Golden Minerals Co - Quarter Report: 2012 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(MARK ONE)

 

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

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2012

 

OR

 

o         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 1-13627

 

GOLDEN MINERALS COMPANY

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

 

 

(303) 839-5060

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

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 HAS SUBMITTED ELECTRONICALLY AND POSTED ON ITS CORPORATE WEB SITE, IF ANY, EVERY INTERACTIVE DATA FILE REQUIRED TO BE SUBMITTED AND POSTED 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 AND POST SUCH FILES).  YES  x  NO  o

 

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A LARGE ACCELERATED FILER, AN ACCELERATED FILER, A NON-ACCELERATED FILER, OR A SMALLER REPORTING COMPANY:

 

 

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 BY CHECK MARK WHETHER THE REGISTRANT HAS FILED ALL DOCUMENTS AND REPORTS REQUIRED TO BE FILED BY SECTIONS 12, 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 SUBSEQUENT TO THE DISTRIBUTION OF SECURITIES UNDER A PLAN CONFIRMED BY A COURT:  YES x  NO  o

 

AT NOVEMBER 9, 2012, 42,578,333 SHARES OF COMMON STOCK, $0.01 PAR VALUE PER SHARE, WERE ISSUED AND OUTSTANDING.

 

 

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GOLDEN MINERALS COMPANY

FORM 10-Q

QUARTER ENDED SEPTEMBER 30, 2012

 

INDEX

 

		PAGE
PART I — FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS (Unaudited)	3
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	20
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	27
ITEM 4.	CONTROLS AND PROCEDURES	27
PART II — OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	28
ITEM 1A.	RISK FACTORS	28
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	28
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	28
ITEM 4.	MINE SAFETY DISCLOSURES	28
ITEM 5.	OTHER INFORMATION	28
ITEM 6.	EXHIBITS	28
SIGNATURES		29

 

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PART I. FINANCIAL INFORMATION

 

Item 1.   Financial Statements

 

GOLDEN MINERALS COMPANY

CONSOLIDATED BALANCE SHEETS

(Expressed in United States dollars)

(Unaudited)

 

		September 30,			December 31,
		2012			2011
		(in thousands, except share data)
Assets
Current assets
Cash and cash equivalents		$	53,561		$	48,649
Investments (Note 4)		417			—
Trade receivables		1,199			—
Inventories (Note 6)		5,170			5,312
Value added tax receivable (Note 7)		3,033			1,317
Prepaid expenses and other assets (Note 5)		1,177			3,119
Total current assets		64,557			58,397
Property, plant and equipment, net (Note 8)		282,031			284,199
Goodwill (Note 9)		12,942			70,155
Prepaid expenses and other assets (Note 5)		197			264
Total assets		$	359,727		$	413,015
Liabilities and Equity
Current liabilities
Accounts payable and other accrued liabilities (Note 10)		$	6,034		$	8,070
Other current liabilities (Note 12)		7,512			7,505
Total current liabilities		13,546			15,575
Asset retirement obligation (Note 11)		2,226			3,781
Deferred tax liability (Note 14)		49,226			55,603
Other long term liabilities (Note 12)		217			288
Total liabilities		65,215			75,247
Commitments and contingencies (Note 18)
Equity (Note 15)
Common stock, $.01 par value, 100,000,000 shares authorized; 42,578,333 and 35,690,035 shares issued and outstanding, respectively		424			355
Additional paid in capital		491,411			453,756
Accumulated deficit		(197,308		)	(116,221		)
Accumulated other comprehensive loss		(15		)	(122		)
Parent company’s shareholder’s equity		294,512			337,768
Total liabilities and equity		$	359,727		$	413,015

 

The accompanying notes form an integral part of these consolidated financial statements.

 

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GOLDEN MINERALS COMPANY

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)

(Expressed in United States dollars)

(Unaudited)

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2012			2011			2012			2011
		(in thousands, except share data)
Revenue:
Sale of metals (Note 16)		$	7,063		$	—		$	18,384		$	—
Costs and expenses:
Costs applicable to sale of metals (exclusive of depreciation shown below) (Note 16)		(8,573		)	(965		)	(23,103		)	(965		)
Exploration expense		(1,207		)	(4,639		)	(5,419		)	(12,645		)
El Quevar project expense		(985		)	(5,520		)	(3,574		)	(23,276		)
Velardeña project expense		(767		)	—			(6,291		)	—
Administrative expense		(1,934		)	(1,836		)	(5,787		)	(6,242		)
Severence and acquisition related cost		—			(5,353		)	—			(7,050		)
Stock based compensation		(308		)	(3,260		)	(831		)	(5,328		)
Reclamation and accretion expense		(40		)	(31		)	(185		)	(126		)
Goodwill Impairment (Note 9)		(57,213		)	—			(57,213		)	—
Other operating income & (expenses), net		264			(76		)	479			340
Depreciation, depletion and amortization		(2,774		)	(717		)	(6,617		)	(1,580		)
Total costs and expenses		(73,537		)	(22,397		)	(108,541		)	(56,872		)
Loss from operations		(66,474		)	(22,397		)	(90,157		)	(56,872		)
Other income and expenses:
Interest and other income		162			11,099			2,323			11,240
Royalty income		14			155			371			285
Interest expense		—			(337		)	—			(337		)
Gain (loss) on foreign currency		368			(1,432		)	802			(1,646		)
Total other income and expenses		544			9,485			3,496			9,542
Loss from operations before income taxes		(65,930		)	(12,912		)	(86,661		)	(47,330		)
Income tax benefit		2,614			1,168			5,574			1,070
Net loss		$	(63,316	)	$	(11,744	)	$	(81,087	)	$	(46,260	)
Comprehensive loss:
Unrealized gain (loss) on securities		166			251			107			(309		)
Comprehensive loss		$	(63,150	)	$	(11,493	)	$	(80,980	)	$	(46,569	)
Net loss per common share — basic and diluted
Loss		$	(1.74	)	$	(0.59	)	$	(2.27	)	$	(2.79	)
Weighted average common stock outstanding - basic and diluted (1)		36,318,747			19,989,334			35,762,251			16,605,896

