29, 2007, the Board increased the salaries of the Company’s executive officers
to be commensurate with industry standards as follows: Gifford A.
Dieterle, President, Treasurer and Chairman of the Board, $250,000; John
Brownlie, Chief Operating Officer, $225,000; Christopher Chipman, Chief
Financial Officer, $175,000 (consulting fee); Jeffrey W. Pritchard, Vice
President - Investor Relations and Secretary, $195,000; Roger A. Newell, Vice
President - Development, $135,000; and J. Scott Hazlitt, Vice President - Mine
Development, $135,000. The salary increase for Mr. Brownlie and the consulting
fee increase for Mr. Chipman were retroactive to May 1, 2007 and the salary
increase for Mr. Pritchard was retroactive to August 1, 2007. The Board also
increased directors’ compensation to the Company’s independent directors and to
Robert Roningen by $1,000 per month.
On
September 10, 2007, Roger A. Newell resigned as our Vice President of
Development.
NOTE
18 – Income Taxes
On
October 1, 2007, the Mexican Government enacted legislation which introduces
certain tax reforms as well as a new minimum flat tax system. This new
flat tax system integrates with the regular income tax system and is based
on
cash-basis net income that includes only certain receipts and
expenditures. The flat tax is set at 17.5% of cash-basis net income as
determined, with transitional rates of 16.5% and 17.0% in 2008 and 2009,
respectively. If the flat tax is positive, it is reduced by the regular
income tax and any excess is paid as a supplement to the regular income
tax. If the flat tax is negative, it may serve to reduce the regular
income tax payable in that year or can be carried forward for a period of up
to
ten years to reduce any future flat tax.
Companies
are required to prepay income taxes on a monthly basis based on the greater
of
the flat tax or regular income tax as calculated for each monthly period.
Accordingly, the Company has recorded a prepayment requirement of approximately
$845,000 as of April 30, 2008, on net income earned during the first four
calendar months in 2008. This amount is slightly greater than the anticipated
regular income tax of approximately $806,000 due to certain credits factored
into the Company’s tax accrual. Annualized income projections indicate
that the Company will not be liable for any excess flat tax for calendar year
2008 and, accordingly, has recorded a $834,000 Mexican income tax provision
as
of April 30, 2008.
As
the
new legislation was recently enacted, it remains subject to ongoing varying
interpretations. There is the possibility of implementation amendments by
the Mexican Government and the estimated future income tax liability recorded
at
the balance sheet date may change.
NOTE
19 - Concentrations of Credit Risk
Financial
instruments that potentially subject the Company to significant concentrations
of credit risk consist principally of cash and cash equivalents and marketable
securities. The Company maintains cash balances at financial institutions which
exceed the Federal Deposit Insurance Corporation limit of $100,000 at times
during the year.
NOTE
20 – Recently Issued Accounting Pronouncements
In
September 2006, the Financial Accounting Standards Board (“FASB”) issued FASB
Statement No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 defines
fair value, establishes a framework for measuring fair value in generally
accepted accounting principles, and expands disclosures about fair value
measurements. The provisions of FAS 157 were adopted January 1, 2008. In
February 2008, the FASB staff issued Staff Position No. 157-2 “Effective
Date of FASB Statement No. 157” (“FSP FAS 157-2”). FSP FAS 157-2 delayed
the effective date of FAS 157 for nonfinancial assets and nonfinancial
liabilities, except for items that are recognized or disclosed at fair value
in
the financial statements on a recurring basis (at least annually). The
provisions of FSP FAS 157-2 are effective for the Company’s fiscal year
beginning August 1, 2009. The Company is currently evaluating the potential
impact of adopting this statement.
In
February 2007, the FASB issued FASB Statement No. 159, “The Fair Value
Option for Financial Assets and Financial Liabilities” (“FAS 159”). FAS 159
permits entities to choose to measure many financial instruments and certain
other items at fair value, with the objective of improving financial reporting
by mitigating volatility in reported earnings caused by measuring related assets
and liabilities differently without having to apply complex hedge accounting
provisions. The provisions of FAS 159 were adopted January 1, 2008. The
Company did not elect the Fair Value Option for any of its financial assets
or
liabilities, and therefore, the adoption of FAS 159 had no impact on the
Company’s consolidated financial position, results of operations or cash flows.
In
June
2007, the EITF reached consensus on Issue No. 06-11, “Accounting for Income
Tax Benefits of Dividends on Share-Based Payment Awards” (“EITF 06-11”). EITF
06-11 requires that the tax benefit related to dividend and dividend equivalents
paid on equity-classified nonvested shares and nonvested share units, which
are
expected to vest, be recorded as an increase to additional paid-in capital.
EITF
06-11 is to be applied prospectively for tax benefits on dividends declared
in
the Company’s fiscal year beginning August 1, 2008. The Company believes
that the adoption of EITF 06-11 will not have a material impact on the Company’s
consolidated financial position, results of operations or cash flows.
In
December 2007, the FASB issued FASB Statement No. 141(R), “Business
Combinations” (“FAS 141(R)”) which amends FAS 141, and provides revised
guidance for recognizing and measuring identifiable assets and goodwill
acquired, liabilities assumed, and any noncontrolling interest in the acquiree.
It also provides disclosure requirements to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. FAS 141(R) is effective for the Company’s fiscal year beginning
August 1, 2009 and is to be applied prospectively. The Company does not
believe the adoption of this statement will have a material impact on the
Company’s consolidated financial position, results of operations or cash
flows.
In
December 2007, the FASB issued FASB Statement No. 160, “Noncontrolling
Interests in Consolidated Financial Statements—an amendment of ARB No. 51”
(“FAS 160”) which establishes accounting and reporting standards pertaining to
(i) ownership interests in subsidiaries held by parties other than the
parent, (ii) the amount of net income attributable to the parent and to the
noncontrolling interest, (iii) changes in a parent’s ownership interest,
and (iv) the valuation of any retained noncontrolling equity investment
when a subsidiary is deconsolidated. FAS 160 also requires that the
reporting company clearly identify and distinguish between the interests of
the
parent and the interests of the noncontrolling owners. FAS 160 is effective
for the Company’s fiscal year beginning August 1, 2009. The Company does
not believe the adoption of this statement will have a material impact on the
Company’s consolidated financial position, results of operations or cash flows.
