Gatos Silver, Inc. - Quarter Report: 2021 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☑ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2021

or

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______________ to _______________

Commission File Number: 001-39649

GATOS SILVER, INC.

(Exact name of registrant as specified in its charter)

8400 E. Crescent Parkway, Suite 600

Greenwood Village, CO 80111

(Address of principal executive offices) (Zip Code)

(303) 784-5350

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Securities registered pursuant to Section 12(b) of the Act:

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 ¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x    No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No x

The Company has 700,000,000 shares of common stock, par value $0.001, authorized of which 59,409,052 were issued and outstanding as of May 3, 2021.

TABLE OF CONTENTS

Page

PART I – FINANCIAL INFORMATION

GATOS SILVER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(In thousands, except for share and per share amounts)

See accompanying notes to the condensed consolidated financial statements.  

GATOS SILVER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In thousands, except for share and per share amounts)

(1) Prior period results have been adjusted to reflect the two-for-one reverse split in October 2020.

See accompanying notes to the condensed consolidated financial statements.

GATOS SILVER, INC.

CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(In thousands, except for share amounts)

(1) Prior period results have been adjusted to reflect the two-for-one reverse split in October 2020.

See accompanying notes to the condensed consolidated financial statements.

GATOS SILVER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

See accompanying notes to the condensed consolidated financial statements.  

GATOS SILVER, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 

(In thousands, except share, per share, option, and stock unit amounts)

Organization and Nature of Business

Gatos Silver, Inc. (“Gatos Silver” or “the Company”) is a silver dominant production, development and exploration, company that discovered a new silver and zinc-rich mineral district in southern Chihuahua State, Mexico.

The Company’s primary efforts are focused on the operation of the Los Gatos Joint Venture (“LGJV”) in Chihuahua, Mexico. On January 1, 2015, the Company entered into the LGJV to develop the Los Gatos District (“LGD”) with Dowa Metals and Mining Co., Ltd. (“Dowa”). The LGJV operating entities consist of Minera Plata Real S. de R.L. de C.V (“MPR”), Operaciones San Jose del Plata S. de R.L. de C.V. and Servicios San Jose del Plata S. de R.L. de C.V. (collectively the “LGJV Entities”). The LGJV completed an advanced definitional drilling and decline development program in 2016, a feasibility study in January 2017 and a technical update to the feasibility study in July 2020. Dowa completed its $50,000 funding requirement on April 1, 2016 thereby acquiring a 30% interest in the LGJV and the right to purchase future zinc-concentrate production at market rates. In May 2019, Dowa increased its ownership interest by 18.5% to 48.5% through the conversion of the Dowa MPR Loan to equity. On March 11, 2021, the Company repurchased the 18.5% interest from Dowa. See Note 8 — Commitments, Contingencies and Guarantees for further discussion. As of March 31, 2021, the LGJV ownership is 70.0% Gatos Silver and 30.0% Dowa.

On September 1, 2019, the LGJV commenced commercial production of its two concentrate products: a lead concentrate and a zinc concentrate. The LGJV’s lead and zinc concentrates are currently sold to third-party customers.

The Company continues to perform additional definitional drilling to further define and expand mineralization of the Cerro Los Gatos deposit, and will be performing definitional and exploratory drilling at the nearby Esther deposit. On December 5, 2020, the LGJV began the first infill and extensional drilling program at the Cerro Los Gatos deposit.

The Company’s other regional Mexico exploration efforts are conducted through its wholly-owned subsidiary, Minera Luz del Sol S. de R.L. de C.V. (“MLS”). In March 2021, the Company commenced a 5,400-meter exploration program on the Santa Valeria property.

Discontinued Operations

   In October 2020, the Company completed the distribution of its wholly-owned subsidiary, Silver Opportunity Partners LLC (“SOP”), and SOP has been presented as discontinued operations in the Company’s condensed consolidated financial statements. See Note 9 – Discontinued Operations for additional detail.

Basis of Consolidation and Presentation

The financial statements represent the condensed consolidated financial position and results of operations of Gatos Silver, Inc. and its subsidiary, MLS. Unless the context otherwise requires, references to Gatos Silver or the Company mean Gatos Silver, Inc. and its consolidated subsidiary. All equity interest in the Company’s wholly-owned subsidiary, SOP, was distributed to its stockholders in October 2020. The accounts for SOP have been presented as discontinued operations in the accompanying interim condensed consolidated financial statements.

The interim condensed consolidated financial statements are unaudited, but include all adjustments, consisting of normal recurring entries, which are necessary for a fair presentation for the dates and periods presented. Interim results are not necessarily indicative of results for a full year. The financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information. Accordingly, they do not include all financial information and disclosures required by GAAP for complete financial statements and should be read in conjunction with the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 10-K”).

Summary of Significant Accounting Policies

The consolidated financial statements for the year ended December 31, 2020 disclose those accounting policies considered significant in determining results of operations and financial position. There have been no material changes to, or in the application of, the accounting policies previously identified and described in the 2020 10-K.

