UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

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

For the quarterly period ended June 30, 2014

☐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: 001-34857

 

GOLD RESOURCE CORPORATION

(Exact Name of Registrant as Specified in its charter)

 

 

2886 Carriage Manor Point, Colorado Springs, Colorado 80906

(Address of Principal Executive Offices) (Zip Code)

 

 (303) 320-7708

(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  ☒    No   ☐ 

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 post such files). Yes  ☒ No ☐ 

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

 

 

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:  54,179,369 shares of common stock outstanding as of August 6, 2014.

 

 

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GOLD RESOURCE CORPORATION

 

FORM 10-Q

 

Index

 

 

 

 

References in this report to agreements to which Gold Resource Corporation is a party and the definition of certain terms from those agreements are not necessarily complete and are qualified by reference to the agreements. Readers should refer to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013 and the exhibits listed therein.

 

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PART I - FINANCIAL INFORMATION

ITEM 1.  Financial Statements

 

 

 

 

 

 

 

 

 

 

 

 

 

   

 

 

 

 

 

 

 

 

 

 

 

 

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GOLD RESOURCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

June 30,  2014

 (Unaudited)

1.  Nature of Operations and Basis of Presentation

Nature of Operations

Gold Resource Corporation (the “Company”) was organized under the laws of the State of Colorado on August 24, 1998. The Company is a producer of metal concentrates that contain gold, silver, copper, lead and zinc at its El Aguila Project in the southern state of Oaxaca, Mexico. The El Aguila Project includes the El Aguila open pit mine, which ceased operations in February 2011, and the La Arista underground mine, which is currently in operation. The Company is also performing exploration and evaluation work on its portfolio of base and precious metal exploration properties in Mexico and is evaluating other properties for possible acquisition.

On April 30, 2014, the Company announced the completion of its reserve study and issued a report dated December 31, 2013 confirming the existence of proven and probable reserves as defined in Industry Guide 7 promulgated by the U.S. Securities and Exchange Commission (“Guide 7”). As a result of the completion of the reserve study, the Company has transitioned from an Exploration Stage Enterprise to a Production Stage Enterprise in accordance with Guide 7. The Company no longer considers itself to be a Development Stage Entity as defined in Accounting Standards Codification 915 – Development Stage Entities (“ASC 915”). Accordingly, cumulative and other disclosures required by ASC 915 are no longer included in the Company’s financial statements.

Basis of Presentation

Basis of Presentation: The unaudited interim condensed consolidated financial statements included herein are expressed in United States dollars and were prepared in conformance with United States generally accepted accounting principles (“U.S. GAAP”) and applicable rules of the SEC regarding interim financial reporting. The unaudited interim condensed consolidated financial statements include the accounts of the Company and its wholly owned U.S. subsidiary GRC Nevada Inc. (“GRC Nevada”) and Mexican subsidiary Don David Gold Mexico S.A. de C.V. (“Don David Gold Mexico”).  Significant intercompany accounts and transactions have been eliminated.  Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to SEC rules and regulations, although the Company believes that the disclosures included herein are adequate to make the information presented not misleading.  These unaudited interim condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto contained in the Company’s Form 10-K for the year ended December 31, 2013.  Except as noted below, there have been no material changes to the footnotes from those accompanying the audited financial statements contained in the Company’s Form 10-K.

In management’s opinion, the unaudited condensed consolidated financial statements contained herein reflect all material normal and recurring adjustments that are necessary for the fair presentation of the Company’s financial position, results of operations, and cash flows on a basis consistent with that of its audited consolidated financial statements for the year ended December 31, 2013. However, the results of operations for the interim period ended June 30, 2014 may not be indicative of results of operations to be expected for the full fiscal year. 

Use of Estimates: The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Management routinely makes judgments and estimates about the effects of matters that are inherently uncertain and bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances.  Actual results could differ from these estimates.

Revenue Recognition: Sales of concentrates are recorded net of treatment and refining charges, plus final settlement and mark-to-market price adjustments.  Treatment and refining charges represent payments or price adjustments that are fixed and applied on a per tonne, pound or ounce basis, and in some cases provide for an increase in charges based on increases in metal prices above a base price. Treatment and refining charges are estimated upon shipment of concentrates based on contractual terms, with adjustments made at final settlement.  Adjustments at final settlement typically do not vary materially from estimates made upon shipment; however, mark-to-market price adjustments could vary materially based on the precious metals market.  In addition, because a portion of the metals contained in concentrates are unrecoverable as a result of the smelting process, the Company’s revenues from sales of concentrates are also recorded net of allowances based on the quantity and value of these estimated unrecoverable metals.  These allowances are negotiated with the buyer of the Company’s concentrates. 

