Notes to the Unaudited Consolidated Financial Statements
March 31, 2016
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
LKA Gold Incorporated (Formerly LKA International, Inc.) (“LKA” or the “Company”) is currently engaged in efforts to expand mine production and continues to seek additional investment opportunities.
The accompanying unaudited condensed consolidated financial statements have been prepared by LKA pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted in accordance with such rules and regulations. The information furnished in the interim consolidated financial statements include normal recurring adjustments and reflects all adjustments, which, in the opinion of management, are necessary for a fair presentation of such financial statements. Although management believes the disclosures and information presented are adequate to make the information not misleading, it is suggested that these interim consolidated financial statements be read in conjunction with LKA’s most recent audited financial statements. Operating results for the three months ended March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current year presentation.
NOTE 2 - RELATED PARTY TRANSACTIONS
Related Party Debt – Office Space
LKA pays a company owned by an officer and shareholder $1,500 per month for office rent and expenses. The affiliated company (Abraham & Co., Inc. a FINRA member and registered investment advisor) also executes LKA’s securities transactions and manages its investment portfolio. LKA owed Abraham & Co. $19,500 and $15,000 as of March 31, 2016 and December 31, 2015, respectively.
Related Party Debt – Accounts and Wages Payable
At March 31, 2016 and December 31, 2015, LKA owes $8,181 and $309, respectively, for purchases made on the personal credit card of LKA’s President, Kye Abraham. Additionally, LKA owed Kye Abraham $88,257 and $75,757 in unpaid salary at March 31, 2016 and December 31, 2015, respectively.
Convertible Debentures
On September 29, 2015, LKA issued two convertible debentures (Convertible Debentures), each in the amount of $125,000, or a total of $250,000 to members of the Koski family, the Company’s largest shareholders. Principal on the Convertible Debentures is due September 29, 2018. The Convertible Debentures accrue interest at 7.5% and are convertible at any time into shares of LKA common stock at $0.50 per share. Interest is due on a semi-annual basis and LKA is required to retain a reserve amount of the proceeds to pay the first two semi-annual interest payments, which, if the Convertible Debentures are converted within one year, will be paid to the Convertible Debenture holders. As such, LKA has designated $9,375 and $18,750 as restricted cash at March 31, 2016 and December 31, 2015, respectively.
During the three months ended March 31, 2016, LKA paid $9,374 in interest payments on the convertible debentures.
If any event of default occurs, the interest rate increases to 15% per annum and the conversion rate shall be decreased to $0.25 per share. As a result of the potential variable conversion rate, the conversion option embedded in this instrument is classified as a liability in accordance with Accounting Series Codification Topic 815, “Derivatives and Hedging” (ASC 815) and LKA recognized a debt discount of $250,000. During the three months ended March 31, 2016, LKA recognized $261 of interest expense from the amortization of the debt discounts.
LKA incurred $12,500 in debt issuance costs on the convertible debenture issuance. The debt issuance costs are being amortized over the three year term of the convertible debenture. During the three months ended March 31, 2016, LKA recognized $970 of interest expense from the amortization of debt issuance costs.
NOTE 3 - CONVERTIBLE DEBENTURES
During October 2015, LKA issued a 7.5% convertible debenture for $50,000 in cash. The convertible debenture accrues interest at 7.5% per annum, is unsecured, due in three years from the date of issuance and is convertible into shares of LKA common stock at any time at the option of the holder at a rate of $0.50 per share. Interest is due in semi-annual payments and LKA is required to maintain a reserve of proceeds equal to the first two semi-annual payments. As such, LKA has designated $1,875 and $3,750 as restricted cash at March 31, 2016 and December 31, 2015, respectively.
During the three months ended March 31, 2016, LKA paid $1,875 in interest payments on the convertible debenture.
If any event of default occurs, the interest rate increases to 15% per annum and the conversion rate shall be decreased to $0.25 per share. As a result of the potential variable conversion rate, the conversion option embedded in this instrument is classified as a liability in accordance with ASC 815 and LKA recognized a debt discount of $50,000. During the three months ended March 31, 2016, LKA recognized $43 of interest expense from the amortization of the debt discount.
LKA incurred $2,500 in debt issuance costs on the convertible debenture issuance. The debt issuance costs are being amortized over the three year term of the convertible debenture. During the year ended December 31, 2015, LKA recognized $164 of interest expense from the amortization of debt issuance costs.
NOTE 4 - DERIVATIVE LIABILITY
LKA analyzed the conversion options embedded in the convertible notes payable and convertible notes payable related party for derivative accounting consideration under ASC 815 and determined that the instruments embedded in the above referenced Convertible Notes should be classified as liabilities and recorded at fair value due to the potentially variable conversion prices.
The fair value of the conversion options was determined to be $358,006 as of the issuance date using a Black-Scholes option-pricing model. Upon the date of issuance of the Convertible Notes, $300,000 was recorded as debt discount and $58,006 was recorded as day one loss on derivative liability. During the three months ended March 31, 2016, $55,806 of loss was recorded on mark-to-market of the conversion options, respectively.