Recent Accounting Pronouncements

The Company has adopted the provisions of Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842) and ASU No. 2019-12, Income Taxes (Topic 740). These provisions did not have a material impact on the financial statements.

Mineral Properties

Mining Concessions

In Mexico, mineral concessions from the Mexican government can only be held by Mexican nationals or Mexican-incorporated companies. The concessions are valid for 50 years and are extendable provided the concessions are kept in good standing. For concessions to remain in good standing a semi-annual fee must be paid to the Mexican government and an annual report describing the work accomplished on the property must be filed. These concessions may be cancelled without penalty with prior notice to the Mexican government. MLS is the concession holder of a series of claims titles granted by the Mexican government. The rights to certain concessions are held through exploration agreements with purchase options, as discussed below:

Santa Valeria Concession

The Company is required to make a production royalty payment of 1% of the net smelter returns on production. The Company may terminate the agreement upon prior notice.

LGJV

The Company has a services agreement with the LGJV to provide certain consulting and administrative services. The Company earned $1,250 and $1,200 under this agreement for the three months ended March 31, 2021 and 2020, respectively, and received nil in cash from the LGJV under this agreement for the three months ended March 31, 2021 and 2020. The Company had receivables under this agreement of $2,450 and $5,950 as of March 31, 2021 and 2020, respectively. The Company also incurs certain LGJV costs and provides short term advances that are reimbursed by the LGJV.

SSMRC

The Company has a Management Services Agreement with Sunshine Silver Mining & Refining Corporation (“SSMRC”) (formerly named Silver Opportunity Partners Corporation), pursuant to which the Company provides certain executive and managerial advisory services to SSMRC until terminated by either party. SSMRC reimburses the Company for costs of such services. The Company earned $16 and nil from SSMRC under this agreement for the three months ended March 31, 2021 and 2020, respectively, all of which was receivable as of March 31, 2021.

The Company is authorized to issue 700,000,000 shares of $0.001 par value common stock and 50,000,000 shares of $0.001 par value preferred stock.

Stock Option Transactions

The Company’s stock options have a contractual term of 10 years and entitle the holder to purchase shares of the Company’s common stock. The options granted to the Company’s employees and LGJV personnel prior to 2020 have a requisite service period of four years and vest in equal annual installments. Starting in 2020, the options granted to the Company’s employees and LGJV personnel have a requisite service period of three years. The options granted to non-employee directors prior to 2020 have a requisite service period of one year and vest in equal monthly installments. The options granted to non-employee directors in January 2020 have a requisite service period of one and a half years and vest in monthly installments.

The Company did not grant any stock options during the three months ended March 31, 2021. The Company granted 798,333 stock options during the three months ended March 31, 2020. The weighted-average grant-date fair value per share was $6.62 for the three months ended March 31, 2020. The Company received $1,559 from stock options exercised during the three months ended March 31, 2021.

Total unrecognized stock-based compensation expense as of March 31, 2021 was $7,931 which is expected to be recognized over a weighted average period of 2.1 years.

Stock option activity for the three months ended March 31, 2021 is summarized in the following tables:

Deferred Stock Unit Transactions

Deferred stock units (“DSUs”) are awarded to directors at the discretion of the Board of Directors. The DSUs are fully vested on the grant date and each DSU entitles the holder to receive one share of the Company’s common stock upon departure from the Company. The fair value of the DSUs are equal to the fair value of the Company’s common stock on the grant date.

At March 31, 2021, there were 225,152 DSUs outstanding. The Company granted 85,961 and 5,103 DSUs during the three months ended March 31, 2021 and 2020, respectively. For the three months ended March 31, 2021, 43,523 DSUs were converted to common stock upon termination of the holders’ consulting agreements.

The Company establishes a framework for measuring the fair value of financial assets and liabilities and nonfinancial assets and liabilities which are measured at fair value on a recurring (annual) basis in the form of a fair value hierarchy that prioritizes the inputs into valuation techniques used to measure fair value into three broad levels. This hierarchy gives the highest priority to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs. Further, financial assets and liabilities should be classified by level in their entirety based upon the lowest level of input that was significant to the fair value measurement. The three levels of the fair value hierarchy are as follows:

Level 1: Unadjusted quoted market prices in active markets for identical assets or liabilities that are accessible at the measurement date.

Level 2: Quoted prices in inactive markets for identical assets or liabilities, quoted prices for similar assets or liabilities in active markets, or other observable inputs either directly related to the asset or liability or derived principally from corroborated observable market data.

Level 3: Unobservable inputs due to the fact there is little or no market activity. This entails using assumptions in models which estimate what market participants would use in pricing the asset or liability.

Financial Assets and Liabilities

At March 31, 2021 and December 31, 2020, the Company’s financial instruments consist of cash and cash equivalents, receivables, accounts payable and other current liabilities. The carrying amounts of these financial instruments approximate fair value due to their short maturities.

Non-Financial Assets and Liabilities

The Company discloses and recognizes its non-financial assets and liabilities at fair value on a non-recurring basis. The estimated fair value for these non-financial liabilities are classified as Level 3 of the fair value hierarchy, as the valuation was determined based on internally developed assumptions that market participants would use in the pricing of such assets without observable inputs and no market activity.