Production Costs: Production costs include labor and benefits, royalties, concentrate shipping costs, mining subcontractors, fuel and lubricants, legal and professional fees related to mine operations, stock-based compensation attributable to mine employees, materials and supplies, repairs and maintenance, explosives, housing and food, insurance, reagents, travel, medical services, security equipment, office rent, tools and other costs that support our mining operations.

Mine Development: The Company expenses general prospecting costs and the costs of acquiring and exploring unevaluated mineral properties. When a mineral property has determined to have proven and probable reserves, subsequent development costs are capitalized to mineral properties. When mineral properties are developed and operations commence, capitalized costs are charged to operations using the units-of-production method over proven and probable reserves. Upon abandonment or sale of a mineral property, all capitalized costs relating to the specific property are written off in the period abandoned or sold and a gain or loss is recognized.

 Reclassifications: Certain amounts presented in prior periods have been reclassified to conform to current period presentation. 

Exploration Stage Company:  As of January 31, 2014 the condensed consolidated financial statements are no longer presented in accordance with Accounting Standards Codification 915 and the provisions of SEC Industry Guide 7 relating to exploration stage entities. On April 30, 2014, the Company issued a report on the reserve estimate for the La Arista underground mine at the El Aguila Project with an effective date of December 31, 2013. The report confirms the existence of proven and probable reserves, allowing the Company to transition from an Exploration Stage Company as defined in ASC 915 and an Exploration Stage Enterprise to a Production Stage Enterprise as defined in SEC Industry Guide 7. Consistent with the Company’s transition from an Exploration Stage Entity to a Production Stage Entity as defined in Guide 7, certain underground mine development costs associated with the Company's El Aguila Project were capitalized beginning January 1, 2014.  These costs include the cost of building access ways, lateral development, drift development, ramps and infrastructure development. All such costs are amortized using the units-of-production method over the estimated life of the ore body based on estimated recoverable ounces to be produced from proven and probable reserves.    

Investments: We make elections, on an investment-by-investment basis, as to whether we measure our investments at fair value. Such elections are generally irrevocable. We have elected the fair value method for most of our investments as we believe this method generally provides the most meaningful information to our investors. However, for investments over which we have significant influence, we consider the significance of transactions between our company and our equity affiliates and other factors in determining whether the fair value method should be applied. In general, we elect the fair value option for those equity method investments with which the Company or its consolidated subsidiaries have significant related-party transactions.

 

Under the fair value method, investments are recorded at fair value and any changes in fair value are reported in realized and unrealized gains or losses due to changes in fair values of certain investments and debt, net, in our consolidated statement of operations. All costs directly associated with the acquisition of an investment to be accounted for using the fair value method are expensed as incurred. For additional information regarding our fair value method investments, see notes 2 and 4.

 

2.  Fair Value Measurement 

The Company’s financial instruments consist of accounts receivable (which include provisionally priced sales) and investments in equity securities.  The Company’s Level 1 assets as of June 30, 2014 included investments in equity securities determined using a market approach based upon unadjusted quoted prices for identical assets in an active market. The Level 2 carrying values for accounts receivable approximated their fair values at June 30, 2014 and December 31, 2013 due to their short maturities.

When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:

The following tables summarize the Company’s financial instruments required to be measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013:

 

 

 

 

 

 

(1) Certain concentrate sales contracts provide for provisional pricing as specified in such contracts. These sales contain an embedded derivative related to the provisional pricing mechanism which is bifurcated and accounted for as a derivative. At the end of each reporting period, the Company records an adjustment to sales to reflect the mark-to-market of outstanding provisional invoices. Because these provisionally priced sales have not yet settled, the mark-to-market adjustment related to these invoices is included in accounts receivable as of each reporting date. The receivable is the sales contract with no quoted market price, whereas the underlying metal values (inputs) are directly observable for the full amount of the receivable (Level 2).

Gains and losses related to changes in the fair value of these financial instruments were included in the Company’s condensed consolidated statement of income for the three and six months ended June 30, 2014.

 

3. Gold and Silver Bullion

The Company periodically purchases gold and silver bullion on the open market for investment purposes and to use in its dividend exchange program whereby shareholders may exchange their cash dividend for gold and silver bullion.  The Company’s investment in gold and silver bullion is carried at cost and evaluated for impairment at relevant financial reporting dates.

During the six months ended June 30, 2014, the Company made no purchases of gold or silver.    During the six months ended June 30, 2013, the Company purchased approximately 507 ounces of gold and 1,005 ounces of silver at market prices for a total cost of $0.8 million. During the six months ended June 30, 2014, approximately five ounces of gold and 507 ounces of silver were converted into gold and silver bullion and distributed under the Company’s gold and silver bullion dividend exchange program, resulting in a realized gain of $2,500 in that period. During the six months ended June 30, 2013, approximately 562 ounces of gold and 2,242 ounces of silver were converted into gold and silver bullion and distributed under this dividend program, resulting in a realized loss of $0.1 million in that period.