 

(1)         Potentially dilutive shares have not been included because to do so would be anti-dilutive.

 

The accompanying notes form an integral part of these consolidated financial statements.

 

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GOLDEN MINERALS COMPANY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Expressed in United States dollars)

(Unaudited)

 

		Nine Months Ended
		September 30,
		2012			2011
		(in thousands)
Cash flows from operating activities:
Net cash used in operating activities (Note 17)		$	(27,396	)	$	(46,704	)
Cash flows from investing activities:
Sale of available for sale investments		—			1,221
Cash received net of cash paid in ECU merger		—			5,614
Convertible note issued to ECU		—			(15,713		)
Proceeds from sale of assets		2,535			404
Capitalized costs and acquisitions of property, plant and equipment		(7,118		)	(6,230		)
Net cash used in investing activities		$	(4,583	)	$	(14,704	)
Cash flows from financing activities:
Proceeds from issuance of stock units, net of issue costs		36,891			—
Payments of long term debt		—			(554		)
Payment of customer advance		—			(4,049		)
Net cash (used in) / provided by financing activities		$	36,891		$	(4,603	)
Net increase (decrease) in cash and cash equivalents		4,912			(66,011		)
Cash and cash equivalents - beginning of period		48,649			120,990
Cash and cash equivalents - end of period		$	53,561		$	54,979

 

See Note 16 for supplemental cash flow information.

 

The accompanying notes form an integral part of these consolidated financial statements.

 

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GOLDEN MINERALS COMPANY

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Expressed in United States dollars)

(Unaudited)

 

													Accumulated
													Other
							Additional						Comprehensive
		Common Stock					Paid-in			Accumulated			income			Total
		Shares		Amount			Capital			Deficit			(loss)			Equity
		(in thousands except share data)
Balance, December 31, 2010		15,124,567		$	152		$	185,051		$	(53,550	)	$	165		$	131,818
Stock compensation accrued		331,166		—			5,540			—			—			5,540
Treasury shares acquired and retired		(106,056	)	—			(1,834		)	—			—			(1,834		)
Warrants exercised		104,889		1			(1		)	—			—			—
Shares issued to ECU shareholder’s and officers		16,117,319		161			224,514			—			—			224,675
ECU replacement options and warrants		—		—			9,853			—			—			9,853
Private placements, net		4,118,150		41			30,633			—			—			30,674
Unrealized loss on marketable equity securities		—		—			—			—			(287		)	(287		)
Net loss		—		—			—			(62,671		)	—			(62,671		)
Balance, December 31, 2011		35,690,035		$	355		$	453,756		$	(116,221	)	$	(122	)	$	337,768
Stock compensation accrued		25,000		—			831			—			—			831
Registered offering stock units, net (Note 15)		5,497,504		55			29,377			—			—			29,432
Private placements stock units, net (Note 15)		1,365,794		14			7,447			—			—			7,461
Unrealized loss on marketable equity securities		—		—			—			—			107			107
Net loss		—		—			—			(81,087		)	—			(81,087		)
Balance, September 30, 2012		42,578,333		$	424		$	491,411		$	(197,308	)	$	(15	)	$	294,512

 

The accompanying notes form an integral part of these consolidated financial statements.

 

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GOLDEN MINERALS COMPANY

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(Expressed in United States dollars)

 

1.              Basis of Preparation of Financial Statements and Nature of Operations

 

Golden Minerals Company (the “Company”), a Delaware corporation, has prepared these unaudited interim consolidated financial statements in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). Such rules and regulations allow the omission of certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), so long as such omissions do not render the financial statements misleading.  The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures normally required by GAAP.

 

On September 2, 2011, the Company and ECU Silver Mining Inc. (“ECU”) completed a business combination (the “Transaction”) more fully described in Note 20.  The Company’s consolidated financial statements include the results of the ECU Transaction from September 2, 2011.

 

In the opinion of management, these financial statements reflect all adjustments that are necessary for a fair presentation of the financial results for the periods presented. These interim financial statements should be read in conjunction with the annual financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Certain prior period amounts have been reclassified to conform to the current period presentation.  Such reclassifications did not affect results of operations.

 

The Company is primarily engaged in the operation and further development of the recently acquired Velardeña mining operations in Mexico (the “Velardeña Operations”) (see Note 20), the advancement of its El Quevar advanced exploration property in Argentina, and the exploration and potential monetization of its portfolio of exploration properties in South America and Mexico.  The financial statements have been prepared on a going concern basis under which an entity is considered to be able to realize its assets and satisfy its liabilities in the normal course of business.  However, the continuing operations of the Company are dependent upon its ability to secure sufficient funding and to generate future profitable operations.  The underlying value and recoverability of the amounts shown as mineral properties in the consolidated balance sheet are dependent on the ability of the Company to generate positive cash flow from operations and to continue to fund exploration and development activities that would lead to profitable production or proceeds from the disposition of the mineral properties.  There can be no assurance that the Company will be successful in generating future profitable operations or securing additional funding in the future on terms acceptable to the Company or at all.