The Company recorded its initial investment in affiliates at fair value. The estimated fair value for this non-financial asset is classified as Level 3 of the fair value hierarchy, as the valuation was determined based on internally developed assumptions with few observable inputs and no market activity.

In determining its accruals and disclosures with respect to loss contingencies, the Company will charge to income an estimated loss if information available prior to the issuance of the financial statements indicates that it is probable that a liability has been incurred at the date of the financial statements and the amount of the loss can be reasonably estimated. Legal expenses associated with the commitments and contingencies are expensed as incurred. If a loss contingency is not probable or reasonably estimable, disclosure of the loss contingency is made in the financial statements when it is at least reasonably possible that a material loss could be incurred.

The Company’s mining and exploration activities are subject to various laws, regulations and permits governing the protection of the environment. These laws, regulations and permits are continually changing and are generally becoming more restrictive. The Company has made, and expects to make in the future, expenditures to comply with such laws, regulations and permits, but cannot predict the full amount of such future expenditures.

In July 2017, the LGJV Entities entered into a loan agreement (the “Term Loan”) with Dowa whereby the LGJV Entities could borrow up to $210,000 for LGD development, with a maturity date of December 29, 2027. Interest on the Term Loan accrues daily at LIBOR plus 2.35% per annum, with the interest to be added to the amount borrowed until commencement of production. During 2018, the LGJV paid Dowa a $4,200 closing fee. Commencing June 30, 2021, 14 consecutive semi-annual equal payments of the aggregate principal and capitalized interest begin. The Company is required to pay an arrangement fee on the borrowing, calculated as 2% per annum of 70% of the outstanding principal balance, payable in semi-annual installments, on that date which is two business days prior to June 30 and December 31 each fiscal year until maturity, commencing after the initial drawdown which occurred in July 2018. The Term Loan also requires additional principal payments equal to 70% of excess cash flows (as defined). As of March 31, 2021, the LGJV had $222,783 outstanding under the Term Loan.

On January 23, 2018, the LGJV entered into a loan agreement (the “Dowa MPR Loan”) with Dowa whereby the LGJV could borrow up to $65,700 to continue LGD development. Interest on this loan accrued daily at LIBOR plus 1.5% per annum and was added to the amount borrowed. The amount borrowed plus accrued interest was due the earlier of June 30, 2019, or upon LGD’s substantial completion. If the Company’s 70% portion of the Dowa MPR Loan was not repaid in full on or before the due date, Dowa could elect to convert all or a portion of the principal amount into additional LGJV ownership at a favorable conversion rate.

The Company contributed $18,200 to the LGJV in May 2019 to provide funding for a partial repayment of principal and interest related to the Dowa MPR Loan. In late May 2019, the Dowa MPR Loan was fully extinguished with a cash payment of $18,200 and the conversion of the remaining $50,737 of principal and interest. The conversion of the remaining principal and interest increased Dowa’s ownership in the LGJV entities by 18.5% to 48.5%. On March 11, 2021, the Company repurchased the 18.5% interest from Dowa, for a total consideration of $71,550, including Dowa holding costs of this incremental interest, increasing the Company’s ownership in the LGJV to 70.0%. These transactions resulted in a $47,400 higher basis than the underlying net assets of the LGJV Entities. This basis difference is being amortized over the LGJV Entities proven and probable reserves.

On May 30, 2019, the LGJV entered into a working capital facility agreement ( the “WCF”) with Dowa whereby the LGJV could borrow up to $60,000 to fund the working capital and sustaining capital requirements of the LGD. Interest on this loan accrued daily at LIBOR plus 3.0% per annum and all outstanding principal and interest was to mature on June 28, 2021. The Company was required to pay an arrangement fee on the borrowing, calculated as 15.0% per annum of 70.0% of the average daily principal amount outstanding under the WCF during such fiscal quarter. On March 11, 2021, the full $60,000 amount outstanding under the WCF was extinguished of which the Company’s pro-rata capital contribution to the LGJV was $42,000.

The Company has guaranteed 70% of the outstanding principal and accrued interest of the Term Loan in the event of default by the LGJV. The Company has guaranteed the payment of all obligations, including accrued interest, under the LGJV equipment loan agreements. As of March 31, 2021, the LGJV had $11,141 outstanding under the LGJV equipment loan agreements, net of unamortized debt discount of $28, with varying maturity dates through August 2023.

In October 2020, the Company completed the distribution of its reportable U.S. segment, which was comprised of SOP. To effect the distribution, the Company distributed, on a pro rata basis, all equity interest of SOP to its stockholders of record immediately prior to completion of the initial public offering. Shareholders received approximately 0.10594 shares of common stock of SOP for every share of the Company’s common stock held. SOP became a wholly owned subsidiary of a newly created Delaware corporation named Silver Opportunity Partners Corporation, subsequently renamed to SSMRC.

