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Form 10-K/A for SILVER FALCON MINING, INC.

9-Aug-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

Disclosure Regarding Forward Looking Statements

This Annual Report on Form 10-K includes forward looking statements ("Forward Looking Statements"). All statements other than statements of historical fact included in this report are Forward Looking Statements. In the normal course of our business, we, in an effort to help keep our shareholders and the public informed about our operations, may from time-to-time issue certain statements, either in writing or orally, which contain or may contain Forward-Looking Statements. Although we believe that the expectations reflected in such Forward Looking Statements are reasonable, we can give no assurance that such expectations will prove to have been correct. Generally, these statements relate to business plans or strategies, projected or anticipated benefits or other consequences of such plans or strategies, past and possible future, of acquisitions and projected or anticipated benefits from acquisitions made by or to be made by us, or projections involving anticipated revenues, earnings, levels of capital expenditures or other aspects of operating results. All phases of our operations are subject to a number of uncertainties, risks and other influences, many of which are outside of our control and any one of which, or a combination of which, could materially affect the results of our proposed operations and whether Forward Looking Statements made by us ultimately prove to be accurate. Such important factors ("Important Factors") and other factors could cause actual results to differ materially from our expectations are disclosed in this report, including those factors discussed in "Item 1A. Risk Factors." All prior and subsequent written and oral Forward Looking Statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the Important Factors described below that could cause actual results to differ materially from our expectations as set forth in any Forward Looking Statement made by or on behalf of us.

Overview

On September 14, 2007, GoldLand acquired an interest in 174.82 acres of land on War Eagle Mountain, consisting of a 100% interest in 103 acres, and a 29.166% interest in 71.82 acres. GoldLand also has five placer claims on War Eagle Mountain from the U.S. Bureau of Land Management, each of which covers approximately 20 acres, or approximately 100 acres in total.

On October 11, 2007, GoldLand leased its mineral rights on War Eagle Mountain to us. Under the lease, we are responsible for all mining activities on War Eagle Mountain, and we are obligated to pay GoldLand annual lease payments of $1,000,000, payable on a monthly basis, a monthly non-accountable expense reimbursement of $10,000 during any month in which ore is mined from the leased premises, and a royalty of 15% of all amounts we receive from the processing of ore mined from tailing piles on the premises or through shafts or adits located on the premises. The lease, as amended, provides that lease payments must commence July 1, 2010. Effective October 1, 2010, GoldLand agreed to allow us to defer lease payments until December 31, 2011, and to extend the lease term by fifteen months.

On September 21, 2008, we acquired from Mineral Extraction, Inc. all mineral, mining and access rights to two mining claims on War Eagle Mountain, covering 18.877 total acres, as well as claims for four mill site locations and the Sinker Tunnel location.

We began actual operations in May 2010. Initially, as described below, actual operations consists of processing dump material left on the mine site from prior mining operations. Later, after we complete an exploration program to prove up and locate reserves on our property, and make further capital improvements to the mine site, we plan to begin mining and processing raw ore.

Our plan to develop our mining properties into an active mine will take place in three phases.

Start-up Phase

Our initial phase involved completing construction of a mill, and using the mill to process tailings left over from prior mining operations. We were successful in our negotiations to purchase a parcel of land about half way between Highway 78 and the Sinker Tunnel entrance where we have constructed our mill. We closed on the purchase of this site in December 2009. We have purchased all of the milling equipment we need, which is currently installed and operating in Murphy, Idaho. As the mill is up and running, we plan to haul sufficient dump material, leftover from 6 prior mill sites on the mountain, during the summer months, to our mill site for processing during the summer and winter. Our testing indicates that, as a result of milling techniques used in the 1800's which failed to extract all of the gold and silver from the raw material , there are sufficient quantities of gold and silver remaining in the dump material to justify further processing. We elected to build the mill on private property that we own, rather than BLM property, because of lower reclamation costs, even though the offsite property will entail higher transportation costs. In early 2011, we began construction of a metallurgical lab at our mill site. A temporary smelter became operational in July 2011, although we still need to complete a building to house the smelter and lab. In the Fall of 2013, we plan to install a chemical leaching facility at our mill site in order to improve the yields from our raw material .