 

2.  Liquidity and Capital Resources

 

At September 30, 2012 the Company’s aggregate cash and short-term investments totaled $54.0 million and, based on the assumptions described below, we expect to have a cash balance of approximately $41.5 million at December 31, 2012. During the quarter ended September 30, 2012 the Company completed a registered offering and concurrent private placement  of units comprised of one share of the Company’s common stock and a five year warrant to acquire half a share of the Company’s common stock for net proceeds of $36.9 million (see Note 15).  As a result, the Company expects to have sufficient funding to continue its long-term business strategy through 2013.

 

Assuming metals prices of $30.00 per ounce of silver and $1,500 per ounce of gold during the fourth quarter 2012 the Company expects to generate a negative gross margin, which the Company defines as revenue from the sale of metals less costs applicable to the sale of metals (exclusive of depreciation), of approximately $1.0 million during the quarter. With the cash and investment balance at September 30, 2012 of $54.0 million and an anticipated $1.0 million of negative gross margin from the sale of metals at the Velardeña Operations, and $2.0 million of proceeds from the monetization of certain properties in the exploration portfolio, the Company plans to spend the following amounts during the fourth quarter 2012 pursuant to its long-term business strategy:

 

1.                                      Approximately $7.5 million on capital and development costs related to the continued development of the San Mateo ramp and other mine development and capital expenditures intended to increase the capacity and productivity of the Velardeña Operations and plant facilities;

 

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2.                                      Approximately $1.5 million at the El Quevar project to fund limited exploration, maintenance activities and the continuation of project evaluation costs;

 

3.                                      Approximately $1.5 million on other exploration activities and property holding costs related to the Company’s portfolio of exploration properties located in South America and Mexico as the Company pursues strategies to monetize portions of the portfolio;

 

4.                                      Approximately $2.0 million on general and administrative costs and $1.0 million on other working capital.

 

The actual amount that the Company spends through year-end 2012 and the projected year-end cash and investment balance may vary significantly from the amounts specified above and will depend on a number of factors, including metals prices, the results of continuing operations and development work at the Velardeña Operations to continue the ramp up to 850 tonnes per day, the results of continued project assessment work at El Quevar and other exploration properties, and whether the Company is able to monetize additional portions of its exploration portfolio.  There can be no assurance that the current expenditures planned for the Velardeña Operations will result in the anticipated amounts of silver and gold production.  If the anticipated production does not occur, or metals prices decline from the levels noted previously, the Company would likely end the year 2012 with a lower cash and investment balance than the approximately $41.5 million currently expected.

 

3.              Significant Accounting Policies

 

Goodwill

 

ASC 350 “Intangibles-Goodwill and Other” (“ASC 350”) requires that an entity assign its goodwill to reporting units and test each reporting unit’s goodwill for impairment at least on an annual basis and between annual tests in certain circumstances.  All of the goodwill recorded on the Company’s books is related to the Velardeña Operations acquired in the Transaction, which is considered by the Company to be a separate reporting unit. During the third quarter 2012, the Company determined that based on an analysis of events that have occurred and circumstances that have changed since year-end 2011 the carrying value of the goodwill was impaired (see Note 9).

 

Property, plant and equipment

 

Property, plant and equipment are recorded at cost and per the guidance of ASC 360 “Property, Plant and Equipment”, (“ASC 360”), the Company assesses the recoverability of its property, plant and equipment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable.   If the sum of estimated future net cash flows on an undiscounted basis is less than the carrying amount of the related asset, impairment is considered to exist. The related impairment loss is measured by comparing estimated future net cash flows on a discounted basis to the carrying amount of the asset.  At September 30, 2012, the Company completed an impairment analysis based on events that have occurred and circumstances that have changed since year-end 2011 and determined that property, plant and equipment were not impaired.

 

New accounting pronouncements

 

There were no new accounting pronouncements during the period that would have an impact on the Company’s financial position or results of operations.

 

4.              Investments

 

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Short-term investments include investments with maturities greater than three months, but not exceeding 12 months, or highly liquid investments with maturities greater than 12 months that the Company intends to liquidate during the next 12 months for working capital needs.

 

The Company determines the appropriate classification of its investments in equity securities at the time of purchase and re-evaluates those classifications at each balance sheet date.  Available for sale investments are marked to market at each reporting period with changes in fair value recorded as a component of other comprehensive income (loss). If declines in fair value are deemed other than temporary, a charge is made to net income (loss) for the period.

 

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The following tables summarize the Company’s investments at September 30, 2012:

 

September 30, 2012		Cost			Estimated Fair Value			Carrying Value
		(in thousands)
Investments:
Short-term:
Warrant to purchase common stock		$	124		$	—		$	—
Available for sale common stock		$	270		$	417		$	417
Total available for sale		394			417			417
Total short term		$	394		$	417		$	417

 

Available for sale investments at December 31, 2011 had a nominal carrying value of less than one thousand dollars.

 

The Company holds warrants to purchase common stock of a junior mining company. The warrants were acquired in a transaction related to the Company’s exploration activities during 2010.  The warrants will expire during the fourth quarter 2012, and had a nominal carrying value of less than one thousand dollars at December 31, 2011 and at September 30, 2012.