The results of operations for SOP have been reflected as discontinued operations in the condensed consolidated statement of operations for the quarter ended March 31, 2020, and consist of the following:

The cash flow activity from discontinued operations for the quarter ended March 31, 2020 have been reflected as discontinued operations in the condensed consolidated statement of cash flows for the quarter ended March 31, 2020, and consist of the following:

The Company operates in a single industry as a corporation engaged in the acquisition, exploration and development of silver mineral interests. The Company has mineral property interests in Mexico. The Company’s reportable segments are based on the Company’s mineral interests and management structure and include Mexico and Corporate segments. The Mexico segment engages in the development and exploration on the Company’s Mexican mineral properties and includes the Company’s investment in the LGJV. Financial information relating to the Company’s segments is as follows:

During the three months ended March 31, 2021 and 2020, the Company recognized $2,701 of income and a $13,445 loss, respectively, on its investment in the LGJV Entities, representing its ownership share of the LGJV Entities’ results. The equity income or loss in affiliate includes amortization of the carrying value of the investment in excess of the underlying net assets of the LGJV Entities. This basis difference is being amortized over the LGJV Entities proven and probable reserves.

The LGJV Entities combined balance sheets as of March 31, 2021 and December 31, 2020, and the combined statements of income (loss) for the three months ended March 31, 2021 and 2020 are as follows:

LOS GATOS JOINT VENTURE
COMBINED BALANCE SHEETS (UNAUDITED)
(in thousands)

LOS GATOS JOINT VENTURE
COMBINED STATEMENTS OF INCOME (LOSS) [UNAUDITED]

(in thousands)

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Company’s consolidated financial statements and related notes and other information included elsewhere in this Form 10-Q (the “Report”) and the Company’s audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2020 and the related “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2020 (the “2020 10-K”), filed with the Securities and Exchange Commission (“SEC”) on March 29, 2021.

Forward-Looking Statements

This Report contains statements that constitute “forward looking information” and “forward-looking statements” within the meaning of U.S. and Canadian securities laws. Forward-looking statements are often identified by words such as ‘‘may,’’ ‘‘might,’’ ‘‘could,’’ ‘‘would,’’ ‘‘achieve,’’ ‘‘budget,’’ ‘‘scheduled,’’ ‘‘forecasts,’’ ‘‘should,’’ ‘‘expects,’’ ‘‘plans,’’ ‘‘anticipates,’’ ‘‘believes,’’ ‘‘estimates,’’ ‘‘predicts,’’ ‘‘potential’’ or ‘‘continue,’’ the negative of these terms and other comparable terminology. These forward-looking statements may include, but are not limited to, those relating to projections of our future financial performance, our anticipated growth strategies and anticipated trends in our industry, production from the Cerro Los Gatos Mine (“CLG”), our expectations relating to further exploration of the Los Gatos District and the Santa Valeria property, estimated calculations of mineral reserves and resources at our properties, anticipated expenses, tax benefits, future strategic infrastructure development at the CLG and our requirements for additional capital.

All forward-looking statements speak only as of the date on which they are made. These statements are not a guarantee of future performance and involve certain risks, uncertainties and assumptions concerning future events that are difficult to predict. Therefore, actual future events or results may differ materially from these statements. Important factors that could cause our actual results to differ materially from those expressed or implied by forward-looking statements include, but are not limited to, the following:

These factors should not be construed as exhaustive and should be read in conjunction with the other cautionary statements and information included in this Report and those described from time to time in our filings with the SEC, including, but not limited to, our 2020 10-K. These risks and uncertainties, as well as other risks of which we are not aware or which we currently do not believe to be material, may cause our actual future results to be materially different than those expressed in our forward-looking statements. Undue reliance should not be placed on these forward-looking statements. We do not undertake any obligation to make any revisions to these forward-looking statements to reflect events or circumstances after the date of this filing or to reflect the occurrence of unanticipated events, except as required by law. Certain forward-looking statements are based on assumptions, qualifications and procedures which are set out only in the Los Gatos Technical Report. For a complete description of assumptions, qualifications and procedures associated with such information, reference should be made to the full text of the Los Gatos Technical Report.

Overview

We are a U.S.-based precious metals production, development and exploration company with the objective of becoming a premier silver producer. We are currently focused on the production and continued development of the CLG and the further exploration and development of the Los Gatos District:

COVID-19 Pandemic

In March 2020, the World Health Organization declared COVID-19 a global pandemic. The COVID-19 pandemic temporarily affected our operations in 2020 in part due to the loss of revenue resulting from the 45-day temporary suspension of all nonessential activities at the LGJV’s CLG site and the expenses associated with the development and implementation of COVID-19 protocols. We believe we have taken appropriate steps to minimize the risk to our employees and to maintain normal business operations. We may take further actions as may be required by government authorities or as we determine are in the best interests of our employees and business partners which may cause additional closures of some or all of our operations in the future.