The installation and startup of the mill and the working capital to begin transport of raw material to the mill for processing has necessitated an investment of approximately $3.46 million, as follows:

The purchase and the preparation of property for mill use cost about $549,375;

The installation and certification of the mill cost about $517,283;

Completing the purchase mill equipment cost about $1,617,368;

Moving raw material to stockpile at the mill in 2010 cost about $352,911;

The purchase and installation of smelter equipment;

Start-up mill salaries to the end of 2010 cost $425,238.

We have also made a number of improvements that we initially expected would not occur until the development phase. In particular, in 2010, the roads to the Sinker Tunnel Complex were upgraded to allow 25-ton trucks access to the site, and an area 300x400 feet was prepared to act as a staging area at the 5,200 foot level. The Sinker Tunnel was aerated in its entire length and the entrance to the Sinker Tunnel was permanently extended to avoid land or snow slides to block access to the Sinker Tunnel. Permanent drainage pipes are being laid in the tunnel as it was determined that the Sinker Tunnel is the main drain for the War Eagle complex. Exploring and shoring or rock bolting of some weak points in the top wall is underway. Permitting for exploration of the Sinker Tunnel is underway with training for underground personnel and safety measures being installed as per the latest mining rules and regulations.

We need approximately $1,900,000 in capital to complete the start-up phase , of which about $1,800,000 is attributable to working capital and $100,000 is the estimated cost of completing our permanent metallurgical lab. In addition, we estimate that our leaching facility will cost an estimated $2,000,000.

Exploration Phase

During 2010, we substantially revised the scope and cost of our exploration phase. Our exploration phase refers to a program to prove up and locate reserves on our property. We need to obtain a satisfactory estimate of the remaining reserves on the property and their location in order to develop a comprehensive plan for the full development of the mine site. The program will involve building a three dimensional map of War Eagle Mountain showing the precise location of veins, shafts and tunnels. Through exploratory drilling and core sampling, we hope to obtain as much information as possible about the location, thickness and quality of the vein systems near the main shafts, and later throughout the entire mountain. The map will be a valuable tool in analyzing the extent of the remaining reserves, mineralization trends, and other pertinent geological and mining information. The most significant change to the exploration phase contemplates a more comprehensive set of core samples, both from the surface of the mountain and from the inside of the mountain using the Sinker Tunnel, and associated costs, including locating drilling equipment at the site, and logistical costs for the crew, such as vehicles, meals, shelter on the mountain, and accommodations for a geologist, field technician and drill crew. We decided to expand the scope of the exploration phase in order to obtain a National Instrument 43-101, which is a report developed by the Canadian Securities Administrators for mining companies. A National Instrument 43-101 is necessary for listing our common stock on any exchange overseen by the Canadian Securities Authority, including the Toronto Stock Exchange.

Another aspect of the exploration phase will involve the development of a plan to use the Sinker Tunnel to mine the interior of the mountain on a year round basis. The plan will involve accessing and draining the mine shafts on the top of the mountain from the Sinker Tunnel, as well as relocating and collaring old shafts on the mountain. We estimate that the exploration phase will take about 18 months from mid-April 2013, and will cost approximately $10,000,000. We began preliminary work on the exploration phase in mid-2010.

Development Phase

The development phase involves transitioning the mine from processing tailings leftover from prior mining activities to extracting and processing raw material or ore from the mountain, assuming that the exploration phase demonstrates that there are economically viable reserves in War Eagle Mountain. We believe that full scale mining of raw material or ore will be profitable. In particular, historical records of mining on the site, and subsequent reports of the geology of the mountain, indicate that veins containing gold and silver extend much further vertically than could be mined when the site was last mined in the 1880's. In addition, historical records indicate that gold and silver exists in the veins in sufficient densities to warrant mining using modern extraction and milling techniques. The scope of the development phase will depend on the outcome of the exploration phase, which is designed to test the accuracy of our analysis. The development phase will not take place unless that exploration phase demonstrates that there are reserves in War Eagle Mountain that can be extracted and processed in an economically viable fashion. Our goal is to develop a drilling program that reaches as many reserves as possible at the lowest cost. Among the improvements to the mine site that we anticipate making in the development phase are:

We plan to connect the mine shafts on the top of the mountain to the Sinker Tunnel in order to provide drainage to those shafts;

We plan to install a transportation system in the Sinker Tunnel (either tire mounted trams, narrow gauge railway, or conveyor system) to move raw material or ore out of the Sinker Tunnel for transport to our mill site; and

Additional improvements include housing, storage, food preparation facilities, generators for power, etc.