 

The available for sale common stock consists of 262,500 shares of a junior mining company received during the first quarter 2012 in a transaction related to the Company’s exploration activities and 3.0 million shares of another junior mining company received during the third quarter 2012 related to the 2011 sale of the Company’s Paca Pulacayo property in Bolivia.

 

Quoted market prices at September 30, 2012 were used to determine the fair values of the above investments.  See Note 13 for further discussion on the fair value measurement techniques used by the Company to value the above investments.

 

5.   Prepaid expenses and other current assets

 

Prepaid expenses and other current assets consist of the following:

 

		September 30,			December 31,
		2012			2011
		(in thousands)
Prepaid insurance		$	313		$	590
Prepaid contractor fees and vendor advances		486			1,557
Accounts receivable		—			682
Recoupable deposits and other		378			290
		$	1,177		$	3,119

 

The prepaid contractor fees and vendor advances consist of advance payments made to equipment manufacturers, contractors and suppliers primarily at the Company’s Velardeña Operations in Mexico.

 

Included in non-current assets at September 30, 2012 and December 31, 2011 were approximately $0.2 million and $0.3 million, respectively of prepaid insurance on which amortization will be recognized through 2015.

 

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6.   Inventories

 

Inventories at the Velardeña Operations at September 30, 2012 and December 31, 2011 consist of the following:

 

		September 30,			December 31,
		2012			2011
		(in thousands)			(in thousands)
Metals inventory		$	3,392		$	4,250
In-process inventory		369			257
Material and supplies		1,409			805
		$	5,170		$	5,312

 

At September 30, 2012, the Company had written down its metals inventory to net realizable value including a charge to cost of metals sold of approximately $2.0 million and a charge to depreciation expense of approximately $0.6 million.

 

Material and supplies inventory consists primarily of operating supplies at the Velardeña Operations and are carried at the lower of cost or market.

 

7.   Value added tax recoverable

 

The Company has recorded value added tax (“VAT”) paid in Mexico and related to the Velardeña Operations as a recoverable asset. Mexican tax law allows for certain VAT payments to be recovered through ongoing applications for refunds. The Company expects that the current amounts will be recovered within a one year period.

 

The Company has also paid VAT in Mexico as well as other countries, primarily related to exploration projects, which has been charged to expense as incurred because of the uncertainty of recoverability.

 

8.   Property, Plant and Equipment

 

The components of property, plant and equipment are as follows:

 

		September 30,			December 31,
		2012			2011
		(in thousands)
Mineral properties		$	239,200		$	239,200
Exploration properties		16,549			16,549
Royalty properties		200			1,208
Buildings		4,477			4,766
Mining equipment and machinery		27,489			21,335
Other furniture and equipment		1,812			1,553
Asset retirement cost		1,883			3,506
		291,610			288,117
Less: Accumulated depreciation		(9,579		)	(3,918		)
		282,031			284,199

 

During the second quarter 2012 the Company completed the sale if its 1% net smelter royalty interest in the Platosa property to Excellon Resources Inc. for $2.4 million and recorded a $1.8 million gain on the sale which is reflected in interest and other income on the accompanying statements of operations.

 

The asset retirement cost is all related to the Company’s Velardeña Operations in Mexico and was adjusted during the second quarter 2012 based on the completion of a mine closure plan during the period as discussed in detail in Note 11.

 

Additions to property, plant and equipment for the nine months ended September 30, 2012 are primarily related to activity at the Company’s Velardeña Operations.

 

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9.   Goodwill

 

The carrying value of goodwill, related to the Mexico ECU reporting unit, was $12.9 million at September 30, 2012 and $70.2 million at December 31, 2012. The reduction in the carrying value of goodwill is the result of the Company recording an impairment charge of $57.2 million during the third quarter 2012 which is reflected in operating costs and expenses in the accompanying consolidated statements of operations.

 

Goodwill is related to the Transaction (see Note 20) and is primarily the result of the requirement to record a deferred tax liability for the difference between the fair value and the tax basis of the assets acquired and liabilities assumed at amounts that do not reflect fair value.  The goodwill is not deductable for income tax purposes.

 

The Company assesses the recoverability of its long lived assets, including goodwill, whenever events or changes in circumstances indicate that the carrying value of the assets may be impaired. In the year since the completion of the Transaction, the Company’s forecast of future gold and silver prices has decreased by approximately 20% and certain assumptions related to ore processing throughput rates and other aspects of the long term operating plan for the Velardeña Operations have changed. As a result of these changes, and per the guidance of ASC 350, the Company completed an impairment analysis of the goodwill carrying value.  The analysis indicated that goodwill was impaired by the amount indicated above.

 

The impairment amount was calculated by applying the income approach to determine the fair value of the net assets of the reporting unit per the guidance of ASC Topic 820 “Fair Value Measurements and Disclosures” (“ASC 820”).  The Company utilized discounted cash flows and an excess earnings model to determine the fair value of the entity and the implied goodwill. This model falls within level 3 of the fair value hierarchy per ASC 820 (see Note 13) and includes various inputs including the weighted average cost of capital, future metals prices, and assumptions from the Company’s Velardeña Operations operating plan extended over a twenty five year period. The most significant unobservable factors are certain assumptions used in the Velardeña Operations operating plan and include: 1) ore grades consistent with the Company’s current and previously reported estimates of mineralized material, 2) plant throughput consistent with the Company’s plan to ramp up to 1,150 tonnes per day by 2014, and 3) the Company’s projections of operating costs.  The weighted average cost of capital of 21 percent and forecast of future metals prices were obtained from a third party valuation consultant that derived the data from corroborated observable market data.  Metals prices used in the analysis for silver ranged from $35.78 to $21.88 per ounce and for gold from $1,879 to $1,315 per ounce.