In
March
2008, the FASB issued FASB Statement No. 161, “Disclosure about
Derivative Instruments and Hedging Activities—an amendment of FASB Statement
No. 133” (“FAS 161”) which provides revised guidance for enhanced
disclosures about how and why an entity uses derivative instruments, how
derivative instruments and the related hedged items are accounted for under
FAS
133, and how derivative instruments and the related hedged items affect an
entity’s financial position, financial performance and cash flows. FAS 161 is
effective for the Company’s fiscal year beginning August 1, 2009. The
Company is currently evaluating the potential impact of adopting this statement
on the Company’s derivative instrument disclosures.
In
September 2007, the FASB published Proposed FSP No. APB 14-a “Accounting for
Convertible Debt Instruments That May Be Settled in Cash upon Conversion
(Including Partial Cash Settlement)” (the “Proposed FSP”). The Proposed FSP
applies to convertible debt instruments that, by their stated terms, may be
settled in cash (or other assets) upon conversion, including partial cash
settlement, unless the embedded conversion option is required to be separately
accounted for as a derivative under FASB Statement No. 133. Convertible
debt instruments within the scope of the Proposed FSP are not addressed by
the
existing APB 14. The Proposed FSP would require that the liability and equity
components of convertible debt instruments within the scope of the Proposed
FSP
shall be separately accounted for in a manner that reflects the entity’s
nonconvertible debt borrowing rate. This will require an allocation of the
convertible debt proceeds between the liability component and the embedded
conversion option (i.e., the equity component). The difference between the
principal amount of the debt and the amount of the proceeds allocated to the
liability component would be reported as a debt discount and subsequently
amortized to earnings over the instrument’s expected life using the effective
interest method. The Company does not believe the adoption of this statement
will have a material impact on the Company’s consolidated financial position,
results of operations or cash flows.
Item
2. Management's
Discussion and Analysis of Financial Condition and Results of
Operations.
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, costs, grade, production and recovery rates,
permitting, financing needs and the availability of financing on acceptable
terms or other sources of funding 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
Part
II; Item 1A. “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.
General
Through
wholly-owned subsidiaries, 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 commenced mining operations on two of these concessions in late March 2007
and achieved gold production and revenue from operations in early August 2007.
We sometimes refer to the operations on these two concessions as the El Chanate
Project. Our results of operations differ from preceding periods because we
now
are realizing revenue from operations.
In
May
2007, we completed an expanded 72-hole reverse circulation drilling campaign
to
identify additional proven and probable gold reserves at the El Chanate Project.
The 72 holes totaled approximately 8,300 meters, and were positioned to fill
in
gaps in the ore body and test the outer limits of the currently known ore zones.
We updated the assay database and digital geologic model and contracted
Independent Mining Consultants, Inc. (“IMC”) of Tucson, AZ to update our ore
reserve and our mine plan. On August 30, 2007, IMC delivered to us an updated
resource block model and an updated mine plan and mine production schedule
(the
“2007 Report”). The original feasibility study (the “2003 Study”) on the El
Chanate Project was prepared by M3 Engineering of Tucson in August 2003. M3
updated the 2003 Study in October 2005 (the “2005 Study”). An August 2006
technical report from SRK Consulting, Denver, Colorado (the “2006 Update”)
further updated the feasibility study.
According
to the 2007 Report, our proven and probable reserve tonnage has increased by
approximately 98 percent from 19.9 million to 39.5 million metric tonnes with
a
gold grade of 0.66 grams per tonne (43.5 million US short tons at 0.019 ounces
per ton). The open pit stripping ratio is 0.6:1 (0.6 tonnes of waste to one
tonne of ore). The updated pit design for the revised plan in the 2007 Report
is
based on a plant recovery of gold that varies by rock types, but is expected
to
average 66.8%. A gold price of US$550 (three year average as of July 31, 2007
as
determined by IMC) per ounce was used to re-estimate the reserves compared
with
a gold price of $450 per ounce used in the previous estimate.
The
following Summary is extracted from the 2007 Report. 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
832,280 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 555,960 ounces, or approximately 66.8% of
the
contained gold. The gold recovery rate is expected to average approximately
66.8% 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%; siltstone ore types recoveries may be about 48%
and
latite intrusive ore type recoveries may be about 50%.
El
Chanate Project
Production
Summary
|
|
Metric
|
|
U.S.
|
|
Materials
Reserves
Proven
Probable
Total
Reserves
Waste
Total
Contained Gold
Production
Ore
Crushed**
Operating
Days/Year
Gold
Plant Average Recovery
Average
Annual Production**
Total
Gold Produced
|
|
26.7
Million Tonnes @ 0.68 g/t*
12.8
Million Tonnes
@
0.61
g/t*
39.5
Million Tonnes @ 0.66 g/t*
24.1
Million Tonnes
63.6
Million Tonnes
25.89
Million grams
2.6
Million Tonnes /Year 7,500
Mt/d
365
Days per year
66.8
%
1.35
Million grams
17.29
Million grams
|
|
29.4
Million Tons @ 0.0198 opt*
14.1
Million Tons
@
0.0179
opt*
43.5
Million Tons @ 0.0192 opt*
26.6
Million Tons
70.1
Million tons
832,280
Oz
2.87
Million Tons/Year 8,267
t/d
365
Days per year
66.8
%
43,414
Oz
555,960
Oz
|
|
*
“g/t”
means grams per metric tonne, “opt” means ounces per ton, “Mt/d” means metric
tonnes per day and “t/d” means tons per day. The reserve estimates are based on
a recovered gold cutoff grade of 0.17 to 0.21 grams per metric tonne, depending
on the operating year, and as described below.
**
Based
on mining rate of 7,500 metric tonnes per day of ore. It does not take into
account the anticipated increase to 10,000 metric tonnes per day or
more.