While the full impact of this pandemic is unknown, we are closely monitoring the developments of the outbreak and continually assessing the potential impact on our business. Any prolonged disruption of our operations and closure of facilities could result in additional costs incurred, production and development delays, cost overruns and operational restart costs that would negatively impact our business, financial condition and results of operations. The degree to which the pandemic impacts our business, financial condition and results of operations will depend on future developments, which are highly uncertain, continuously evolving and in many cases cannot be predicted, including, but not limited to, the duration and spread of the pandemic, its severity and the actions to contain the virus or treat its impact, such as the efficacy of vaccines (particularly with respect to emerging strains of the virus). Accordingly, there remains significant uncertainty about the duration and extent of the impact of the COVID-19 pandemic. See “Item 1A. Risk Factors” in the 2020 10-K for additional risks we face due to the COVID-19 pandemic.

Exploration Drilling Programs

In December 2020, the LGJV commenced a 90-hole, 27,000-meter exploration program to convert CLG’s established 3.2 million tonnes of inferred resources to the measured and indicated category and to discover additional resources along the northwest and southeast extensions of the CLG deposit. To date, 30 holes have been drilled.

In 2021, the LGJV intends to initiate a second exploration program to expand resources throughout the Los Gatos District. The initial target is an estimated 19,000-meter campaign at the Esther deposit, to expand its initial NI 43-101 compliant indicated resource of 0.46 million tonnes at 133 g/t silver, 2.1% zinc, 0.7% lead and inferred resource of 2.29 million tonnes at 98 g/t silver, 3.0% zinc, and 1.6% lead. Esther is located about four kilometers from CLG and contains similar styles of mineralization and geochemistry. The Company believes that further drilling may materially expand the size and mineral tenor of this resource.

In March 2021, the Company commenced an 18-hole, 5,400-meter exploration program on its wholly-owned Santa Valeria property. The Santa Valeria target has been developed through regional geologic work by the Company’s exploration team, which defined a large basin structure hosting the mineralization zones within the Los Gatos District. Santa Valeria is geologically comparable to CLG, and the Company believes it may contain similar mineral content. To date, two drill holes have been completed.

Components of Results of Operations

Operating Expenses

Exploration Expenses

We conduct exploration activities under mining concessions in Mexico. We expect exploration expenses to increase significantly as we continue to expand our exploration activities at the Los Gatos District and our other exploration properties. Our exploration expenses primarily consist of drilling costs, lease concession payments, assay costs and other geological and support costs at our exploration properties.

General and Administrative Expenses

Our general and administrative expenses consist of salaries and benefits, stock compensation, professional and consultant fees, insurance and other general administration costs. Our general and administrative expenses have increased and are expected to further increase significantly as we operate as a public company. We expect higher costs related to salaries, benefits, stock compensation, legal fees, compliance and corporate governance, accounting and audit expenses, stock exchange listing fees, transfer agent and other shareholder-related fees, directors’ and officers’ and other insurance costs, and other administrative costs. We are party to a Management Services Agreement with SSMRC, pursuant to which we will provide certain executive and managerial advisory services to SSMRC. SSMRC reimburses us for costs of providing such services.

Equity (Income) Loss in Affiliates

Our equity (income) loss in affiliates relates to our proportional share of net income or loss incurred from the LGJV and the amortization of the basis difference between our investment in the LGJV and the net assets of the LGJV.

LGJV Arrangement Fee

Our LGJV arrangement fee consists of arrangement fees related to the Term Loan and the WCF with Dowa. The arrangement fees are based on a fixed 1% and 15% rate for the Term Loan and the WCF, respectively, and 70% of the outstanding principal of the respective facility. These arrangement fees are solely our responsibility. On March 11, 2021, the WCF was extinguished and thus we do not expect to incur LGJV arrangement fees in future periods with respect to the WCF, but will continue to incur LGJV arrangement fees with respect to the Term Loan as long as such loan remains outstanding.

Income Taxes

As we have incurred substantial losses from our exploration and pre-development activities, we may receive further benefits in the form of deferred tax assets that can reduce our future income tax liabilities, if it is more likely than not that the benefit will be realized before expiration. Historically, we have not recognized these potential benefits in our financial statements and have fully reserved for such net deferred tax assets, as we believe it is more likely than not that the full benefit of these net deferred tax assets will not be realized before expiration.

Royalties

Exploration activities are conducted on the Los Gatos District mining concessions and on the Company’s 100% owned Santa Valeria concessions in Mexico. Mineral and concession lease payments are required to be paid to various entities to secure the appropriate claims or surface rights. Certain of these agreements also have royalty payments that were triggered when we began producing and selling metal-bearing concentrate.

Results of Operations

The following table presents certain information relating to our operating results for the three months ended March 31, 2021 and 2020. In accordance with generally accepted accounting principles in the United States (‘‘GAAP’’), these financial results represent the consolidated results of operations of our Company and its subsidiary (in thousands).

Three Months Ended March 31, 2021 Compared to Three Months Ended March 31, 2020

For the three months ended March 31, 2021, we incurred a net loss from continuing operations of $1,620 thousand compared to a net loss of $16,041 thousand for the three months ended March 31, 2020. The $14,421 thousand decrease in net loss from continuing operations was primarily attributable to $16,146 thousand change in equity (income) loss in affiliates from the LGJV operations, partially offset by the $2,766 thousand increase in general and administrative expense due to higher legal and consulting costs and directors and officers insurance premiums related to public company governance and reporting requirements, and increased stock-based compensation expense.