 

10.   Accounts Payable and Other Accrued Liabilities

 

The Company’s accounts payable and other accrued liabilities consist of the following:

 

		September 30,			December 31,
		2012			2011
		(in thousands)
Accounts payable and accruals		$	2,808		$	5,172
Accrued employee compensation and benefits		3,226			2,898
		$	6,034		$	8,070

 

September 30, 2012

 

Accounts payable and accruals at September 30, 2012 are primarily related to amounts due to contractors and suppliers in the amounts of $2.0 million, $0.7 million and $0.1 million related to the Company’s Velardeña Operations, corporate administrative activities and exploration, respectively.

 

Accrued employee compensation and benefits at September 30, 2012 consist of $0.2 million of accrued vacation payable and $3.0 million related to withholding taxes and benefits payable, of which $1.8 million is related to activities at the Velardeña Operations.

 

December 31, 2011

 

Accounts payable and accruals at December 31, 2011 are primarily related to amounts due to contractors and suppliers in the amounts of $3.0 million, $0.8 million, $0.6 million and $0.8 million related to the Company’s Velardeña Operations, the El Quevar project, exploration and corporate administrative activities, respectively.

 

Accrued employee compensation and benefits at December 31, 2011 consist of $0.3 million of accrued vacation payable and $2.6 million related to withholding taxes and benefits payable, of which $2.1 million is related to activities at the Velardeña Operations.

 

11.   Asset Retirement and Reclamation Liabilities

 

The Company recorded an approximately $3.5 million asset retirement obligation (“ARO”) and offsetting asset retirement cost (“ARC”) related to the Velardeña Operations upon the acquisition of ECU (see Note 20).  The Company

 

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with the help of a third party engineering firm, estimated the ARO and ARC based on the engineering firm’s experience with mining operations of similar size and scope as that of the Velardeña Operations. Shortly after the completion of the acquisition the Company retained the services of another engineering firm to complete a detailed closure plan for the Velardeña Operations.  That plan was completed during the second quarter 2012 and indicated an ARO and ARC of approximately $1.9 million.  The ARO and ARC amounts were adjusted accordingly as set forth in changes in estimates, and other in the table below.

 

  The Company will continue to accrue additional estimated ARO amounts based on an asset retirement plan as activities requiring future reclamation and remediation occur.  During the first nine months of 2012 the Company recognized approximately $0.1 million of accretion expense during the period and approximately $0.2 million of amortization expense related to the ARC.

 

The following table summarizes activity in the Velardeña Operations ARO:

 

		September 30,			December 31,
		2012			2011
		(in thousands)			(in thousands)
Beginning balance		$	3,577		$	—
ARO arising in the period (acquired at merger)		—			3,506
Changes in estimates, and other		(1,656		)	—
Liabilities settled		—			—
Accretion expense		118			71
Ending balance		$	2,039		$	3,577

 

Asset retirement and reclamation liabilities for both periods include approximately $0.2 million of reclamation liabilities related to activities at the El Quevar project in Argentina.

 

12.   Other Liabilities

 

The Company recorded other current liabilities of $7.5 million at both September 30, 2012 and December 31, 2011.  The September 30, 2012 and December 31, 2011 amounts include a loss contingency of $4.8 million and $4.9 million, respectively and an unrecognized tax benefit of $2.7 million and $2.6 million, respectively.  The amounts are all related to foreign withholding taxes and include estimated interest, penalties and other adjustments that may be required upon settlement of the liability.  The loss contingency is expected to be settled over the next five years.

 

The Company has recorded other long term liabilities of approximately $0.2 million and $0.3 million at September 30, 2012 and December 31, 2011 respectively, related to a deferred leasehold liability which represents the recording of rent expense on a straight-line basis while actual rent payments are escalating over the course of the lease and where certain leasehold improvement costs, reimbursable by the landlord, are being amortized, on a straight-line basis, against rent expense over the life of the lease which expires in November 2014.

 

13.   Fair Value Measurements

 

Effective January 1, 2008, the Company adopted ASC 820 for financial assets and liabilities and nonfinancial assets and liabilities which are measured at fair value on a recurring (annual) basis.  ASC 820 establishes a framework for measuring fair value in the form of a fair value hierarchy which prioritizes the inputs into valuation techniques used to measure fair value into three broad levels.  This hierarchy gives the highest priority to quoted prices (unadjusted) 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 per ASC 820 are as follows:

 

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

 

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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 that 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.

 

The following table summarizes the Company’s financial assets at fair value at September 30, 2012, by respective level of the fair value hierarchy:

 

		Level 1			Level 2			Level 3			Total
		(in thousands)
Assets:
Cash equivalents		$	53,561		$	—		$	—		$	53,561
Short-term available for sale securities		417			—			—			417
Trade accounts receivable		1,199			—						1,199
		$	55,177		$	—		$	—		$	55,177

 

The Company’s cash equivalents, comprised principally of U.S. treasury securities, are classified within Level 1 of the fair value hierarchy.

