LKAI LKA Gold Incorporated (CE)

Notes to the Unaudited Consolidated Financial Statements

September 30, 2019

NOTE 1 -        ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

The consolidated financial statements presented are those of LKA Gold, Incorporated, a Delaware corporation and its wholly owned subsidiary LKA International, Inc., a Nevada corporation ("LKA" or the "Company"). LKA was incorporated on March 15, 1988, under the laws of the State of Delaware. LKA is currently engaged in efforts to expand mine production and continues to seek additional investment opportunities.

The accompanying unaudited 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 nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ended December 31, 2019.

Recent Accounting Pronouncements

The Company has implemented all new accounting pronouncements that are in effect and that may impact its financial statements. The Company does not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on its financial position or results of operations.

In February 2016, the FASB issued ASC 842, Leases (“ASC 842”). ASC 842 related to leases to increase transparency and comparability among organizations by requiring the recognition of right of use assets and lease liabilities on the balance sheet. Most prominent among the changes in the standard is the recognition of ROU assets and lease liabilities by lessees for those leases classified as operating leases. Under the standard, disclosures are required to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases. The Company is also required to recognize and measure leases existing at, or entered into after, the beginning of the earliest comparative period presented using a modified retrospective approach, with certain practical expedients available.

The Company elected to early adopt ASC 842 effective January 1, 2018 and has elected all available practical expedients. The standard did not have a material impact on our financial statements as we have no outstanding leases.

In June 2018, the Financial Accounting Standards Board (FASB) issued ASU 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. ASU 2018-07 simplifies the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees, with certain exceptions. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018. The Company adopted the new standard on January 1, 2019 without a material impact on our financial statements.

 

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260) Distinguishing Liabilities from Equity (Topic 480) Derivatives and Hedging (Topic 815): I. Accounting for Certain Financial Instruments with Down Round Features, II. Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. Part I of Topic 260 eliminates the requirement to consider “down round” features when determining whether certain equity-linked financial instruments or embedded features are indexed to an entity’s own stock. The ASU 2017-11 amendments in Part I are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company adopted the new standard on January 1, 2019 without a material impact on our financial statements.

Net Income (Loss) per Common Share

Basic net income (loss) per share is computed on the basis of the weighted average number of common shares outstanding during each year. Diluted net income (loss) per share is computed similar to basic net income (loss) per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive. In periods where losses are reported, the weighted-average number of common stock outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive.

For the three and nine months ended September 30, 2019 and 2018, the Company realized net losses, resulting in outstanding warrants, and outstanding convertible debt having an antidilutive effect.

The following table summarizes the potential shares of common stock that were excluded from the computation of basic and diluted net loss per share for the three and nine months ended September 30, 2019 and 2018 as such shares would have had an anti-dilutive effect:

NOTE 2 -       RELATED PARTY TRANSACTIONS

Drilling Contract

On August 4, 2019, Caldera Partners Limited Partnership, a Washington State limited partnership ("Caldera") entered into a three year Drilling Contract (the "Agreement") with LKA, whereby Caldera will supervise, manage, and conduct exploratory surface drilling operations on LKA mining claims in Hinsdale County, Colorado. All costs of the Agreement, including labor, equipment, materials, supplies, and services of whatever character shall be provided by Caldera and the results of the Drilling Program (“Drilling Results”) are exclusively owned by Caldera until and unless the Drilling Results are acquired by LKA. During the term of this Agreement, LKA shall have an option to acquire the Drilling Results upon the payment by LKA to Caldera of an amount equal to all expenditures made by Caldera on the drilling program together with interest on all expenditures from the time expenditures were made, at the rate of 8% per annum.

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 owes Abraham & Co., Inc. $12,447 and $6,447 as of September 30, 2019 and December 31, 2018, respectively.

Related Party Payables – Notes, Accounts and Wages Payable

At September 30, 2019 and December 31, 2018, LKA owes $21,514 and $223, respectively, for purchases made on the personal credit card of LKA's President, Kye Abraham and owes Kye Abraham $140 at September 30, 2019 for a payment made on that credit card on behalf of LKA.  

At September 30, 2019 and December 31, 2018, LKA owes an entity controlled by LKA's President and Chairman, Kye Abraham, $12,704 and $12,702, respectively, for short-term loans that do not accrue interest, are unsecured and due upon demand. During the nine months ended September 30, 2019, the entity paid $400 of LKA’s related party accounts payable, advanced $5,402 in cash and was repaid $5,800.

NOTE 3 -      CONVERTIBLE DEBENTURES

During October 2015, LKA issued a 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. During December 2018, LKA entered into a one-year extension agreement through October 20, 2019 in exchange for a reduction of the conversion price to a fixed $0.25 per share. The modification of this note was not deemed substantial.

During April 2016, LKA issued two $50,000 Convertible Debentures for $100,000 in cash.  The Convertible Debentures accrue interest at 7.5% per annum due in semi-annual payments, are unsecured, due in five years from the dates of issuance and are 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.

On April 26, 2017, LKA issued a convertible debenture in the amount of $50,000 for cash. Principal on the Convertible Debenture is due April 26, 2020. The Convertible Debenture accrues interest at 7.5% and is convertible at any time into shares of LKA common stock at $0.50 per share. Interest is due on a semiannual basis. During April 2018, the holder of the convertible note elected to convert a total of $20,000 in convertible debt principal, leaving a principal balance of $30,000 at September 30, 2019 and December 31, 2018. 