Through
April 30, 2008, approximately 2.80 million tonnes of ore had been placed on
the
leach pad containing an estimated 73,985 ounces of gold. As of April 30, 2008,
we estimate that we have 33,769 recoverable ounces on the leach pad. Gold
production for the nine months ended April 30, 2008, totaled approximately
28,774 ounces of Gold.
Gold
production at El Chanate is currently near the feasibility study rate of 4,000
ounces per month. We have started to ramp up daily tonnage levels from 7,500
tonnes per day (“tpd”) to 10,000 tpd. This should boost our gold production
toward 5,000 ounces per month (60,000 ounces per year). We anticipate that
the
increased plant throughput at these levels will not require any capital since
additional ore crushing and stacking capacity was factored into the original
design.
With
the
reserve increase, we are analyzing what steps are necessary to effectively
increase production rates to a range of 70,000 to 80,000 ounces per year by
2009
and improve gold recoveries by conducting further metallurgical test work at
our
laboratory facilities at the mine. We will continue our ongoing studies to
possibly increase production levels to 100,000 ounces per year thereafter.
To
this end, we engaged Golder Engineering and its Mexican associates to supply
engineering services for leach pad expansion. The leach pad expansion was
completed in April 2008. In addition, we discussed options available with the
crusher manufacturer, Excel Machinery, with regards to adding an additional
secondary crusher into the crushing circuit, to enable the system to handle
increased tonnage. We anticipate that another crusher should move daily tonnage
up closer to 15,000 tpd. We are still evaluating whether an additional secondary
crusher is necessary at this time. The estimated cost to achieve these increased
production rates will be approximately $7,000,000 over a two year period.
Management has been and will continue to fund these expansion costs with its
cash on hand as well as through revenues from gold sales.
In
addition, we identified certain restrictions related to our ADR plant capacity
which limited the amount of solution that can be processed. We have addressed
these issues by doubling the installed pumping capacity to increase solution
flow to the leach pad and added additional carbon capacity to the system. We
have also purchased an additional set of carbon columns and a strip vessel
to
process an additional two tonnes of carbon per strip. We believe the additional
carbon columns will be completed by the end of our current fiscal year (July
31,
2008), thereby lifting the limitations on our current gold production.
For
the
nine months ended April 30, 2008, our capital expenditure cost related to the
leach pad and ADR Plant expansion totaled approximately $3,000,000. This was
fully funded from cash flow from operations. We anticipate total capital
expenditures for the leach pad expansion and the ADR plant upgrade will amount
to approximately $3,750,000.
In
December 2007, we completed an additional 26 hole reverse circulation drilling
program amounting to 4,912 meters. The drill holes were mainly positioned to
test the outer limits of the currently known ore zones. The results of this
drilling campaign have not been included in our resource model as we continue
to
receive assay results.
We
recently leased 12 mining concessions totaling 1,790 hectares located northwest
of Saric, Sonora. Also, a claim has been filed for approximately 2,200
additional hectares adjacent to this property. These concessions and this claim
are about a sixty mile drive northeast of the El Chanate project. Mineralization
is evident throughout and is hosted by shear zones and quartz veins in granite
intrusive. A short drill program, along with some geochemical work, is currently
underway.
In
January 2008, pursuant to the terms of our agreement with AngloGold Ashanti
North America, the entity from which we acquired our rights to the El Chanate
concessions, we made a good faith determination and notified AngloGold that
the
drill indicated resources at the El Chanate gold mine exceeded two million
ounces of contained gold. The term "drill indicated resources" is defined in
the
agreement. A drill indicated resource number does not rise to the level of,
and
should not be considered proven and probable reserves as those terms are defined
under SEC guidelines. We utilized an independent third party consultant,
Independent Mining Consultants, Inc. (“IMC”) of Tucson, AZ, to assist us in the
good faith determination. AngloGold has until July 28, 2008, or 180 days from
the date of notification, to determine whether or not it will choose to exercise
it’s one time back-in right to acquire a 51% interest in the El Chanate project,
for a purchase price equal to two times the total project costs, as defined
in
the agreement, since 2001. As of the date of this report, we have not received
a
formal response from Anglo concerning this option to back-in.
We
continue to actively investigate other exploration projects in northern Mexico.
Results
of Operations
You
should read the following discussion and analysis of our financial condition
and
results of operations in conjunction with our unaudited interim financial
statements and related notes included elsewhere in this report.
Three
months ended April 30, 2008 compared to Three months ended April 30,
2007
Net
income for the three months ended April 30, 2008 was approximately $2,740,000
compared to a net loss, of approximately $2,649,000 for the three months ended
April 30, 2007. The principal reason for this transition was our realizing
revenue from operations during the current quarter. Net income per common share
was $0.02 for the three months ended April 30, 2008, on a basic basis and $0.01
on a diluted basis. The net loss per share for the same period in 2007 was
$0.01
on a basic basis.
Revenues
& Costs Applicable to Sales
Gold
sales in the current period totaled approximately $8,730,000. We sold 9,466
ounces at an average realizable price per ounce of $922. Costs applicable to
sales were approximately $2,717,000 for the current period. There were no metal
sales in 2006. Our cash cost and total cost per ounce sold was $250 and $305,
respectively, for the current period.
Revenues
from by-product sales (silver) are credited to Costs
applicable to sales
as a
by-product credit. Silver sales totaled 10,190 ounces at a price of $19.73
amounting to approximately $201,000 for the three months ended April 30, 2008.
Depreciation
and Amortization
Depreciation
and amortization expense during the three months ended April 30, 2008 and 2007
was approximately $800,000 and $286,000, respectively. The primary reason for
the increase of approximately $514,000 was depreciation and amortization charges
related to the El Chanate capital costs being incurred in the current period.
There were minimal charges during the same period in the prior year as most
of
these assets were placed in service in April 2007. Depreciation and amortization
also represents deferred financing costs resulting from the Credit Facility
entered into in August 2006 with Standard Bank Plc. This accounted for
approximately $272,000 of the amortization expense during the three months
ended
April 30, 2008 and 2007, respectively.
General
and Administration Expense
General
and administrative expenses during the three months ended April 30, 2008 were
approximately $1,072,000, an increase of approximately $102,000 or 11% from
the
three months ended April 30, 2007. The increase in general and administrative
expenses resulted primarily from higher investor relations fees, higher
accounting and auditing fees, and an increase in insurance costs versus the
same
period a year earlier as we initiated production in April 2007.