 

The Company’s short-term available for sale securities are classified within Level 1 of the fair value hierarchy and are comprised of common stock, which have been valued using quoted prices in active markets.

 

The Company’s trade accounts receivable is classified within Level 1 of the fair value hierarchy and is related to the sale of metals at our Velardeña Operations and is valued at published metals prices per the terms of the refining and smelting agreements.

 

The Company did not have any Level 2 or Level 3 financial assets at September 30, 2012.

 

Credit Risk

 

Credit risk is the risk that a third party might fail to fulfill its performance obligations under the terms of a financial instrument. For cash and cash equivalents and investments, the Company’s maximum exposure to credit risk represents the carrying amount on the balance sheet. The Company attempts to mitigate credit risk for cash and cash equivalents by placing its funds with high credit-quality financial institutions, limiting the amount of exposure to each financial institution, monitoring the financial condition of the financial institutions and investing only in government and corporate securities rated “investment grade” or better. The Company invests with financial institutions that maintain a net worth of not less than $1.0 billion and are members in good standing of the Securities Investor Protection Corporation.

 

14.  Income Taxes

 

The Company accounts for income taxes in accordance with the provisions of ASC 740, “Income Taxes” (“ASC 740”), on a tax jurisdictional basis. The Company recorded a $2.6 million deferred tax benefit for the quarter ended September 30, 2012, and a $5.6 million deferred tax benefit for the nine months ended September 30, 2012, both related primarily to Mexico net operating losses. The goodwill impairment of $57.2 million recorded as of September 30, 2012, as described in Note 9, is not deductable for income tax purposes, and the tax effect of this impairment is the principal reconciling difference between the provision for income taxes computed at the US statutory rate of 34% and the provision for income taxes as shown in the consolidated statements of operations and comprehensive income (loss). For the nine months ended September 30, 2011, the Company recorded a deferred tax benefit of $1.1 million related primarily to Mexico net operating losses. Based on the limited history that the Company has with its Velardeña Operations, an estimated effective tax rate is not used to report the year-to-date results.

 

In accordance with ASC 740, the Company presents deferred tax assets net of its deferred tax liabilities on a tax jurisdictional basis on its Consolidated Balance Sheets. The net deferred tax liability of $49.2 million and $55.6 million as of September 30, 2012 and December 31, 2011, respectively, consists primarily of a $64.0 million and $65.5 million deferred tax liability related to the basis differences of the properties, plant and equipment of our Velardeña Operations, and a $14.9 million and $10.1 million deferred tax asset related to Mexico net operating losses, respectively.

 

The Company, a Delaware corporation, and its subsidiaries file tax returns in the United States and in various foreign jurisdictions. The tax rules and regulations in these countries are highly complex and subject to interpretation. The Company’s income tax returns are subject to examination by the relevant taxing authorities and in connection with such examinations, disputes can arise with the taxing authorities over the interpretation or application of certain tax rules within

 

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the country involved. In accordance with ASC 740, the Company identifies and evaluates uncertain tax positions, and recognizes the impact of uncertain tax positions for which there is less than a more-likely-than-not probability of the position being upheld upon review by the relevant taxing authority. Such positions are deemed to be “unrecognized tax benefits” which require additional disclosure and recognition of a liability within the financial statements. The Company had unrecognized tax benefits of $2.6 million as of September 30, 2012 and $2.7 million as of December 31, 2011.

 

15.  Equity (Deficit)

 

Registered offering

 

On September 19, 2012, the Company completed a registered offering (the “Offering”) of 5,497,504 shares (the “Shares”) of the Company’s common stock, par value $0.01 per share, and warrants (the “Warrants”) to purchase 2,748,752 shares of the Company’s common stock. The Shares and Warrants were sold in units (“Units”) at a price of $5.75 per Unit, with each Unit consisting of one Share of the Company’s common stock and a Warrant to purchase 0.50 of a share of the Company’s common stock. The Warrants become exercisable on March 20, 2013, at an exercise price of $8.42 per share and will expire on September 19, 2017, five years from the date of issuance. The Shares and the Warrants are immediately separable and were issued separately. The underwriter purchased the Units at a price of $5.4625 per Unit, which was net of the underwriting discount of 5 percent. The Company received net proceeds from the Offering of approximately $29.4 million after the underwriter discount of approximately $1.6 million and other costs of approximately $0.6 million.

 

Private placement

 

On September 19, 2012 the Company also completed a private placement (the “Private Placement”) with The Sentient Group (“Sentient”), the Company’s largest stockholder, pursuant to which Sentient purchased, pursuant to Regulation S under the U.S. Securities Act of 1933, a total of 1,365,794 Units, with each Unit consisting of one share of the Company’s common stock and a Warrant to purchase 0.50 of a share of the Company’s common stock. The Warrants become exercisable on March 20, 2013, at an exercise price of $8.42 per share and will expire on September 19, 2017, five years from the date of issuance. Each Unit was priced at $5.4625, the same discounted price paid by the underwriter in the Offering. The Company received net proceeds from the Private Placement of approximately $7.5 million after the discount of approximately $0.4 million. Following the completion of the Private Placement and the Offering, Sentient continues to hold approximately 19.9% of the Company’s outstanding common stock (excluding restricted common stock held by the Company’s employees).