For the October 2015 convertible debenture, if any event of default occurs, the interest rate increases to 15% per annum.  An event of default means LKA fails to make any interest or principal payments on a timely basis and/or fails to remain current in its public filings with the Securities and Exchange Commission. During the default period, the convertible note holder shall hold voting power equal to the voting power of the number of common shares of the Company into which the note is convertible at the default conversion rate. Also, during the default period the holders of all 7.5% convertible debentures as a class may appoint a representative that shall be an observer to the Board of Directors until such time as the default conditions no longer exist. This convertible debenture is in default as of September 30, 2019.

For the April 2016 and April 2017 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. An event of default means LKA fails to make any interest or principal payments on a timely basis and/or fails to remain current in its public filings with the Securities and Exchange Commission. During the default period, the convertible note holder shall hold voting power equal to the voting power of the number of common shares of the Company into which the note is convertible at the default conversion rate. Also, during the default period the holders of all 7.5% convertible debentures as a class may appoint a representative that shall be an observer to the Board of Directors until such time as the default conditions no longer exist. These convertible debentures are in default as of September 30, 2019.

As a result of the reset provision in the conversion price, the conversion options embedded in these instruments are classified as a liability in accordance with ASC 815 and were recognized as a debt discount on the date these notes were issued along with $12,500 of debt issuance costs.

During the nine months ended September 30, 2019 and 2018, LKA recognized $21,575 and $61,542 of interest expense from the amortization of the debt discount, respectively.

NOTE 4 -      DERIVATIVE LIABILITY

LKA analyzed the conversion options embedded in the convertible debentures for derivative accounting consideration under ASC 815, Derivative and Hedging, and determined that the instruments embedded in the above referenced convertible notes should be classified as liabilities and recorded at fair value due to reset provisions in the conversion prices.

During April 2019, as a result of default on a $50,000 convertible note, the previously variable conversion rate is now a fixed conversion rate of $0.25 per share and is no longer subject to derivative liability treatment. As such, LKA retired the $36,990 fair value amount of the derivative liability to additional paid-in capital.

During the nine months ended September 30, 2019 and 2018, LKA recorded gains of $2,954 and $35,473 on mark-to-market of the conversion options, respectively.

The following table summarizes the derivative liabilities included in the consolidated balance sheets at September 30, 2019:

The Company valued its derivatives liabilities using the Black-Scholes option-pricing model.  Assumptions used during the nine months ended September 30, 2019 include (1) risk-free interest rates of 1.75% - 1.92%, (2) lives of between 0.58 and 1.54 years, (3) expected volatility between 302% - 419%, (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

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 September 30, 2019. Actual completion of remediation work at the site was completed in late 2014 by the EPA. The EPA has not yet issued its notice of final determination.

NOTE 6 -      COMMITMENTS AND CONTINGENCIES

Wastewater Discharge Liability

During the fourth quarter of 2014, LKA received a Notice of Violation (NOV) from the Colorado Department of Health and Environment (CDPHE) for failure to meet certain requirements of the Company's wastewater discharge permit. During 2016, the Company undertook all corrective actions specified in the NOV, under CDPHE oversight, and believes it is in compliance with the terms of its permit. Work is required to modify and upgrade the mine's water treatment process in 2019 to meet regulatory requirements and bring LKA back into compliance with its discharge permit requirements. Until this work is completed to the satisfaction of CDPHE, the Company is considered to be in a "non-compliance" status with the terms of its discharge permit and additional penalties could be assessed beyond those described (anticipated) above. Engineering and lab testing is ongoing and further modifications (upgrades) to the Company's water treatment system is scheduled for 2020. Once completed, LKA expects improvements to its water treatment system will meet or exceed regulatory requirements. It is currently expected that any financial penalty assessed and any further corrective actions will not likely cost less than $75,000 but not more than $150,000. If LKA is unsuccessful in achieving full compliance with permit requirements, it may be subject to additional penalties or revocation of its discharge permit. As a result, LKA has accrued the liability of $150,000 as there is no better estimate of the amount of loss within this range.  The outstanding balance of this accrued liability is $98,312 and $99,974 as of September 30, 2019 and December 31, 2018, respectively.

Vendor Litigation Settlement

During November 2018, LKA was served with a vendor lawsuit, resulting in a judgement against the Company in the amount of approximately $141,000, including attorney fees. As a result, LKA accrued a total of $141,000 in accounts payable as of December 31, 2018 to cover the full amount of the judgement. During the nine months ended September 30, 2019, LKA believes it has incurred an additional $9,000 in expenses related to the ultimate settlement and accordingly accrued an additional $9,000 in accounts payable as of September 30, 2019. Additionally, LKA has paid $3,979 in accrued expenses during the nine months ended September 30, 2019. The amount accrued in accounts payable was $146,021 and $141,000 as of September 30, 2019 and December 31, 2018, respectively.

NOTE 7 -     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, has a working capital deficit and has negative cash flows from operations, which 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 LKA's ability to continue as a going concern are as follows:

LKA is currently engaged in an exploration program at the Golden Wonder mine with the objective of returning the mine to a commercial producing status. The exploration program, which began in November 2008, has involved extensive sampling/assaying for the purpose of identifying possible new production zones within the mine. During this evaluation period, sampling and analysis of exposed veins yielded encouraging results and some precious metals revenues. While encouraging, no conclusion can be drawn at this time about the commercial viability of the mine and LKA continues to evaluate potential merger, joint venture or lease agreements for the property.

In order to support continued operation of the mine, LKA will need to raise additional funds to support operations during 2020. 

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.