Exploration
Expense
Exploration
expense during the three months ended April 30, 2008 and 2007 was approximately
$19,000 and $811,000, respectively, or a decrease of $792,000. Exploration
expense for the quarter ended April 30, 2007 included costs incurred related
to
our 72-hole reverse circulation drilling campaign to identify additional proven
and probable gold reserves at the El Chanate Project. The 72 holes totaled
approximately 8,300 meters, and were positioned to fill in gaps in the ore
body
and test the outer limits of the currently known ore zones. We anticipate
incurring higher exploration expenditures for the remainder of the calendar
year
as we complete the results of our short drill program, along with some
geochemical work, at our new leased concessions in Saric, Sonora.
Equity
Based Compensation
Equity
based compensation during the three months ended April 30, 2008 was
approximately $14,000 as compared to $52,000 in costs for the same period a
year
earlier. These costs primarily represent the equity compensation expense from
the issuance of stock options for professional services provided by
non-employees during the current and prior period.
Other
Income and Expense
Our
loss
on the change in fair value of derivative instruments during the three months
ended April 30, 2008 and 2007, was approximately $336,000 and $319,000,
respectively, and was reflected as an other expense. This
was
primarily due to the change in fair value of our two identically structured
derivative contracts with Standard Bank which correlates to fluctuations in
the
gold price. These contracts were not designated as hedging derivatives; and
therefore, special hedge accounting does not apply.
Interest
expense was approximately $377,000 for the three months ended April 30, 2008
compared to approximately $275,000 for the same period a year earlier. This
increase was mainly due to higher interest charges incurred during the current
period related to our fully outstanding Credit Facility with Standard Bank.
As
of April 30, 2008 and 2007, there was $12,500,000 outstanding, respectively,
on
this credit facility.
Nine
months ended April 30, 2008 compared to Nine months ended April 30,
2007
Net
income for the nine months ended April 30, 2008 was approximately $6,613,000
compared to a net loss, of approximately $5,484,000 for the nine months ended
April 30, 2007. The principal reason for this transition was our realizing
revenue from operations during the nine months ended April 30, 2008. The
Company’s first gold sale occurred in August 2007. Net income per common share
was $0.04 for the nine months ended April 30, 2008, on a basic basis and $0.03
on a diluted basis. The net loss per share for the same period in 2007 was
$0.04
on a basic basis.
Revenues
& Costs Applicable to Sales
Gold
sales for the nine months ended April 30, 2008 totaled approximately
$23,299,000. We have sold 28,210 ounces at an average realizable price per
ounce
of $826. Costs applicable to sales were approximately $7,343,000 for the current
period. There were no metal sales in the prior period. Our cash cost and total
cost per ounce sold was $247 and $310, respectively, for the nine months ended
April 30, 2008.
Revenues
from by-product sales (silver) are credited to Costs
applicable to sales
as a
by-product credit. Silver sales totaled 20,190 ounces at an average price of
$17.20 amounting to approximately $347,000 for the nine months ended April
30,
2008.
Depreciation
and Amortization
Depreciation
and amortization expense during the nine months ended April 30, 2008 and 2007
was approximately $ 2,630,000
and $632,000, respectively. The increase of approximately $1,998,000 was
primarily due to depreciation and amortization charges related to the El Chanate
capital costs being incurred in the current period. The charges during the
same
period in the prior year were significantly lower as most of these assets were
placed in service in April 2007. Depreciation and amortization also represents
deferred financing costs resulting from the Credit Facility. This accounted
for
approximately $816,000 and $632,000 of the amortization expense during the
nine
months ended April 30, 2008 and 2007, respectively.
General
and Administration Expense
General
and administrative expenses during the nine months ended April 30, 2008 were
approximately $3,186,000, an increase of approximately $1,035,000 or 48% from
the nine months ended April 30, 2007. The
increase in general and administrative expenses resulted primarily from: 1)
higher salaries and wages including the awarding of cash bonuses to officers
and
employees of approximately $315,000 and the granting of stock options and
restricted stock to our officers and employees under our 2006 Equity Incentive
Plan amounting to approximately $477,000, 2) higher investor relations fees
and
travel fees of approximately $230,000, and 3) an increase in insurance costs
of
approximately $77,000 versus the same period a year earlier as we were not
yet
in full production in the prior period. The above mentioned increases in
compensation were granted based upon recommendations from an independent report
on executive compensation. This independent report, requested by our
Compensation Committee, was obtained in order to assist us in attracting and
retaining individuals of experience and ability, to provide incentive to our
employees and directors, to encourage employee and director proprietary
interests in the Company, and to encourage employees to remain in our employ.
Exploration
Expense
Exploration
expense during the nine months ended April 30, 2008 and 2007 was approximately
$650,000 and $1,325,000, respectively, or a decrease of $675,000 or 51%. The
primary reason for the decrease in exploration expense was the result of higher
engineering and planning costs related to our El Chanate Project being expensed
in the prior period as well as the costs incurred from our 72-hole reverse
circulation drilling campaign to identify additional proven and probable gold
reserves at the El Chanate Project which was completed in May 2007. The current
period includes costs from our completed 26 hole reverse circulation drilling
program in December 2007 amounting to 4,912 meters at El Chanate. The drill
holes were mainly positioned to test the outer limits of the currently known
ore
zones.
Equity
Based Compensation
Equity
based compensation during the nine months ended April 30, 2008 was approximately
$122,000 as compared to $153,000 in costs for the same period a year earlier.
These costs primarily represent the equity compensation expense from the
issuance of stock options for professional services provided to non-employees
during the current and prior period.
Other
Income and Expense
Our
loss
on the change in fair value of derivative instruments during the nine months
ended April 30, 2008 and 2007, was approximately $1,037,000 and $847,000,
respectively, and was reflected as an other expense. This
was
primarily due to the change in fair value of our two identically structured
derivative contracts with Standard Bank which correlates to fluctuations in
the
gold price. These contracts were not designated as hedging derivatives; and
therefore, special hedge accounting does not apply.