In addition to the improvements identified above, we expect that we will need to make other improvements necessary to access the highest quality mineral veins, which improvements are not known at this time but which will be identified in our National Instrument 43-101 report. In 2010, we started (and have since completed) some improvements to the mine site that were previously part of our development phase, including improving about four miles of the county road linking State Route 78 with Silver City, 1.8 miles of access road to the Sinker Tunnel Complex from the county road, and about 1.6 miles of access road to the Oro Fino vein outcrop area to permit heavier loads and year round access, as well improvements to the physical facilities at the milling location site and mine site to accommodate our workers.

Our revenue, profitability, and future growth rate depend substantially on factors beyond our control, including our success in the commencement of mining operations, as well as economic, political, and regulatory developments and fluctuations in the market prices of minerals processed from raw material or ore derived from our mining operations.

Results of Operations

Fiscal Years ended December 31, 2012 and 2011

We are in the exploration stage and generated revenues of $162,141 in the year ended December 31, 2012 and $174,002 in the year ended December 31, 2011. Our revenues in the year ended December 31, 2012 are not representative of our revenues in the future. Our primary operations consist of processing tailing from our mine site at the mill, and our ancillary operations consist of exploring War Eagle Mountain to evaluate and prove up its reserves. Our analysis indicates that we can profitably process tailings left from prior mining operations if we have the proper infrastructure to extract the minerals from the tailings. In May 2010, we began processing tailings from our mine site at our mill. We initially planned to process the tailings into concentrate, which would then be shipped for final processing to a smelter, which would either then either return the material to us in the form of dore bars (which would have to be shipped to a refiner for final processing) or pay us a market price for the minerals ultimately extracted from the concentrate.
In October 2010, we shipped our first load of concentrate to a smelter. We subsequently decided to construct our own metallurgical lab at our milling site, and stockpiled concentrate until we had the capacity to smelt our concentrate.
In 2011, we completed a temporary smelter on our mill site and began shipping dore bars in limited quantities to a refiner on a regular basis. We expect to report increased revenues from our milling operation when our metallurgical lab and our leaching facility are completed. The leaching facility will increase the percentage of valuable minerals that are extracted from the raw materials, and the completion of the metallurgical lab will increase the rate at which we can complete dore bars for shipment to refiners. Until the metallurgical lab and leaching facility are completed, our revenues may not differ materially from what we generated in 2012.

Below are some metrics that are relevant to our current operations:

In 2011, we transported 15,231 tons of tailings to our mill. In 2012, we decided not to transport tailings and focus our resources on completing our metallurgical lab, floatation circuit and leaching circuit which will increase our recoveries.

In 2012 and 2011, we processed 12,039 and 11,988 tons of tailings, respectively, through our mill circuit into concentrate. We have stockpiled most of the concentrate until it can be processed in our metallurgical lab. In addition to concentrate, the processed tailings have been stockpiled for further processing through the planned leaching circuit.

In 2011, our refiner extracted 100.698 ounces of gold and 190.534 ounces of silver. The average price per ounce was $1,665.64 for gold and $33.878 for silver.

In 2012, our refiner extracted 98.33 ounces of gold and 80.776 ounces of silver.
The average price per ounce was $1,623.28 for gold and $33.25 for silver.

We reported losses from operations during the years ended December 31, 2012 and 2011 of ($10,433,678) and ($12,022,786), respectively. The decrease in loss in 2012 as compared to 2011 was largely attributable to the following factors:

Consulting fees decreased ($1,120,687) from $4,163,376 in 2011 to $3,042,689 in 2012 as a result of decreased use of consultants in connection with our efforts to commence mining operations on War Eagle Mountain. The material components of expenses charged to consulting services in both years were as follows:

                 Type of Services                  2012              2011

     Shareholder relations services              $  208,519       $   786,500
     Investment banking                             183,180           496,000
     Equity line fees                                     -           164,000
     Locating and due diligence services on
     future acquisition opportunities             1,518,400           515,300
     Administrative, office, clerical                     -            31,112
     Technical consulting                                 -           187,792
     Legal services                                  63,320            59,325
     Advice on debt and equity capital raising      945,000         1,977,000

Exploration expenses were $28,248 in 2012 as compared to $1,362,022 in 2011 as a result of decreased activity developing and refurbishing the Sinker Tunnel;

Mill operating expenses were $665,572 in 2012 as compared to $512,453 in 2011.
Mill operations ramped up in 2011 and we incurred more operating costs, however, we capitalized operating costs of $766,677 in inventory.