 

The table below shows the balance of the Company’s holdings of bullion as of June 30, 2014 and December 31, 2013: 

 

 

 

The Company recorded no impairment on its gold and silver bullion for the three and six months ended June 30, 2014. 

 

4. Investments

Investments in equity securities at June 30, 2014 and December 31, 2013 consisted of the following:

 

 

 

 

 (1) On February 26, 2014, the Company announced the purchase of 22,222,222 shares in Canamex Resource Corp., a publically traded company in Canada. The Company’s shares represented approximately 18.4% of the outstanding shares of Canamex. Pursuant to the terms of the subscription agreement, the Company appointed Jason Reid as its representative to the Board of Directors of Canamex on April 14, 2014.

 

 

 

 

 

 

 

5.  Inventories 

Inventories at June 30, 2014 and December 31, 2013 consisted of the following:

 

 

 

 

 

 

 

6.  Property, equipment and mine development - net

Property, equipment and mine development at  June 30, 2014 and December 31, 2013 consisted of the following:

 

In May and June 2013, the Company entered into financing transactions with certain equipment financing companies whereby the Company sold to them mining equipment that was purchased by the Company from February 2013 through June 2013.  The equipment was subsequently leased back to the Company for a three-year period with a bargain purchase option at the end of the lease term, which the Company intends to exercise.  The Company will retain full use and all benefits attributable to the leased equipment. 

 

The equipment leases qualify as capital leases and have been recorded at the present value of the future minimum lease payments, including the bargain purchase option and transaction fees, which approximates the net carrying value of the equipment.  The equipment leases bear interest of 4.5% to 5.5% per annum, with monthly principal and interest payments of approximately $0.1 million over the three-year lease term.   The Company has an option to purchase the equipment at the end of the lease term for less than $0.1 million.  The present value of the future minimum lease payments, including the bargain purchase options and up-front transaction fees, totaled $4.8 million. Depreciation on the leased assets is recorded over their estimated useful lives.

 

As of June 30, 2014, the Company’s obligations under capital leases are as follows:

 

 

 

 

 

 

 

 

 

7.  Reclamation and Remediation

 

The Company’s reclamation and remediation obligations relate to its El Aguila Project.  The following table presents the changes in reclamation and remediation obligations for the six months ended June 30, 2014 and the year ended December 31, 2013:

 

 

 

 

 

8.  Shareholders’ Equity 

The Company declared dividends of $1.6 million and $4.8 million and paid gross cash dividends of $1.6 million and $6.4 million during the three months ended June 30, 2014 and 2013, respectively. The Company declared dividends of $3.2 million and $14.3 million and paid gross cash dividends of $3.2 million and $15.9 million during the six months ended June 30, 2014 and 2013, respectively. Under our dividend exchange program, shareholders who participated during the three months ended June 30, 2014 exchanged gross cash dividends of $9,000 for approximately two ounces of gold and 278 ounces of silver and during the three months ended June 30, 2013 exchanged gross cash dividends of $0.3 million for approximately 213 ounces of gold and 562 ounces of silver, respectively.  Under our same program, shareholders who participated during the six months ended June 30, 2014 exchanged gross cash dividends of $18,000 for approximately five ounces of gold and 507 ounces of silver and during the six months ended June 30, 2013 exchanged gross cash dividends of $1.0 million for approximately 562 ounces of gold and 2,242 ounces of silver, respectively.

The Board of Directors has authorized the Company’s dividends to be charged to paid-in capital until such time as the Company has retained earnings, at which time dividends will be charged to retained earnings to the extent that the Company has retained earnings.  For the six months ended June 30, 2014 and 2013, $3.2 million and $0.2 million of declared dividends were charged to retained earnings, and nil and $14.1 million was charged to paid-in capital, respectively.

 

9.    Concentrate Sale Settlements

The Company records adjustments to sales of metals concentrate that result from final settlement of provisional invoices in the period that the final invoice settlement occurs.  The Company also reviews assays taken at the mine site on its concentrate shipments, upon which the Company’s provisional invoices are based, with assays obtained from samples taken at the buyer’s warehouse prior to final settlement, upon which the final invoices are in part based, to assess whether an adjustment to sales is required prior to final invoice settlement. These adjustments resulted in a decrease of $1.8 million and $2.5 million to sales during the three and six months ended June 30, 2014, respectively, and a decrease to sales of $0.7 million and $0.3 million for the three and six months ended June 30, 2013, respectively.