Interest
expense was approximately $945,000 for the nine months ended April 30, 2008
compared to approximately $474,000 for the same period a year earlier. This
increase was mainly due to higher interest charges incurred during the current
period related to our fully outstanding credit facility with Standard Bank.
As
of April 30, 2008 and 2007, there was $12,500,000 outstanding, respectively, on
this credit facility.
Changes
in Foreign Exchange Rates
During
the nine months ended April 30, 2008, we recorded equity adjustments from
foreign currency translations of approximately $300,000. These translation
adjustments are related to changes in the rates of exchange between the Mexican
Peso and the US dollar and are included as a component of other comprehensive
income.
Summary
of Quarterly Results
(000’s
except per share Data)
|
|
For
the three
|
|
For
the three
|
|
For
the Nine
|
|
For
the Nine
|
|
|
|
Months
ended
|
|
Months
ended
|
|
Months
ended
|
|
Months
ended
|
|
|
|
April
30,
2008
|
|
April
30,
2007
|
|
April
30,
2008
|
|
April
30,
2007
|
|
|
|
|
|
|
|
|
|
|
|
Revenues
|
|
|
8,730
|
|
|
-
|
|
|
23,299
|
|
|
-
|
|
Net
Income (loss)
|
|
|
2,740
|
|
|
(2,649
|
)
|
|
6,613
|
|
|
(5,484
|
)
|
Basic
net income (loss) per
share
|
|
|
0.02
|
|
|
(0.02
|
)
|
|
0.04
|
|
|
(0.04
|
)
|
Diluted
net income (loss) per
share
|
|
|
0.01
|
|
|
-
|
|
|
0.03
|
|
|
-
|
|
Liquidity
and Capital Resources
As
of
April 30, 2008, we had approximately $4,936,000 in cash and cash equivalents,
an
increase of $2,711,000 over July 31, 2007. Working capital was approximately
$10,398,000, an increase of $4,055,000 over July 31, 2007. Cash
provided by operating activities during the nine months ended April 30, 2008
was
approximately $4,818,000, which primarily represents cash flows resulting from
our realization
of revenue from operations during the nine months ended April 30, 2008.
Cash
used
in investing activities during the nine months ended April 30, 2008, amounted
to
approximately $4,691,000, primarily from the leach pad expansion and the
acquisition of equipment, including additional conveyors and ADR plant
equipment, as well as additional water rights related to our El Chanate Project.
Cash provided by financing activities during the nine months ended April 30,
2008 amounted to approximately $2,284,000, primarily from the exercising of
6,646,750 warrants for gross proceeds of approximately $2,277,000. We
believe that our available funds in conjunction with anticipated revenues from
gold sales will be adequate to cover operating activities at El Chanate for
the
life of mine as well as our leach pad and ADR plant expansion activities. We
anticipate total capital expenditures related to the leach pad expansion and
the
ADR plant upgrade will amount to approximately $3,750,000.
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 Facility. 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. To date, rather than modifying
the
original Gold Price Protection agreement with Standard Bank to satisfy these
forward sale obligations, we have opted for a net cash settlement between the
call option purchase price of $535 and the forward sale price of $500, or $35.00
per oz. We have paid Standard Bank approximately $1,346,000 on the settlement
of
38,455 ounces with corresponding reductions in our derivative liability
($887,000 or 25,329 ounces of gold) during the nine months ended April 30,
2008.
The remaining ounces to settle with regard to this agreement amounted to 83,472
as of April 30, 2008.
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
that commenced on October 11, 2006 and terminated on March 31, 2007 and the
second covers the period from March 30, 2007 through 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
received a mandate letter, dated February 27, 2008, from Standard Bank to
refinance the existing project finance facility on the El Chanate mine. The
key
anticipated amendments to the refinance include: 1) removal of cash restrictions
and covenants, 2) reduction of the finance interest rate by 1.5%, 3) addition
of
a five million dollar line of credit at LIBOR + 2%, and 4) exercise of a portion
of the warrants currently held by Standard Bank to provide additional support
for El Chanate expansion plans and to fully fund the debt service reserve
account. We anticipate a closing date by the end of fiscal 2008 (July 31,
2008).
While
we
believe that our available funds in conjunction with anticipated revenues from
gold sales will be adequate to cover operating activities at El Chanate and
general and administrative expenses for the life of the mine as well as the
remaining capital costs associated with the ADR plant expansion, if we encounter
unexpected problems we may need to raise additional capital. We also may need
to
raise additional capital for significant property acquisitions and/or
exploration activities. To the extent that we need to obtain additional capital,
management intends to raise such funds through the sale of our securities and/or
joint venturing with one or more strategic partners. We cannot assure that
adequate additional funding, if needed, will be available. If we need additional
capital and we are unable to obtain it from outside sources, we may be forced
to
reduce or curtail our operations or our anticipated exploration activities.
Please see “We
just recently started to receive cash flow from operations and, historically,
have relied on external funding sources. While we believe that we will continue
to generate cash flow and profits from operations, if we encounter unexpected
problems, we may need to raise additional capital. If additional capital is
required and we are unable to obtain it from outside sources, we may be forced
to reduce or curtail our operations or our anticipated exploration
activities.”
In
Part
II; Item 1A. “Risk
Factors”
below.
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. Once we revise our new mine plan based on
the
2007 Report, we will work to extend the permits for mining and processing for
the new life of mine. We received the original explosive permit from the
government in August 2006. This permit, as extended, expires on December 31,
2008 and is renewable annually.
We
own
properties in Leadville, Colorado for which we have previously 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. The Division of
Reclamation, Mining and Safety of the State of Colorado (the “Division”)
conducted its most recent inspection of our Leadville Mining properties in
August 2007. The Division concluded that based upon 2007 equipment prices and
labor costs, an additional $46,000 was necessary to be bonded with the Division
to reclaim the site to achieve the approved postmining land use. The total
amount of the bond sufficient to perform reclamation as of April 30, 2008,
is
approximately $82,000. We have met this bonding requirement.