Property lease fees were $1,000,000 in 2012 as compared to zero in 2011 due to the extension of the commencement of lease payments to GoldLand that expired on January 1, 2012;

Compensation expense decreased to $414,005 in 2012 as compared to $729,288 in 2011 as a result of lower compensation accruals to employees.

Stock compensation expense increased to $4,122,143 in 2012 as compared to $4,107,200 in 2011 as a result of the issuance of stock options and common stock for compensation.

General and administrative expenses decreased to $929,054 in 2012 as compared to $977,008 in 2011 primarily due to lower legal, travel and general office expenses.

We reported net losses during the years ended December 31, 2012 and 2011 of ($12,955,490) and ($12,270,871), respectively. The increased loss in 2012 as compared to 2011 was largely attributable to debt conversion costs and increased interest expense resulting from higher interest-bearing debt in 2012 as compared to 2011, offset by decreased loss from operations. In particular, interest expense increased from $248,085 in 2011 to $432,813 in 2012.

Liquidity and Sources of Capital

The following table sets forth the major sources and uses of cash for fiscal
years ended December 31, 2011 and 2012:

                                            Fiscal Year ended December 31,
                                              2011                  2012
    Net cash provided by (used) in
    operating activities                 $   (1,734,319)       $   (2,498,652)
    Net cash provided by (used) in
    investing activities                     (1,009,932)             (519,504)


    Net cash provided by (used) in
    financing activities                       2,682,721             3,021,297
    Net (decrease) increase in
    unrestricted cash and cash
    equivalents                           $     (61,530)         $       3,141

Comparison of 2011 and 2012

In the years ended December 31, 2011 and 2012, we financed our operations primarily through the issuance of convertible notes and the issuance of common stock for services.

Operating activities used ($1,734,319) of cash in 2011, as compared to ($2,498,652) of cash in 2012. Major non-cash items that affected our cash flow from operations in 2011 were non-cash charges of $345,442 for depreciation and amortization, $5,643,059 for the value of common stock issued to consultants for services, $2,274,737 for the value of common stock issued for compensation to officers and employees, and $340,000 for the value of common stock issued for rent. Our operating assets and liabilities supplied $433,334 of cash, most of which resulted from an increase in accounts payable and accrued liabilities of $639,207, an increase in accrued payroll of $803,445, and a decrease in prepaid expenses of $387,842, offset by an increase in amounts due from related parties of ($410,779) and an increase in inventories of ($1,419,341).

Major non-cash items that affected our cash flow from operations in 2012 were non-cash charges of $603,031 for depreciation and amortization, $2,872,931 for the value of common stock issued for compensation to consultants, $113,600 for the value of common stock issued for rent, $3,272,772 for the value of common stock issued for compensation to officers and employees, $1,657,979 for the value of common stock issued for GoldLand officers for compensation, $849,371 for the value of stock options and warrants issued for compensatory purposes, and non-cash debt conversion costs of $2,088,999. Our operating assets and liabilities used ($532,149) of cash, most of which resulted from an increase in inventories of ($846,403), a decrease in prepaid expenses of $15,000, and a reduction of accounts payable and accrued expenses of ($13,048), offset by an increase in accrued payroll of $120,808.

Investing activities used ($519,504) of cash in 2012, as compared to ($1,009,932) of cash in 2011. The significant decrease in cash used in investing activities was primarily attributable to materially lower expenditures for equipment and buildings.

Financing activities supplied $3,021,297 of cash in 2012 as compared to $2,682,721 of cash in 2011. Substantially all of the cash supplied in both years resulted from the issuance of notes, net of sums spent to repay notes. In 2011, we issued $2,683,044 in notes, as compared to 2012 when we issued $3,129,888 of notes.

Liquidity

Our balance sheet as of December 31, 2012 reflects current assets of $3,445,040, current liabilities of $4,104,402, and a working capital deficit of ($659,362).
In January 2013, we issued 3,964,258 shares of Class A Common Stock upon conversion of promissory notes with an aggregate principal and interest amount of $100,692.