In addition to the final settlement adjustments on provisional invoices, the Company records a sales adjustment to mark-to-market outstanding provisional invoices at the end of each reporting period.  These adjustments resulted in a decrease to sales of $0.9 million and $2.1 million for the three and six months ended June 30, 2014, respectively, and a decrease to sales of $2.1 million and $4.4 million for the three and six months ended June 30, 2013, respectively.

 

Sales of metals concentrate are recorded net of smelter refining fees, treatment charges and penalties.  Total charges for these items totaled $3.2 million and $6.1 million for the three and six months ended June 30, 2014, respectively, and $3.3 million and $7.5 million for the three and six months ended June 30, 2013, respectively.

 

 

10. Stock Options

The Company has a non-qualified stock option and stock grant plan under which equity awards may be granted to key employees, directors and others (the “Plan”).  A summary of activity under the Plan for the six months ended June 30, 2014 is presented below:

 

 

The fair value of options granted during the three and six months ended June 30, 2014 was nil and $23,000, respectively. The options vest over a three year period and have an exercise term of 10 years. The total fair value of stock options vested during the three and six months ended June 30, 2014 was nil and $0.7 million, respectively.

 

The following table summarizes information about stock options outstanding at June 30, 2014:

 

 

The fair value of stock option grants is amortized over the respective vesting period. Total stock-based compensation expense related to stock options for the three and six months ended June 30, 2014 was $1.2 million and $2.0 million, respectively, and for the three and six months ended June 30, 2013 was $2.2 million and $3.7 million, respectively.  

 

Stock-based compensation expense has been allocated between production costs and general and administrative expense for the three and six months ended June 30, 2014 and 2013 as follows:

 

The estimated unrecognized stock-based compensation expense from unvested options as of June 30, 2014 was approximately $5.7 million, and is expected to be recognized over the remaining vesting periods of up to 3.0 years. 

 

The assumptions used to determine the value of stock-based awards under the Black-Scholes method are summarized below:   

 

 

 

 

 

 

 

11. Other Income (Expense)

 

Other income (expense) for the three and six months ended June 30, 2014 and 2013 consisted of the following:

 

 

 (1) Our unrealized gain due to changes in fair values of certain investments include gains associated with changes in fair values that are non-cash in nature until such time that these gains are realized through cash transactions. For additional information regarding our investments and fair value measurements, see notes 2 and 4 to our condensed consolidated financial statements.

 

 

 

12.  Income Taxes 

 

The Company recorded income tax expense of $6.4 million and $11.6 million for the three and six months ending June 30, 2014, respectively.  During the three and six months ending June 30, 2013, the Company recorded income tax (benefit) expense of $(1.3) million and $3.7 million, respectively.

 

During the three and six months ending June 30, 2014, the Company received advances of $12.0 million and $12.0 million, respectively, from its Mexican operations. The Company has asserted permanent reinvestment of all Mexico undistributed earnings as of December 31, 2013. The impact of the planned annual dividends for 2014, net of foreign tax credits, is reflected in the estimated annual effective tax rate.

 

During the six months ended June 30, 2014, the Company experienced an increase in its annualized effective tax rate principally due to the newly enacted Mexico mining tax.

 

In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities (including the impact of available carryback and carry forward periods), projected future taxable income and tax-planning strategies in making this assessment. As of June 30, 2014, the Company believes it has sufficient positive evidence to conclude that realization of its federal and foreign deferred tax assets of Gold Resource Corporation are more likely than not to be realized. However, the Company has determined that the realization of its state deferred tax assets is not more likely that not to be realized and has a valuation allowance offsetting the state deferred tax assets.

As of June 30, 2014, the Company believes that it has no liability for uncertain tax positions. If the Company were to determine there was an uncertain tax position, the Company would recognize the liability and related interest and penalties within income tax expense. 

The Company files income tax returns in U.S. federal and state jurisdictions, Mexico and Turkey. The Company is currently not undergoing any income tax examinations in any jurisdiction, however to the extent that net operating losses have been utilized in either the current or preceding years, such losses may be subject to future income tax examination. 

 

13. Net Income (Loss) per Share

 

Basic earnings (loss) per share is calculated based on the weighted average number of common shares outstanding for the period.  Diluted earnings per share is calculated based on the assumption that stock options outstanding, which have an exercise price less than the average market price of the Company’s common shares during the period, have been exercised on the later of the beginning of the period or the date granted and that the funds obtained from the exercise were used to purchase common shares at the average market price during the period.

 

The effect of potentially dilutive stock options on the weighted average number of shares outstanding for the three and six months ended June 30, 2014 and 2013 is as follows:

 

Stock options totaling 3.1 million for the three and six months ending June 30, 2014 were excluded from the computation of diluted weighted average shares outstanding, since the exercise price of those stock options exceeded the average market price of the Company’s common shares of $4.57 and $4.82 during the three and six months ended June 30, 2014. Stock options totaling 2.9 million and 2.8 million for the three and six months ending June 30, 2013 were excluded from the computation of diluted weighted average shares outstanding, since the exercise price of those stock options exceeded the average market price of the Company’s common shares of $9.87 and $11.68 during the three and six months ended June 30, 2013.