The LGJV’s operating income, which is recognized using the equity method of accounting in our financial statements for the three months ended March 31, 2021, resulted primarily from: the increase in our ownership in the LGJV from 51.5% to 70.0% on March 11, 2021; mining and processing activities operating near designed throughput for the three months ended March 31, 2021, compared to the ramp-up to designed throughput during the three months ended March 31, 2020; and significantly higher metals prices for the three months ended March 31, 2021 compared to the three months ended March 31, 2020.

Liquidity and Capital Resources

As of March 31, 2021 and December 31, 2020, we had cash and cash equivalents of $31,031 thousand and $150,146 thousand, respectively, and working capital of $36,027 thousand and $151,728 thousand, respectively. The decrease in cash and cash equivalents and working capital were primarily due to our $71,550 thousand repurchase of the 18.5% interest in the LGJV from Dowa and a $42,000 thousand capital contribution to the LGJV to extinguish our 70% share of the WCF. As a result, our ownership in the LGJV increased to 70.0% and Dowa’s ownership returned to 30% on March 11, 2021.

On October 30, 2020, we completed our initial public offering (the “IPO”) of 21,430,000 shares of common stock at a public offering price of $7.00 per share, resulting in net proceeds of $134,800 thousand, after deducting underwriting discounts and commissions and expenses payable by us. On November 10, 2020, we issued and sold an additional 3,214,500 shares of common stock at a public offering price of $7.00 per share, pursuant to the exercise in full of the underwriters’ over-allotment option, resulting in net proceeds of $20,900 thousand, after deducting underwriting discounts and commissions and expenses payable by us.

We did not have any related party debt as of March 31, 2021 or December 31, 2020. We have no outstanding lines of credit or other bank financing arrangements. We guarantee 70.0% of the Term Loan and all of the LGJV equipment loans as of March 31, 2021. We have certain arrangement fees obligations related to the CLG as detailed in the “LGJV Arrangement Fee” above.

We believe we have sufficient cash and resources to carry out our business plans for at least the next 12 months. We are focused on our forward-looking liquidity needs. We are evaluating our ongoing fixed cost structure as well as decisions related to project retention, advancement and development. We will likely be required to raise capital or take other measures to fund future exploration and development. Significant development activities, if warranted, will require that we arrange for financing in advance of planned expenditures. In addition, we expect to continue to increase our current financial resources with external financings as long as our long-term business needs require us to do so. There can be no assurance that external financing will be available to us on acceptable terms, or at all. We manage liquidity risk through the management of our capital structure.

We may be required to provide funds to the LGJV to support operations at the CLG which, depending upon the circumstances, may be in the form of equity, various forms of debt, joint venture funding or some combination thereof. There can be no assurance that additional funds will be available to us on acceptable terms, or at all. If we raise additional funds by issuing equity or convertible securities, substantial dilution to existing stockholders may result. Additionally, if we raise additional funds by incurring new debt obligations, the terms of the debt may require significant cash payment obligations, as well as covenants and specific financial ratios that may restrict our ability to operate our business.

Dowa Debt Agreements

Dowa Term Loan

On July 11, 2017, we entered into the Term Loan with Dowa whereby the LGJV could borrow up to $210,000 thousand to finance the development of the Los Gatos project, with a maturity date of December 29, 2027. Interest accrues daily at LIBOR plus 2.35% per annum, and the interest was added to the amount borrowed until production commenced at the Los Gatos project. The LGJV is obligated to pay 14 consecutive semi-annual payments totaling the aggregate principal amount and capitalized interest beginning June 30, 2021, with payments made two business days prior to the end of each June and December. We guarantee 70.0% of the Term Loan and are required to pay an arrangement fee on the borrowing, calculated as 2% per annum on 70% of the outstanding principal balance, payable in semi-annual installments. The Term Loan contains affirmative and negative covenants reasonably customary for similar facilities, with which the LGJV is in compliance in all material respects as of March 31, 2021.

Los Gatos Working Capital Facility

On May 30, 2019, we entered into the WCF with the LGJV and Dowa, under which Dowa agreed to provide a maximum of $60,000 thousand for the benefit of the LGJV, with a maturity date of June 28, 2021. Interest payable under the WCF was LIBOR plus 3% per annum and was payable by the LGJV. We guaranteed 70% of this facility and were required to pay an arrangement fee on the borrowing, calculated as 15.0% per annum on 70.0% of the average daily principal amount outstanding during the relevant fiscal quarter. The full principal amount of the WCF was drawn down by the LGJV as of September 2019. On March 11, 2021, we and Dowa contributed $42,000 thousand and $18,000 thousand, respectively, in capital to the LGJV extinguishing the WCF.

Cash Flows

The following table presents our sources and uses of cash for the periods indicated:

Cash used by operating activities was $6,589 thousand and $4,721 thousand for the three months ended March 31, 2021 and 2020, respectively. The $1,868 thousand increase was primarily due to the higher general and administrative costs, partially offset by lower arrangement fees associated with the extinguishment of the WCF.