 

Equity Incentive Plans

 

In April 2009, the Company adopted the 2009 Equity Incentive Plan (the “Equity Plan”) pursuant to which awards of the Company’s common stock may be made to officers, directors, employees, consultants and agents of the Company and its subsidiaries.  The Company recognizes stock-based compensation costs using a graded vesting attribution method whereby costs are recognized over the requisite service period for each separately vesting portion of the award.

 

The following table summarizes the status of the Company’s restricted stock grants issued under the Equity Plan at September 30, 2012 and changes during the nine months then ended:

 

Restricted Stock Grants		Number of Shares		Weighted Average Grant Date Fair Value Per Share
Outstanding at December 31, 2011		223,000		$	11.54
Granted during the period		30,000		8.23
Restrictions lifted during the period		(90,667	)	11.67
Forfeited during the period		(5,000	)	6.19
Outstanding at September 30, 2012		157,333		$	11.00

 

The restricted stock granted during the period was granted to a new officer and an employee hired during the period. One third of the restricted stock granted vests on each of the first, second and third anniversaries of the grant dates, provided the officer or employee continues to serve the Company at that time. Restrictions were lifted during the period on the first anniversary of grants made to certain officers and employees and to a Company officer as a result of his retirement.

 

For the nine months ended September 30, 2012 the Company recognized approximately $0.7 million of compensation expense related to the restricted stock grants. The Company expects to recognize additional compensation expense related to these awards of approximately $0.6 million over the next 28 months.

 

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The following table summarizes the status of the Company’s stock option grants issued under the Equity Plan at September 30, 2012 and changes during the nine months then ended:

 

Equity Plan Options		Number of Shares		Weighted Average Exercise Price Per Share
Outstanding at December 31, 2011		136,810		$	8.01
Granted during period		—		—
Forfeited or expired during period		—		—
Exercised during period		—		—
Outstanding at September 30, 2012		136,810		8.01
Exercisable at end of period		136,810		8.01
Granted and vested		136,810		8.01

 

As a result of the ECU Transaction (see Note 20) all of the stock options outstanding on the September 2, 2011 closing date vested on that date, and the awards were fully expensed at that time. Consequently no compensation expense related to stock option grants was recorded during the nine month period ended September 30, 2012.

 

Also, pursuant to the Equity Plan, the Company’s board of directors adopted the Non-Employee Director’s Deferred Compensation and Equity Award Plan (the “Deferred Compensation Plan”). Pursuant to the Deferred Compensation Plan the non-employee directors receive a portion of their compensation in the form of Restricted Stock Units (“RSUs”) issued under the Equity Plan. The RSUs vest on the first anniversary of the grant and each vested RSU entitles the director to receive one unrestricted share of common stock upon the termination of the director’s board service.

 

The following table summarizes the status of the RSU grants issued under the Deferred Compensation Plan at September 30, 2012 and changes during the nine months then ended:

 

Restricted Stock Units		Number of Underlying Shares		Weighted Average Grant Date Fair Value Per Share
Outstanding at December 31, 2011		63,781		$	11.57
Granted during the period		80,214		3.74
Restrictions lifted during the period		—		—
Forfeited during the period		—		—
Outstanding at September 30, 2012		143,995		$	7.21

 

The RSUs granted during the period are all related to a portion of the annual compensation paid to the directors.

 

For the nine months ended September 30, 2012 the Company recognized approximately $0.2 million of compensation expense related to the RSU grants. The Company expects to recognize additional compensation expense related to these awards of approximately $0.2 million over the next 8 months.

 

16.  Sale of Metals and Related Costs

 

The Company produces marketable products including doré, concentrates and precipitates at its Velardeña Operations. During the quarter ended September 30, 2012 the Company sold marketable products to five customers. Under the terms of the Company’s agreements with one doré and precipitate customer, title does not pass to the purchaser until the product is received by the refinery, at which point revenue is recognized. For the Company’s other customers, title generally passes when a provisional payment is made, which occurs generally after the product is shipped and customary sales documents are completed. Costs related to the sale of metals products includes direct and indirect costs incurred to mine, process and market the products. At September 30, 2012, the Company had written down its metals inventory to net realizable value including a charge to the cost of metals sold of approximately $2.0 million and a charge to depreciation expense of approximately $0.6 million.

 

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17.   Supplemental Cash Flow Information

 

The following table reconciles net loss for the period to cash used in operations:

 

		Nine Months Ended
		September 30,
		2012			2011
		(in thousands)
Cash flows from operating activities:
Net loss		$	(81,087	)	$	(46,260	)
Adjustments to reconcile net loss to net cash used in operating activities:
Amortization and depreciation		6,617			1,580
Accretion of asset retirement obligation		(118		)	—
Foreign currency gain on loss contingency		(117		)	—
Foreign currency gain on deferred tax liability		(522		)	—
Impairment of goodwill		57,213			—
Impairment (reversal of impairment) of accounts receivable		35			151
Asset write off		428			—
Gain on sale of marketable securities		—			215
Fair value of stock/warrants received for mineral rights		(309		)	—
Gain on sale of assets, net		(1,889		)	(389		)
Income tax provision		(5,857		)	(1,070		)
Foreign exchange loss on convertable note		—			472
Stock compensation		831			5,328
Changes in operating assets and liabilities:
Increase in trade accounts receivable		(1,199		)	—
Decrease in prepaid expenses and other assets		1,975			346
Increase in inventories		299			(328		)
Increase in value added tax recoverable, net		(1,716		)	(199		)
Increase in accrued interest payable		—			(60		)
Increase (decrease) in accounts payable and accrued liabilities		(1,909		)	(5,327		)
Decrease in deferred leasehold payments		(71		)	(98		)
Decrease in taxes payable, net		—			769
Treasury shares acquired and retired		—			(1,834		)
Net cash used in operating activities		$	(27,396	)	$	(46,704	)

 

18.  Commitments and Contingencies

 

The Company may have committed errors in prior years in the withholding and payment of certain foreign payroll and value added taxes related to certain of its foreign subsidiaries. The Company believes it is unlikely that it will be assessed any amounts for these taxes prior to the statute of limitations expiring for the years in question, but has estimated that the contingent liability would be in the range of $0.0 to $1.7 million.