 

 

 

14.  Legal Proceedings

 

A securities class action lawsuit subsequently captioned In re Gold Resource Corp. Securities Litigation, No.1:12-cv-02832 was filed on October 25, 2012 in the U.S. District Court for the District of Colorado naming the Company and certain of its current and former officers and directors as defendants.  The complaint alleged violations of federal securities laws by the Company and certain of its officers and directors. On July 15, 2013, the federal district court granted the Company’s motion to dismiss the lawsuit with prejudice.  The plaintiff has appealed the District Court’s decision to the United States Court of Appeals for the Tenth Circuit.

 

On February 8, 2013, a shareholder’s derivative lawsuit entitled City of Bristol Pension Fund v. Reid et al., No. 1:13-CV-00348 was filed in the U.S. District Court for the District of Colorado naming the Company as a nominal defendant, and naming seven of its current and former officers and directors as defendants. The lawsuit alleges breach of fiduciary duty, gross mismanagement and unjust enrichment and seeks to recover, for the Company’s benefit, unspecified damages purportedly sustained by the Company in connection with the alleged misconduct identified in the class action lawsuit discussed above and an award of attorney’s fees and costs. The action was stayed pending resolution of the motion to dismiss in the securities class action lawsuit and the stay has been extended pending the appeal. There has been no discovery as the case is in its initial stages and accordingly, the Company is not in a position to assess the likelihood or estimate the potential range of loss associated with this matter; however, pursuant to the Company’s articles of incorporation and contractual agreements with the individuals, it is obligated to indemnify its officers and directors with respect to this litigation and the Company will bear the cost associated with defense of these claims.

 

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

 

The following discussion summarizes the results of operations of Gold Resource Corporation and its subsidiaries (“we”, “our”, or “us”) for the three and six months ended June 30,  2014 and compares those results to the three and six months ended June 30,  2013.  It also analyzes our financial condition at June 30,  2014 and compares it to our financial condition at December 31, 2013. This discussion should be read in conjunction with the Management’s Discussion and Analysis and the audited financial statements contained in our Form 10-K for the year ended December 31, 2013.  

 

The discussion also presents certain Non-GAAP financial measures that are important to management in its evaluation of our operating results and which are used by management to compare our performance with what we perceive to be peer group mining companies, and are relied on as part of management’s decision-making process.  Management believes these measures may also be important to investors in evaluating our performance. For a detailed description of each of the Non-GAAP financial measures and the limitations inherent in such measures, please see the discussion below under “Non-GAAP Measures”.

 

Overview

 

Business

 

We are a mining company which pursues gold and silver projects that are expected to have low operating costs and high returns on capital.  We are presently focused on mineral production from ore at the El Aguila Project in Oaxaca, Mexico. Ore from the El Aguila open pit mine was processed into a metal concentrate containing the primary product of gold, with silver as a by-product. Operations at the El Aguila open pit mine ceased in February 2011 with the start-up of mine operations at the La Arista underground mine in March 2011. Our La Arista underground mine produces metal concentrates from ore containing our primary metal products of gold and silver, and by-products of copper, lead and zinc.

 

The mill located at our El Aguila Project produced a total of 24,172 precious metal gold equivalent ounces for the three months ended June 30,  2014.  During this period, we sold 20,647 precious metal gold equivalent ounces at a total cash cost net of by-product credits (including royalties and as otherwise defined below) of $438 per precious metal gold equivalent ounce sold. The mill at our El Aguila Project produced a total of 47,896 precious metal gold equivalent ounces for the six months ended June 30, 2014.  During this period, we sold 41,241 precious metal gold equivalent ounces at a total cash cost of $430 per precious metal gold equivalent ounce sold. Precious metal gold equivalent is determined by taking gold ounces produced or sold, plus silver ounces produced or sold converted to precious metal gold equivalent ounces using the gold to silver average price ratio for the period. The gold and silver average prices used to determine the gold to silver average price ratio are the actual metal prices realized from sales of our gold and silver. (Please see the section titled “Non-GAAP Measures” below for additional information concerning the cash cost per ounce measures.) 

 

For the three months ended June 30,  2014, we reported revenue of $33.7 million, mine gross profit of $17.8 million and net income of $7.8 million. For the six months ended June 30, 2014, we reported revenue of $64.8 million, mine gross profit of $34.0 million and net income of $14.9 million.    