We will need substantial capital over the next year. We project that we will need about $1,900,000 of working capital pending the building of a leaching unit, about $2,000,000 to build a leaching unit to improve the yields from our tailings, and about $10,000,000 to complete the exploration phase. In addition, we financed a lot of prior activities by the issuance of convertible notes that mature over the next two years. As of December 31, 2012, we had the following debts that mature in the near future:

$2,299,160 in two year notes payable, of which $1,891,932 is due during 2013.
As of July 1, 2013, we had failed to pay all interest owed on the notes, and we are in default thereunder. We do not face any legal action from any of the note holders at this time;

$472,083 owed to Iliad Research & Trading, LP, which requires monthly payments of $47,208.33 per month, plus the amount of accrued interest on the note. As of July 1, 2013, we were not in default to Iliad;

$717,640 owed to JMJ Financial, consisting of one note for $315,000 which provides for payment of all principal and interest owed on December 4, 2013, and another note for $525,000 which provides for payment of all principal and interest owed on January 12, 2014. As of July 1, 2013, we had failed to honor several conversion requests submitted by JMJ Financial, and as a consequence JMJ Financial has accelerated the maturity of its notes. Our obligation to JMJ Financial is currently in litigation.

Also, beginning January 1, 2012, we began to make monthly payments of $83,333 to GoldLand under our lease of its mining interests on War Eagle Mountain. We pay the monthly liability to Goldland by issuing shares of our Class A Common Stock to GoldLand employees for compensation on behalf of GoldLand, and applying the value of the shares against our liability to GoldLand.

The amount of capital that we currently have the capacity to raise is not sufficient to pay all of the capital expenses that we need to pay to commence operations, and pay our other liabilities as they come due. However, we have a number of options that we believe will enable us to continue with our business plan despite insufficient capital. For example, we plan to continue paying most of the salaries of our management by issuing shares of Class A Common Stock. We also plan to continue paying certain accounts payable with common stock, including our monthly lease payments to GoldLand. GoldLand, for example, is controlled by our officers, and therefore we do not expect GoldLand to take any legal action as a result of our deferral of lease payments to it. We also plan to continue issuing shares to certain service providers that are willing to accept shares for payment. In the event we are able to raise some, but not all, of the capital that we need, we plan to request that note holders extend the maturity of their notes or convert their notes into shares of common stock.

As of March 31, 2013, We currently are obligated to issue approximately 127 million shares of Class A Common Stock upon conversion of outstanding notes.
Our contingent obligation to issue new shares of Class A Common Stock, combined with our plans to issue shares of Class A Common Stock to satisfy certain recurring liabilities, may impair our ability to raise capital by issuing shares of Class A Common Stock or securities convertible into Class A Common Stock, because future investors may be worried about future dilution.

Notwithstanding the fact that we are able to satisfy many of our liabilities by the issuance of shares, there are still many liabilities and capital expenditures that we cannot satisfy through the issuance of shares, including most of the construction cost to complete our metallurgical lab and leaching facility. We are actively seeking investment banking professionals to assist us in raising capital as well as advice on how we can be restructured to make the company sufficiently attractive to induce new investors to provide the capital we need. In the event we are not able to raise new cash capital, we will not be able to complete our business plan, and may be forced to consider a sale of the entire company.

Going Concern

Our financial statements have been presented on the basis that we continue as a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. As shown in the accompanying financial statements, we incurred a net operating loss in the years ended December 31, 2012 and 2011. These factors create an uncertainty about our ability to continue as a going concern. We are currently trying to raise capital through a private offering of preferred stock. Our ability to continue as a going concern is dependent on the success of this plan. The financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

Critical Accounting Estimates

Our significant accounting policies are described in Note 2 of Notes to Financial Statements. At this time, we are not required to make any material estimates and assumptions that affect the reported amounts and related disclosures of assets, liabilities, revenue, and expenses. However, as we begin actual mining operations, we will be required to make estimates and assumptions typical of other companies in the mining business.

For example, we will be required to make critical accounting estimates related to future metals prices, obligations for environmental, reclamation, and closure matters, mineral reserves, and accounting for business combinations. The estimates will require us to rely upon assumptions that were highly uncertain at the time the accounting estimates are made, and changes in them are reasonably likely to occur from period to period. Changes in estimates used in these and other items could have a material impact on our financial statements in the future

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