Cash used by investing activities was $113,823 thousand and $2,580 thousand for the three months ended March 31, 2021 and 2020, respectively. The $111,243 thousand increase was primarily due to the $71,550 thousand acquisition of the 18.5% interest in the LGJV from Dowa and the $42,000 pro-rata capital contribution to the LGJV for the extinguishment of the WCF in March 2021.

Cash provided by (used by) financing activities was $1,297 thousand and $(229) thousand for the three months ended March 31, 2021 and 2020, respectively. The $1,526 thousand increase was primarily related to the $1,559 thousand in proceeds from the issuance of common stock from the exercise of stock options.

Results of LGJV Operations

The following table presents information relating to the LGJV’s financial condition as of March 31, 2021 and December 31, 2020, and the operating results for the three months ended March 31, 2021 and 2020 in accordance with GAAP. Pursuant to the purchase of the 18.5% interest from Dowa on March 11, 2021, our current ownership of the LGJV is 70.0%.

LOS GATOS JOINT VENTURE

COMBINED BALANCE SHEETS (UNAUDITED)
(in thousands)

At March 31, 2021 and December 31, 2020, the LGJV had current assets of $71,969 thousand and $69,602 thousand, respectively. The increase in total current assets was primarily due to an increase in cash and cash equivalents and trade receivables generated from operations, partially offset by a decrease in value added tax receivables primarily from a weakening Mexican Peso. At March 31, 2021 and December 31, 2020, the LGJV had noncurrent assets of $401,063 thousand and $399,816 thousand, respectively. The increase in noncurrent assets was due to sustaining capital expenditures, primarily for mine development at the CLG, partially offset by depletion and depreciation for the three months ended March 31, 2021.

At March 31, 2021 and December 31, 2020, the LGJV had current liabilities of $77,683 thousand and $139,757 thousand, respectively. The decrease in current liabilities was primarily due to the extinguishment of the $60,000 thousand WCF on March 11, 2021. At March 31, 2021 and December 31, 2020, the LGJV had noncurrent liabilities of $204,464 thousand and $206,049 thousand, respectively. The decrease in non-current liabilities was primarily due to scheduled payments on equipment loans.

LOS GATOS JOINT VENTURE

COMBINED STATEMENTS OF INCOME (LOSS) [UNAUDITED]

(in thousands)

For the three months ended March 31, 2021, the LGJV had net income of $6,852 thousand compared to a net loss of $23,907 thousand for the three months ended March 31, 2020. The change in net income (loss) was primarily due to increased revenue as a result of higher metal prices and higher production rates, lower interest expense due to decreasing interest rates, and a lower foreign exchange loss due to the strengthening Mexican Peso.

The following table presents summarized information relating to the LGJV’s cash flows for the three months ended March 31, 2021 and 2020.

LOS GATOS JOINT VENTURE

COMBINED STATEMENT OF CASH FLOWS

(in thousands)

Cash provided by operating activities was $23,335 thousand and $7,950 thousand for the three months ended March 31, 2021 and 2020, respectively. The $15,385 thousand increase in cash provided by operating activities was primarily due to the increase in revenue for the three months ended March 31, 2021 compared to the prior year period, partially offset by increased payments to vendors.

Cash used by investing activities was $17,596 thousand and $8,170 thousand for the three months ended March 31, 2021 and 2020, respectively. The $9,426 thousand increase in cash used was primarily due to higher sustaining capital expenditures for property, plant and equipment and mine development.

Cash (used by) provided by financing activities was $(1,974) thousand and $662 thousand for the three months ended March 31, 2021 and 2020, respectively. The $2,636 thousand change in financing cash flows was primarily due to the $2,574 thousand related party loan to the LGJV during the three months ended March 31, 2020.

Non-GAAP Financial Measures

Non-GAAP financial measures are intended to provide additional information only and do not have any standardized meaning prescribed by GAAP and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with GAAP. The measures are not necessarily indicative of operating profit or cash flow from operations as determined under GAAP.

Cash Costs and All-In Sustaining Costs

Cash costs and all-in sustaining costs (“AISC”) are non-GAAP measures. AISC was calculated based on guidance provided by the World Gold Council (“WGC”). WGC is not a regulatory industry organization and does not have the authority to develop accounting standards for disclosure requirements. Other mining companies may calculate AISC differently as a result of differences in underlying accounting principles and policies applied, as well as definitional differences of sustaining versus expansionary (i.e. non-sustaining) capital expenditures based upon each company’s internal policies. Current GAAP measures used in the mining industry, such as cost of sales, do not capture all of the expenditures incurred to discover, develop and sustain production. Therefore, we believe that cash costs and AISC are non-GAAP measures that provide additional information to management, investors and analysts that aid in the understanding of the economics of the Company’s operations and performance compared to other producers and provides investors visibility by better defining the total costs associated with production.