 

Reserve Report

Beginning January 1, 2014, we transitioned from an Exploration Stage Enterprise to a Production Stage Enterprise as defined by SEC Industry Guide 7. On April 30, 2014, we issued a report on the reserve estimate for the La Arista underground mine at the El Aguila Project with an effective date of December 31, 2013. The report confirms proven and probable reserves and we therefore transitioned from an Exploration Stage Company as defined in Accounting Standards Codification 915 – Development Stage Entities (“ASC 915”) and an Exploration Stage Enterprise to a Production Stage Enterprise as defined in SEC Industry Guide 7. We no longer consider ourselves to be an exploration stage company as defined in ASC 915 and accordingly cumulative and other disclosures required by ASC 915 are no longer included in the Company’s financial statements.

Prior to January 1, 2014, we were considered an exploration stage company under SEC criteria since we had not demonstrated proven or probable reserves at our El Aguila Project in Oaxaca, Mexico or any of our other properties. Accordingly, as required under SEC guidelines, substantially all of our investment in mining properties up to that date, including construction of the mill, mine facilities and mine construction expenditures, were expensed as incurred and therefore do not appear as assets on our balance sheet.

 

Our characterization as an exploration stage company resulted in the classification of our facilities and mine construction expenditures as operating expenses rather than capital expenditures, and may have caused us to report lower net income than if we had capitalized the expenditures.  In addition, prior to January 1, 2014, our financial statements did not reflect a corresponding depreciation or amortization expense for our facilities and mine construction costs since they were expensed as incurred rather than capitalized. The change in our accounting presentation as a result of our transition to a production stage enterprise may make certain period-over-period comparisons in this quarterly report less meaningful than otherwise since we capitalized mine development related expenditures that would have been expensed under our prior accounting presentation.  

 

Exploration Activities

 

El Aguila Project:  Our mine exploration activities during the second quarter of 2014 at El Aguila continued to focus on the La Arista vein system.  In addition to our Arista deposit expansion focus, exploration drilling during the quarter also included targeting the feeder vein of the Aguila open pit and the Chacal Red Zone, both on the El Aguila Project. Twenty-two diamond drill holes totaling 10,444 meters were completed during the second quarter of 2014.  Drilling consisted of both infill and step-out holes testing the mineralized vein extensions at our producing La Arista underground mine.  During the quarter, drilling principally targeted the northwest and southeast extensions of the Arista, Baja, Candelaria, Luz, and Splay 66 veins, and the recently discovered Santa Lucia vein, which are all currently in production in the La Arista underground mine. The Santa Lucia vein is a parallel vein structure located approximately 60 meters northeast of the Arista vein on level 14.  Underground drilling also expanded the Socorro and Splay 5 veins located at the southwest of the system. 

 

Surface drilling southwest of the Arista deposit focused on the Aire and on the northern extension of the Splay 6 vein.  Drilling at the Chacal Red Zone, located 4 km due west of the La Arista mine, is targeting many of the same geological features as those seen at La Arista underground mine and in the El Aguila open pit area. 

 

Las Margaritas property:  Results of previous exploration drilling at the Las Margaritas property continue to be evaluated along with structural geology, alteration, geochemical studies and geophysical surveys completed on the property.    Additional detailed geological mapping, sampling and a review of existing geological and geophysical data is planned for Las Margaritas in the third quarter with diamond drilled planned for the fourth quarter.

 

Alta Gracia property:  A review of existing geological, geophysical, diamond drilling and underground sampling data for Alta Gracia was completed in the second quarter and diamond drilling is being planned for Alta Gracia in the third quarter.

 

El Fuego property: A follow-up field investigation was conducted on the El Fuego property during the second quarter. Additional geologic mapping and surface sampling is planned on El Fuego during the third quarter which we believe will allow us to meet the acceptable minimum amount of work required to maintain the claims.  

 

 

Results of Operations 

 

The following table summarizes our results of operations for the three and six months ended June 30,  2014 as compared to the three and six months ended June 30,  2013:

 

 

 

Sales of metals concentrate, net

 

Metal concentrate sales for the three months ended June 30, 2014 increased by $7.0 million, or 26.3%, primarily as a result of increased mill tonnage throughput, as mill head grades and realized metal prices decreased compared with the corresponding period in 2013. Revenue generated from the sale of base metals contained in our concentrates is considered a by-product of our gold and silver production.  (See “Production and Sales Statistics - La Arista Underground Mine” table below for additional information regarding our mineral production statistics for the three and six months ended June 30, 2014 and 2013).

 

Metal concentrate sales for the six months ended June 30, 2014 decreased by $4.2 million, or 6.0%, was primarily due to lower average grades, lower realized gold and silver prices, and lower beginning concentrate inventory levels when compared to the corresponding period in 2013. Gold and silver prices realized for the six months ended June 30, 2014 decreased by 15.9% to $1,286 per ounce and 25.9% to $20 per ounce, respectively, when compared to the same period in 2013.