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 was
determined at a fixed amount of $0.13 per metric tonne of material to be mined
on a continual, ongoing basis to provide primarily for reclaiming tailing
disposal sites and other reclamation requirements. No assurance can be given
that environmental regulations will not be changed in a manner that would
adversely affect our planned operations. We estimated the reclamation costs
for
the El Chanate site to be approximately $2,300,000. Reclamation costs are
allocated to expense over the life of the related assets and are periodically
adjusted to reflect changes in the estimated present value resulting from the
passage of time and revisions to the estimates of either the timing or amount
of
the reclamation and abandonment costs. The asset retirement obligation is based
on when the spending for an existing environmental disturbance and activity
to
date will occur. We review, on an annual basis, unless otherwise deemed
necessary, the asset retirement obligation at each mine site.
New
Accounting Pronouncements
See
Note
20 to the Condensed Consolidated Financial Statements contained in Item 1.
Financial Statements above.
Disclosure
About Off-Balance Sheet Arrangements
We
do not
have any 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
inventory, revenue recognition, property, plant and mine development, impairment
of long-lived assets, accounting for equity-based compensation, environmental
remediation costs and accounting for derivative and hedging activities.
Stockpiles,
Ore on Leach Pads and Inventories (“In-Process Inventory”)
Costs
that are incurred in or benefit the productive process are accumulated as
stockpiles, ore on leach pads and inventories. Stockpiles, ore on leach pads
and
inventories are carried at the lower of average cost or net realizable value.
Net realizable value represents the estimated future sales price of the product
based on current and long-term metals prices, less the estimated costs to
complete production and bring the product to sale. Write-downs of stockpiles,
ore on leach pads and inventories, resulting from net realizable value
impairments, are reported as a component of Costs
applicable to sales.
The
current portion of stockpiles, ore on leach pads and inventories is determined
based on the expected amounts to be processed within the next 12 months.
Stockpiles, ore on leach pads and inventories not expected to be processed
within the next 12 months are classified as long-term. The major
classifications are as follows:
Ore
on Leach Pads
The
recovery of gold from certain gold ores is achieved through the heap leaching
process. Under this method, oxide ore is placed on leach pads where it is
treated with a chemical solution, which dissolves the gold contained in the
ore.
The resulting “pregnant” solution is further processed in a plant where the gold
is recovered. Costs are added to ore on leach pads based on current mining
costs, including applicable depreciation, depletion and amortization relating
to
mining operations. Costs are removed from ore on leach pads as ounces are
recovered based on the average cost per estimated recoverable ounce of gold
on
the leach pad.
The
estimates of recoverable gold on the leach pads are calculated from the
quantities of ore placed on the leach pads (measured tons added to the leach
pads), the grade of ore placed on the leach pads (based on assay data) and
a
recovery percentage (based on ore type). In general, leach pads recover
approximately 50% to 95% of the recoverable ounces in the first year of
leaching, declining each year thereafter until the leaching process is complete.
Although
the quantities of recoverable gold placed on the leach pads are reconciled
by
comparing the grades of ore placed on pads to the quantities of gold actually
recovered (metallurgical balancing), the nature of the leaching process
inherently limits the ability to precisely monitor inventory levels. As a
result, the metallurgical balancing process needs to be constantly monitored
and
estimates need to be refined based on actual results over time. Our operating
results may be impacted by variations between the estimated and actual
recoverable quantities of gold on its leach pads. Variations between actual
and
estimated quantities resulting from changes in assumptions and estimates that
do
not result in write-downs to net realizable value will be accounted for on
a
prospective basis.
In-process
Inventory
In-process
inventories represent materials that are currently in the process of being
converted to a saleable product. Conversion processes vary depending on the
nature of the ore and the specific processing facility, but include mill
in-circuit, leach in-circuit, flotation and column cells, and carbon in-pulp
inventories. In-process material are measured based on assays of the material
fed into the process and the projected recoveries of the respective plants.
In-process inventories are valued at the average cost of the material fed into
the process attributable to the source material coming from the mines,
stockpiles and/or leach pads plus the in-process conversion costs, including
applicable depreciation relating to the process facilities incurred to that
point in the process.
Precious
Metals Inventory
Precious
metals inventories include gold doré and/or gold bullion. Precious metals that
result from our mining and processing activities are valued at the average
cost
of the respective in-process inventories incurred prior to the refining process,
plus applicable refining costs.
Materials
and Supplies
Materials
and supplies are valued at the lower of average cost or net realizable value.
Cost includes applicable taxes and freight.
Property,
Plant and Mine Development
Expenditures
for new facilities or equipment and expenditures that extend the useful lives
of
existing facilities or equipment are capitalized and depreciated using the
UOP
and straight-line method at rates sufficient to depreciate such costs over
the
estimated productive lives, which do not exceed the related estimated mine
lives, of such facilities based on proven and probable reserves.
Mineral
exploration costs are expensed as incurred. When it has been determined that
a
mineral property can be economically developed as a result of establishing
proven and probable reserves, costs incurred prospectively to develop the
property will be capitalized as incurred and are amortized using the UOP method
over the estimated life of the ore body based on estimated recoverable ounces
or
pounds in proven and probable reserves.
Impairment
of Long-Lived Assets
We
review
and evaluate our long-lived assets for impairment when events or changes in
circumstances indicate that the related carrying amounts may not be recoverable.
An impairment is considered to exist if the total estimated future cash flows
on
an undiscounted basis are less than the carrying amount of the assets, including
goodwill, if any. An impairment loss is measured and recorded based on
discounted estimated future cash flows. Future cash flows are estimated based
on
quantities of recoverable minerals, expected gold and other commodity prices
(considering current and historical prices, price trends and related factors),
production levels and operating costs of production and capital, all based
on
life-of-mine plans. Existing proven and probable reserves and value beyond
proven and probable reserves, including mineralization other than proven and
probable reserves and other material that is not part of the measured, indicated
or inferred resource base, are included when determining the fair value of
mine
site reporting units at acquisition and, subsequently, in determining whether
the assets are impaired. The term “recoverable minerals” refers to the estimated
amount of gold or other commodities that will be obtained after taking into
account losses during ore processing and treatment. Estimates of recoverable
minerals from such exploration stage mineral interests are risk adjusted based
on management’s relative confidence in such materials. In estimating future cash
flows, assets are grouped at the lowest level for which there are identifiable
cash flows that are largely independent of future cash flows from other asset
groups. Our estimates of future cash flows are based on numerous assumptions
and
it is possible that actual future cash flows will be significantly different
than the estimates, as actual future quantities of recoverable minerals, gold
and other commodity prices, production levels and operating costs of production
and capital are each subject to significant risks and uncertainties.