Cash costs include all direct and indirect operating cash costs related directly to the physical activities of producing metals, including mining, processing and other plant costs, treatment and refining costs, general and administrative costs, royalties and mining production taxes. AISC includes total production cash costs incurred at the LGJV’s mining operations plus sustaining capital expenditures. The Company believes this measure represents the total sustainable costs of producing silver from current operations and provides additional information of the LGJV’s operational performance and ability to generate cash flows. As the measure seeks to reflect the full cost of silver production from current operations, new project and expansionary capital at current operations are not included. Certain cash expenditures such as new project spending, tax payments, dividends, and financing costs are not included.

Reconciliation of expenses (GAAP) to cash costs (non-GAAP), co-product all-in sustaining costs before by-product credits (non-GAAP) and by-product all-in sustaining costs after by-product credits (non-GAAP)

The table below presents a reconciliation between the most comparable GAAP measure of expenses to the non-GAAP measures of (i) cash costs, (ii) co-product all-in sustaining costs and (iii) by-product all-in sustaining costs for our operations.

1 Exploration costs are not related to current operations.

2 Represent reductions on customer invoices and included in Sales of the LGJV combined statement of income (loss).

3 By-product credits reflect realized metal prices of zinc, lead and gold for the applicable period.

4 Silver equivalents utilize the average realized prices during the three months ended March 31, 2021 of $24.15/oz silver, $1.16/lb zinc, $0.93/lb lead and $1,812/oz gold.

Off-balance sheet arrangements

During the periods presented, we did not, and we currently do not, have any significant off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to our shareholders.

Critical Accounting Policies

Please refer to Note 2 – Summary of Significant Accounting Policies in our consolidated financial statements included in this Report and the 2020 10-K for discussion of our critical accounting policies and estimates.

Jumpstart Our Business Startups Act of 2012

The Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) permits us, as an “emerging growth company,” to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We have elected to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for public companies that are not emerging growth companies. The decision to opt out of the extended transition period under the JOBS Act is irrevocable.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Commodity Price Risk

We engage in the production of silver and concentrates containing silver, lead, zinc, antimony and gold at the CLG and commenced production on September 1, 2019. Accordingly, we expect the principal source of future revenue to be the sale of silver, and to a lesser extent, lead and zinc. A significant and sustained decrease in the price of these metals from current levels could have a material and negative impact on our business, financial condition and results of operations.

Foreign Currency Risk

Although most of our expenditures are in U.S. dollars, certain purchases of labor, operating supplies and capital assets are denominated in other currencies, primarily the Mexican peso. As a result, currency exchange fluctuations may impact the costs of our operations.

Concentration of Risk

We have placed nearly all of our cash investments with a single, high-quality financial institution. All cash equivalents are invested in high-quality, short-term money market instruments, including certificates of deposit. At no time have we had funds invested in asset-backed commercial paper. We have not experienced any losses on our cash investments.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-15(b). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2021.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting that occurred during the first quarter of 2021 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Limitations on Effectiveness of Controls

Our management, including our Chief Executive Officer and Chief Financial Officer, do not expect that our disclosure controls and procedures will prevent all errors and fraud. 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, not absolute, assurance of achieving the desired control objectives. Further, the design of a control system must reflect resource constraints, which require management to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by management’s override of the control.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

PART II – OTHER INFORMATION

We are, from time to time, involved in legal proceedings of a nature considered normal to our business. We believe that none of the litigation in which we are currently involved, or have been involved since the beginning of our most recently completed financial year, individually or in the aggregate, is material to our consolidated financial condition, cash flows or results of operations. See Note 9 – Commitments, Contingencies and Guarantees in our consolidated financial statements included in this Report for additional information regarding our assessment of contingencies related to legal matters.

Factors that could cause our actual results to differ materially from those in this Report include, but are not limited to, any of the risks described in the 2020 10-K. Any of these factors could result in a significant or material adverse effect on our results of operations or financial condition. Additional risk factors not currently known to us or that we currently deem immaterial may also adversely affect us. As of the date of this Report, there have been no material changes to the risk factors disclosed in the 2020 10-K.

Unregistered Sales of Equity Securities

During the quarter ended March 31, 2021, the Company did not issue any shares of its common stock or other equity securities that were not registered under the Securities Act of 1933, as amended.

Use of Proceeds

On October 27, 2020, the SEC declared effective the Company’s registration statement on Form S-1 (No. 333-249224), as amended, filed in connection with the Company’s IPO. There has been no material change in the planned use of proceeds from the IPO as described in the Company’s final prospectus, filed with the SEC on October 29, 2020 pursuant to Rule 424(b) under the Securities Act.

As of March 31, 2021, the Company has used approximately $119,310 thousand of the net proceeds from the IPO, including (i) $71,550 thousand for the repurchase of the 18.5% interest in the LGJV from Dowa; (ii) $42,000 thousand for the capital contribution to the LGJV to extinguish the Company’s 70% share of the WCF; and (iii) $5,760 thousand for working capital and general corporate purposes.

Purchase of Equity Securities by the Issuer and Affiliated Purchasers

During the quarter ended March 31, 2021, there were no purchases made by or on behalf of the Company or any affiliated purchaser of the Company’s common stock. 

None.

Not applicable.

None.

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 thereunto duly authorized.