 

Production

 

Mill production for the three months ended June 30,  2014,  totaled 24,172 precious metal gold equivalent ounces compared to 20,574 precious metal gold equivalent ounces for the three months ended June 30,  2013.  The increase in precious metal gold equivalent production for the three months ended June 30,  2014 was primarily due to the mill expansion that was completed in 2013, increasing total tonnes milled by 36%  when compared to the corresponding period ended June 30, 2013. The increase in precious metal gold equivalent production for the three months ending June 30, 2014 was partially offset by lower average gold and silver grades when compared to the three months ending June 30, 2013. See  “Production and Sales Statistics-La Arista Underground Mine” table below for additional information regarding our mineral production statistics. 

 

We continue to focus on mining and development activities at the La Arista underground mine. Our production rate at La Arista is directly a result of mine development and the establishment of sufficient stopes and working faces.  We are currently mining the wider veins using the long-hole open stoping method, and the narrower veins using the cut and fill method.  La Arista mine development on average during the first half of 2014 has enabled us to increase mill throughputs over the prior year’s average. Even though we have not yet reached our mill capacity of 1,500 tonnes per day we will continue to strive for that target in the future.    

 

The El Aguila mill expansion increased the mill’s nominal flotation circuit processing capacity to 1,500 tonnes per day.  Commissioning of the expanded mill took place at the end of 2013.  Achieving this processing rate is dependent upon our ability to develop the La Arista underground mine to a point where ore extraction can consistently achieve an average rate of 1,500 tonnes per day.  Although we are targeting a processing rate of 1,500 tonnes per day in the future, we expect a ramp up towards that capacity and there is no assurance that this mining rate can be achieved or sustained over the long-term. During the three and six months ended June 30, 2014 we processed 1,098 and 1,128 ore tonnes per day as compared to 808 and 823 ore tonnes per day for the same period in 2013, representing an increase of 36%  and 37%, respectively.

 

The mineral concessions that comprise our La Arista underground mine are subject to a 4% net smelter returns royalty on sales of any gold and silver doré, and a 5% net smelter returns royalty on sales of any concentrate.  We produce gold and silver in our copper, lead and zinc concentrates, but no gold and silver doré, at our La Arista underground mine.  Royalties are considered mine operating costs and are funded from the sale of concentrates.  Royalty expense is recorded based on provisional invoices and adjusted based on the final invoice. An initial royalty payment of 50% of the provisional invoice amount is made when the provisional invoice is collected.  The remaining royalties owed are paid when we receive full payment for the final invoice.  We made royalty payments for the three and six months ended June 30, 2014 of $1.6 million and $3.1 million, respectively, and $1.4 million $3.5 million for the three and six months ended June 30, 2013. We estimate that between $6 million and $7 million of royalty will be paid in 2014, subject to market prices for the metals in our concentrates, mine production and timing of final invoice settlements.

 

The following table summarizes certain information about our mining operations for the three and six months ended June 30, 2014 and 2013:

 

 

 

 

 

 

 

 

Mine gross profit. For the three months ended June 30, 2014, mine gross profit totaled $17.8 million compared to $11.1 million for the three months ended June 30, 2013.  The increase in gross profit principally resulted from reduced spending and the increase in sales from precious metal gold equivalent ounces sold and copper, lead and zinc tonnes sold. The increase  sales and reduced spending contributed to the increase in our gross profit percentage to 52.9% for the three months ended June 30, 2014 compared to 41.6% for the three months ended June 30, 2013.  For the six months ended June 30, 2014, mine gross profit totaled $34.0 million compared to $37.2 million for the six months ended June 30, 2013. Gross profit percentages for the six months ended June 30, 2014 decreased to 52.5% from 53.9% for the six months ended June 30, 2013. The decrease in mine gross profit from the prior period was primarily due to lower average grade in our gold and silver precious metals mined and lower realized metal prices for the six months ended June 30, 2014 as compared to 2013.

 

Net income. For the three months ended June 30,  2014, we recognized net income of $87.8 million, or $0.14 per basic share, as compared to net loss of  $1.4 million, or $0.03 per basic share, for the comparable period of 2013.  The improvement in operations for the three months ended June 30,  2014 principally resulted from an increase of sales from our metals concentrate and a decrease in general and administrative, exploration and facilities and mine construction expenses due from an accounting change as a result of transitioning from an Exploration Stage Enterprise to a Production Stage Enterprise beginning January 1, 2014 as defined by SEC Industry Guide 7 and partially offset by lower realized metal prices in the 2014 period.  For the six months ended June 30, 2014, net income was $14.9 million, or $0.28 per basic share, as compared to $6.0 million, or $0.11 per basic share, for the comparable period of 2013. The increase in net income results for the six months ended June 30, 2014 of $8.9 million as compared to 2013 was also principally attributable to a decrease in production costs, general and administrative, exploration and construction and development expenses due from an accounting change as a result of transitioning from an Exploration Stage Enterprise to a Production Stage Enterprise as noted above.