Reclamation
and Remediation Costs (Asset Retirement Obligations)
Reclamation
costs are allocated to expense over the life of the related assets and are
periodically adjusted to reflect changes in the estimated present value
resulting from the passage of time and revisions to the estimates of either
the
timing or amount of the reclamation and abandonment costs. The asset retirement
obligation is based on when the spending for an existing environmental
disturbance and activity to date will occur. We review, on an annual basis,
unless otherwise deemed necessary, the asset retirement obligation at our mine
site in accordance with FASB FAS No. 143, “Accounting for Asset Retirement
Obligations.”
Deferred
Financing Costs
Deferred
financing costs which were included in other assets and a component of
stockholders’ equity relate to costs incurred in connection with bank borrowings
and are amortized over the term of the related borrowings.
Intangible
Assets
Purchased
intangible assets consisting of rights of way, easements and net profit
interests are carried at cost less accumulated amortization. Amortization is
computed using the straight-line method over the economic lives of the
respective assets, generally five years or using the UOP method. It is our
policy to assess periodically the carrying amount of our purchased intangible
assets to determine if there has been an impairment to their carrying value.
Impairments of other intangible assets are determined in accordance with SFAS
144. There was no impairment at April 30, 2008.
Fair
Value of Financial Instruments
The
carrying value of our financial instruments, including cash and cash
equivalents, accounts receivable, loans receivable and accounts payable
approximated fair value because of the short maturity of these
instruments.
Revenue
Recognition
Revenue
is recognized, net of treatment and refining charges, from a sale when the
price
is determinable, the product has been delivered, the title has been transferred
to the customer and collection of the sales price is reasonably assured.
Equity
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 purchased a gold
cap, providing the right to buy gold 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 do 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
that commenced on October 11, 2006 and terminated on March 31, 2007 and the
second covers the period from March 30, 2007 through 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, limit our exposure to a single
counterparty under defined guidelines, and monitor the market position with
each
counterparty as required by SFAS 133.
Item
3. Quantitative and Qualitative Disclosures About Market
Risk.
Metal
Prices
Changes
in the market price of gold significantly affect our profitability and cash
flow. Gold prices can fluctuate widely due to numerous factors, such as: demand;
forward selling by producers; central bank sales; purchases and lending;
investor sentiment; the strength of the U.S. dollar and global mine production
levels.
Gold
Price Protection Agreement
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 Facility. 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 also purchased call options from Standard Bank
enabling the right to purchase gold 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.
Together, these forward sales and call options serve to put a floor on our
gold
sales price and thereby protect us from the effects of the market price falling
below $535 per ounce, while allowing us to enjoy the upside of higher gold
prices. To date, rather than modifying the original Gold Price Protection
agreement with Standard Bank to satisfy these forward sale obligations, we
have
opted for a net cash settlement between the call option purchase price of $535
and the forward sale price of $500, or $35.00 per oz. We have paid Standard
Bank
approximately $1,346,000 on the settlement of 38,455 ounces with corresponding
reductions in our derivative liability ($887,000 or 25,329 ounces of gold)
during the nine months ended April 30, 2008. The remaining ounces to settle
with
regard to this agreement amounted to 83,472 as of April 30, 2008. The fair
value
of this derivative liability recorded on the balance sheet as of April 30,
2008,
was approximately $702,000.
The
total
contractual ounces to settle and cash payments remaining on the gold price
protection agreement are as follows:
|
|
Ounces Remaining
|
|
Amount
|
|
|
|
|
|
|
|
2008
|
|
|
8,428
|
|
$
|
295,000
|
|
2009
|
|
|
33,638
|
|
$
|
1,177,000
|
|
2010
|
|
|
33,176
|
|
$
|
1,161,000
|
|
|
|
|
8,230
|
|
$
|
288,000
|
|
Total
|
|
|
83,472
|
|
$
|
2,921,000
|
|
Interest
Rate Swap Contracts
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% 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 that
commenced on October 11, 2006 and terminated on March 31, 2007 and the second
covers the period from March 30, 2007 through 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. The fair value of this
derivative liability recorded on the balance sheet as of April 30, 2008, was
approximately $274,000.
Item
4. 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. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls
and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management
is required to apply its judgment in evaluating the cost-benefit relationship
of
possible controls and procedures. 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
1A. 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 just begun generating operating revenues. If we are unable to sustain
operating revenues, we will not be able to generate profits and our business
may
fail.
Until
recently, we had no producing properties and, historically, have operated at
a
loss. We only commenced gold producing activities and started to generate
revenues in August 2007. 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. While we have commenced revenue producing mining operations,
we
cannot assure that revenues will continue to cover cash flow or continue to
generate profits.
We
just recently started to receive cash flow from operations and, historically,
have relied on external funding sources. While we believe that we will continue
to generate cash flow and profits from operations, if we encounter unexpected
problems, we may need to raise additional capital. If additional capital is
required and we are unable to obtain it from outside sources, we may be forced
to reduce or curtail our operations or our anticipated exploration
activities.
Prior
to
the first fiscal quarter of 2008, we were not able to generate cash flow from
operations. While we now are generating positive cash flow and profits, if
we
encounter unexpected problems and we are unable to continue to generate positive
cash flow and profits, we may need to raise additional capital. We also may
need
to raise additional capital for property acquisition and new exploration. To
the
extent that we need to obtain additional capital, management intends to raise
such funds through the sale of our securities and/or joint venturing with one
or
more strategic partners. We cannot assure that adequate additional funding,
if
needed, will be available. If we need additional capital and we are unable
to
obtain it from outside sources, we may be forced to reduce or curtail our
operations or our anticipated exploration activities.