The following table summarizes the derivative liabilities included in the balance sheet at March 31, 2016 and December 31, 2015:
|
Balance, December 31, 2014
|
|
$
|
-
|
|
|
Day one loss due to convertible debt
|
|
|
58,006
|
|
|
Debt discount
|
|
|
300,000
|
|
|
Gains on change in fair value
|
|
|
(101,728
|
)
|
|
Balance, December 31, 2015
|
|
|
256,278
|
|
|
Loss on change in fair value
|
|
|
55,806
|
|
|
Balance, March 31, 2016
|
|
$
|
312,084
|
|
The Company valued its derivatives liabilities using the Black-Scholes option-pricing model. Assumptions used during the three months ended March 31, 2016 include (1) risk-free interest rates of 1.05%, (2) lives of between 2.53 and 2.59 years, (3) expected volatility of 222%, (4) zero expected dividends, (5) conversion prices as set forth in the related instruments, and (6) the common stock price of the underlying share on the valuation dates.
|
|
NOTE 5 - NOTIFICATION OF POSSIBLE ENVIRONMENTAL REMEDIATION
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In 2002 the Federal Bureau of Land Management (the "BLM") advised LKA of its desire to extend to the Ute-Ulay Property certain environmental clean-up (“remediation”) activities that it is conducting on neighboring properties that LKA does not own. The BLM commissioned and obtained three engineering evaluation and cost analysis ("EE/CA") studies/reports on the Ute-Ulay and the neighboring public lands in 2002-2006. These EE/CA studies analyzed the current environmental state of the Ute-Ulay property and other properties in the area. The studies identified a large volume of mine tailings and metals loading of shallow ground water, with elevated levels of arsenic, cadmium and lead being present. The BLM’s most recent study, “Value Engineering Study on the Ute Ulay Mine/Mill Site – Final Report” dated January 5, 2006, projected the costs of remediation and property stabilization on the Ute-Ulay property to be approximately $2.1 million. Based upon discussions with Hinsdale County, Colorado officials, Colorado Department of Public Health & Environment Ute-Ulay project supervisor, the Federal Environmental Protection Agency’s (the “EPA”) regional manager, and legal counsel, the actual costs associated with this effort are expected to be approximately $1.2 million; substantially below previous BLM estimates. Under the federal Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), the EPA may either require a property owner to perform the necessary cleanup or the agencies may perform the work and seek recovery of costs against the property owner and previous owners. While it cannot be determined with absolute certainty until the project is completed, LKA’s status as a “
de minimis”
participant and the fact that remediation activities are focused on property located largely outside of LKA’s permitted operating area, LKA management expects this project will have a negligible impact on the LKA’s financial condition. Accordingly, pursuant to Generally Accepted Accounting Principles, and all discussions with the above named agencies to date, LKA management believes it is unlikely there will be a material impact to its financial statements and no liability for this project has been recorded as of March 31, 2016. Actual completion of remediation work at the site was completed in late 2013 by the EPA. The EPA has not yet issued its notice of final determination.
NOTE 6 - GOING CONCERN
LKA's consolidated financial statements are prepared using Generally Accepted Accounting Principles applicable to a going concern that contemplates the realization of assets and liquidation of liabilities in the normal course of business. However, LKA has recently accumulated significant losses and has negative working capital. All of these items raise substantial doubt about its ability to continue as a going concern. Management's plans with respect to alleviating the adverse financial conditions that caused management to express substantial doubt about the LKA's ability to continue as a going concern are as follows:
LKA is currently engaged in an intensive exploration program at the Golden Wonder mine with the objective of returning the mine to a producing status. The exploration program, which began in late 2008, has involved extensive exploratory mining and drilling for the purpose of identifying possible new production zones within the mine and on the Company’s adjacent property. During this ongoing evaluation period, bulk sampling, through exploratory mining of high-grade structures (extensions of the initial ore zone) has yielded encouraging results and over $5.1 million in precious metals revenues. Until LKA can locate another ore body, no conclusion can be drawn at this time about the commercial viability of the mine.
In order to support continued exploration of the mine, LKA entered into a financing transaction during the year ended December 31, 2015. The Company expects to raise additional funding through financings or the sale of enriched vein material during 2016 to fund the continued exploration of the Golden Wonder mine. If LKA is not successful in the resumption of profitable mine operations, either from commercial or exploratory mining, it may be forced to continue to raise additional equity or debt financing to fund its ongoing obligations or risk ceasing doing business.
There can be no assurance that LKA will be able to achieve its business plans, raise any more required capital or secure the financing necessary to achieve its current operating plan. The ability of LKA to continue as a going concern is dependent upon its ability to successfully accomplish the plan described in the preceding paragraph and eventually attain profitable operations. The accompanying consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.