Costs and expenses. Total costs and expenses during the three months ended June 30,  2014 were $3.9 million compared to $11.9 million during the comparable period of 2013, a decrease of $8.1 million, or 67.7%, and principally resulted from a decrease in general and administrative, exploration, and facilities and mine construction expenses as discussed in more detail below.  Total costs and expenses during the six months ended June 30, 2014 were $8.2 million compared to $25.6 million during the comparable period of 2013, a decrease of $17.5 million, or 68.2%.The decrease in cost and expenses for the six months ended June 30, 2014, as discussed in more detail below, resulted from decrease in general and administrative, exploration and facilities and mine construction expenses.   

 

General and administrative expenses.  General and administrative expenses for the three months ended June 30,  2014 were $2.3 million, compared to $3.5 million for the same period of 2013.  General and administrative expenses for the six months ended June 30, 2014 were $5.3 million, compared to $7.8 million for the same period of 2013. The decrease in general and administrative expenses for the three and six months ended June 30, 2014 was due to a reduction in  compensation, insurance, computer IT support, investor relations and legal expenses.  

 

Exploration expenses.  Exploration expenses totaled $1.6 million for the three months ended June 30,  2014 as compared to $2.8 million for the corresponding period in 2013.  Exploration expenses totaled $2.9 million for the six months ended June 30, 2014, compared to $6.1 million for the same period of 2013. The $3.2 million decrease for the six month period principally resulted from a temporary decrease in drilling activity at the El Aguila project. In April of 2014 the Board of Directors approved an increase to the 2014 exploration budget by $2.2 million bringing the entire 2014 exploration budget to a total of $6.9 million.  

Facilities and mine construction expenses.  Facilities and mine construction expenses during the three months ended June 30,  2014 were nil,  resulting in a decrease of $5.7 million when compared to $5.7 million during the comparable period in 2013.  Facilities and mine construction expenses during the six months ended June 30, 2014 were nil, resulting in a decrease of $11.7 million when compared to $11.7 million during the comparable period in 2013.The decrease is the result of the Company’s transition from an Exploration Stage Enterprise to a Production Stage Enterprise as defined in SEC Guide 7 due to our new Reserve Report. Prior to the transition, all development of mill, mine facilities, and mine construction expenditures were expensed as incurred to facilities and mine development expenses. The Company now capitalizes such expenditures as a result of our transition to a Production Stage Enterprise.  

Provision (benefit) for income taxes.  During the three and six months ended June 30,  2014, the Company recorded an income tax expense of $6.4 million and $11.6 million, respectively. During the three and six months ended June 30,  2013, the Company recorded income tax (benefit) expense of $(1.3) million and $3.7 million, respectively.  

 

Non-GAAP Measures

 

Reconciliation of Non-GAAP Measures to Total Mine Cost of Sale

 

Throughout this report, we have provided information prepared or calculated according to U.S. GAAP, as well as referenced some non-U.S. GAAP (“non-GAAP”) performance measures. Because the non-GAAP performance measures do not have any standardized meaning prescribed by U.S. GAAP, they may not be comparable to similar measures presented by other companies. Accordingly, these measures are intended to provide additional information and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with U.S. GAAP.

We have reconciled total cash cost, before by-product credits and total cash cost, after by-product credits to total mine cost of sales, which is a reported U.S. GAAP measure.  Total cash cost, before by-product credits, includes all direct and indirect operating cash costs related directly to our production of precious metals which includes mining, milling and other plant facility costs, smelter treatment and refining charges, royalties, and general and administrative costs. 

We use total cash cost, after by-product credits per precious metal gold equivalent ounce sold (including royalties) as one indicator for comparative monitoring of our mining operations from period to period and believe that investors also find this information helpful when evaluating our performance. By-product credits include revenues earned from all base metals other than the primary precious metals sold. Management also uses this measurement for the comparative monitoring of performance of our mining operations period-to-period from a cash flow perspective.  Total cash cost, after by-product credits, per precious gold equivalent ounce sold is a measure developed by the Gold Institute Standard in an effort to provide a uniform standard for comparison purposes. However, there can be no assurance that our reporting of this Non-GAAP measure is similar to that reported by other mining companies. 

 

The following tables present a reconciliation between the non-GAAP measures of total cash cost, before by-product credits and total cash cost, after by-product credits to the GAAP measure of total mine cost of sales and depreciation, accretion, reclamation and stock-based compensation for our operations at the El Aguila project for the three and six months ended June 30,  2014.