Our
Credit Facility with Standard Bank plc imposes restrictive covenants on us.
Our
Credit Facility with Standard Bank 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
are using reconditioned equipment which could adversely affect our cost
assumptions and our ability to economically and successfully mine the
project.
We
are
using reconditioned carbon column collection equipment to recover gold and
Sinergia, our mining contractor, is using equipment that
is
not new. Such equipment is subject to the risk of more frequent breakdowns
and
need for repair than new equipment. If the equipment that we or Sinergia uses
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.
The
gold deposit we have identified at El Chanate is relatively 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 low-grade.
If
the estimates of ore grade or recovery rates turn out to be lower than the
actual ore grade and recovery rates, if costs are higher than expected, or
if we
experience problems related to the mining, processing, 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 initial production phase and to require more
capital than anticipated. There can be no assurance that our operations at
El
Chanate will continue to be profitable.
We
have only one project. As a result, our chances of conducting viable mining
operations are dependent upon the success of that
project.
Our
only
current properties are the El Chanate concessions. 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. 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 the fiscal quarter ended April 2008, the
spot
price for gold on the London Exchange has fluctuated between $867.00 and
$1,011.30 per ounce. During calendar 2007, the spot price for gold on the London
Exchange fluctuated between $608.40 and $841.10 per ounce. Gold prices are
affected by numerous factors beyond our control, including:
|
·
|
the
level of interest rates,
|
|
·
|
world
supply of gold and
|
|
·
|
stability
of exchange rates.
|
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 Credit Facility 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.
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.
To
date,
rather than modifying the original Gold Price Protection agreement with Standard
Bank to satisfy these forward sale obligations, we have opted for a net cash
settlement between the call option purchase price of $535 and the forward sale
price of $500, or $35.00 per oz. We have paid Standard Bank approximately
$1,346,000 on the settlement of 38,455 ounces with corresponding reductions
in
our derivative liability ($887,000 or 25,329 ounces of gold during the nine
months ended April 30, 2008). The remaining ounces to settle with regard to
this
agreement amounted to 83,472 as of April 30, 2008. We believe we will be able
to
deliver the quantity of gold required by our forward sales on a going forward
basis; however, we may continue to opt to net cash settle these forward sale
obligations if it remains the most cost effective option for us. If we are
unable for any reason to produce the quantity of gold required by our forward
sales and generate sufficient cash flow to settle these forward sales in gold
or
cash, it could have a material adverse effect on our financial condition 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 a foreign country
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 operations which, in turn,
could have a material adverse impact on our cash flows, earnings, results of
operations and financial condition. These risks include the
following:
|
·
|
invalidity
of governmental orders,
|
|
·
|
uncertain
or unpredictable political, legal and economic
environments,
|
|
·
|
war
and civil disturbances,
|
|
·
|
changes
in laws or policies,
|
|
·
|
delays
in obtaining or the inability to obtain necessary governmental
permits,
|
|
·
|
governmental
seizure of land or mining claims,
|
|
·
|
limitations
on ownership,
|
|
·
|
limitations
on the repatriation of earnings,
|
|
·
|
increased
financial costs,
|
|
·
|
import
and export regulations, including restrictions on the export of gold,
and
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·
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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
sell gold in U.S. dollars; however, we incur a significant amount of our
expenses in Mexican pesos. If applicable currency exchange rates fluctuate,
our
revenues and results of operations may be materially and adversely affected.
We
sell
gold 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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·
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environmental
regulations,
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·
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repatriation
of income and/or
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Any
such
changes may affect our ability to undertake exploration and development
activities in respect of 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, future environmental legislation could
require:
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·
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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.
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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 insurance against losses or liabilities that could arise from our
operations. If we incur material losses or liabilities in excess of our
insurance coverage, our financial position could be materially and adversely
affected.
Mining
operations involve a number of risks and hazards, including:
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·
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metallurgical
and other processing,
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·
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mechanical
equipment and facility performance problems.
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Such
risks could result in:
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·
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damage
to, or destruction of, mineral properties or production facilities,
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·
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personal
injury or death,
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·
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monetary
losses and /or
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·
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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. We currently maintain general liability, auto and property insurance
coverage. We cannot be certain that the insurance we have in place will cover
all of 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 contractors to develop
our El Chanate Project. If we lose the services of these personnel and
contractors and we are unable to replace them, our planned operations at our
El
Chanate Project may be disrupted and/or materially adversely
affected.
We
are
dependent on a relatively small number of key personnel, including but not
limited to John Brownlie, Chief Operating Officer, who oversees the El Chanate
Project, the loss of any one of whom could have an adverse effect on us. We
are
also dependent upon Sinergia to provide mining services. Sinergia
commenced mining operations on March 25, 2007, and transitioned from the
pre-production to production phase of the mining contract in July 2007.
Sinergia has mobilized its mining fleet to the site; however, its mining fleet
is not new. If we lose the services of our key personnel, or if Sinergia is
unable to effectively maintain its fleet, our planned operations at our El
Chanate Project may be disrupted and/or 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 in 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.
Our
ability to remain profitable long-term 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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·
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the
location of economic ore bodies,
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·
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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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o
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proximity
to infrastructure,
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·
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importing
and exporting gold and
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·
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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
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.
Item
2. Unregistered
Sales of Equity Securities and Use of Proceeds.
We
received proceeds of approximately $120,500 during the quarter ended April
30,,
2008 from the exercising of an aggregate of 326,250 warrants issued in past
private placements.
All
of
the foregoing securities were issued pursuant to exemptions from registration
provided by 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.
None.
Item
6. Exhibits.
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31.1
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Certification
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 from the
Company's Chief Executive Officer.
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31.2
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Certification
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 from the
Company's Chief Financial Officer.
|
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32.1
|
Certification
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 from the
Company's Chief Executive Officer.
|
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32.2
|
Certification
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 from the
Company's Chief Financial Officer.
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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.
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CAPITAL
GOLD CORPORATION
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Registrant
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By:
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/s/
Gifford A. Dieterle
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Gifford
A. Dieterle
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President/Treasurer
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Date:
June 11, 2008
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