 

19.  Segment Information

 

The Company’s activities are the exploration, development and mining of mineral properties containing precious metals. The Company’s reportable segments are based upon the Company’s revenue producing activities and cash consuming activities. The Company reports two segments, one for its producing Velardeña mines in Mexico and the other comprised of non-producing activities including exploration, development and general and administrative activities. Intercompany revenue and expense amounts have been eliminated within each segment in order to report on the basis that management uses internally for evaluating segment performance. The financial information relating to the Company’s segments is as follows:

 

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Three Months Ended September 30, 2012		Revenue			Costs Applicable to Sales			Depreciation, Depletion and Amortization			Exploration, El Quevar, Velardeña and Administrative Expense			Pre-Tax loss			Total Assets			Capital Expenditures
Velardeña Mine		$	7,063		$	8,573		$	2,516		$	767		$	61,167					$	2,115
Corporate, Exploration & Other		—			—			258			4,126			4,763						86
		$	7,063		$	8,573		$	2,774		$	4,893		$	65,930					$	2,201
Nine Months Ended September 30, 2012
Velardeña Mine		$	18,384		$	23,103		$	5,631		$	6,291		$	71,086		$	299,070		$	7,218
Corporate, Exploration & Other		—			—			986			14,780			15,575			60,657			87
		$	18,384		$	23,103		$	6,617		$	21,071		$	86,661		$	359,727		$	7,305
Three Months Ended September 30, 2011
Velardeña Mine		$	—		$	965		$	218		$	135		$	3,910					$	—
Corporate, Exploration & Other		—			—			499			11,860			9,002						1,379
		$	—		$	965		$	717		$	11,995		$	12,912					$	1,379
Nine Months Ended September 30, 2011
Velardeña Mine		$	—		$	965		$	218		$	135		$	3,910		$	375,559		$	—
Corporate, Exploration & Other		—			—			1,362			42,028			43,420			68,276			6,230
		$	—		$	965		$	1,580		$	42,163		$	47,330		$	443,835		$	6,230

 

20.  Acquisition of ECU Silver Mining Inc.

 

On September 2, 2011, the Company completed the Transaction with ECU. Pursuant to the terms and conditions of an agreement dated June 24, 2011, between the Company and ECU, the businesses of the Company and ECU were combined by way of a court-approved plan of arrangement (the “Arrangement”) pursuant to the provisions of the Business Corporations Act (Québec).

 

Pursuant to the Arrangement Agreement:

 

·                  each ECU common share outstanding immediately prior to the effective time of the Arrangement on September 2, 2011 (the “Effective Time”) was exchanged for the right to receive 0.05 shares of the Company’s common stock (the “Exchange Ratio”) and Cdn$0.000394 in cash, resulting in the issuance of 16,004,111 shares of common stock and payment of approximately Cdn$126,112 in cash;

 

·                  each warrant to purchase ECU common shares (an “ECU Warrant”) outstanding immediately prior to the Effective Time issued pursuant to ECU’s February 2009 warrant indenture or ECU’s December 2009 warrant indenture was exchanged at the Exchange Ratio for the right to receive a warrant to purchase shares of the Company’s common stock (a “Replacement Warrant”) on the same terms and conditions as were applicable to such ECU Warrant immediately prior to the Effective Time, resulting in the issuance of warrants to purchase 386,363 shares of the Company’s common stock at an exercise price of Cdn$18.00 per share expiring on December 9, 2011, and warrants to purchase 1,831,929 shares of the Company’s common stock at an exercise price of Cdn$19.00 per share expiring on February 20, 2014; and

 

·                  each option to purchase ECU common shares (an “ECU Option”) outstanding immediately prior to the Effective Time granted under the ECU’s stock option plan was exchanged at the Exchange Ratio for an option to purchase shares of the Company’s common stock (a “Replacement Option”) on the same terms and conditions as were applicable to the corresponding ECU Options immediately prior to the Effective Time; resulting in the issuance of options to purchase 653,000 shares of the Company’s common stock at exercise prices ranging Cdn$16.00 and Cdn$60.00 and with expiration dates ranging from September 24, 2011 to October 22, 2014.

 

The Company incurred approximately $4.7 million of transaction costs for financial advisory, legal, accounting, tax and consulting services as part of the Arrangement. The Company also incurred approximately $2.5 million in severance related payments as part of the termination of ECU’s officers and certain employees following the acquisition of ECU. The transaction and severance payment costs were recognized separately from the purchase price for the Arrangement.

 

The Company followed the acquisition method of accounting in accordance with ASC 805 “Business Combinations” (“ASC 805”). The following tables summarize the preliminary calculation of the purchase price and the fair values of the assets acquired and liabilities assumed on September 2, 2011 in connection with the Transaction.

 

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