LKAI LKA Gold Incorporated (CE)

Notes to the Unaudited Consolidated Financial Statements

September 30, 2018

NOTE 1 -       ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

LKA Gold Incorporated ("LKA" or the "Company") 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, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

During May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)" ("ASU 2014-09"). ASU 2014-09 supersedes the revenue recognition requirements in ASC Topic 605, "Revenue Recognition" and some cost guidance included in ASC Subtopic 605-35, "Revenue Recognition - Construction-Type and Production-Type Contracts." The core principle of ASU 2014-09 is that revenue is recognized when the transfer of goods or services to customers occurs in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. ASU 2014-09 requires the disclosure of sufficient information to enable readers of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts. ASU 2014-09 also requires disclosure of information regarding significant judgments and changes in judgments, and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 provides two methods of retrospective application. The first method would require the Company to apply ASU 2014-09 to each prior reporting period presented. The second method would require the Company to retrospectively apply ASU 2014-09 with the cumulative effect recognized at the date of initial application.

 

ASC 606 requires companies to identify contractual performance obligations and determine whether revenue should be recognized at a point in time or over time based on when control of goods and services transfer to a customer. LKA performed a review of its sales history and compared historical accounting policies and practices to the new standard, electing to utilize the modified retrospective transition method effective January 1, 2018, with no impact to LKA's financial statements due to no sales in the past two years.

During November 2016, the FASB issued ASU 2016-18, "Statement of Cash Flows (Topic 230)" ("ASU 2016-18"). ASU 2016-18 requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period to total amounts shown on the statement of cash flows.

LKA had previously excluded restricted cash from the "Total Cash" and included the change in restricted cash balances in investing activities. As such, amounts presented in the nine months ended September 30, 2017 statement of cash flows have been changed to include $28,945 in restricted cash in the newly titled "Total Cash and Restricted Cash Ending Balance" as of September 30, 2017. Additionally, $1,101 in restricted cash as of December 31, 2016 is now reflected in the "Cash and Restricted Cash at Beginning of Period" balance.

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, 2018, the Company realized a net loss, resulting in outstanding warrants, and outstanding convertible debt having an antidilutive effect.

 

The calculation of basic and diluted net loss per share for the three and nine months ended September 30, 2017 are as follows:

NOTE 2 -        RELATED PARTY TRANSACTIONS

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. During the nine months ended September 30, 2018, Abraham & Co., Inc. agreed to exchange $23,805 in outstanding accounts payable and $1,785 in accrued interest for 127,952 shares of LKA common stock at $0.20 per share. LKA owes Abraham & Co., Inc. $3,500 and $23,805 as of September 30, 2018 and December 31, 2017, respectively.

Related Party Payables – Notes, Accounts and Wages Payable

At September 30, 2018 and December 31, 2017, LKA owes $876 and $100, respectively, for purchases made on the personal credit card of LKA's President, Kye Abraham.  

During March 2018, LKA's President, Chairman of the Board and Director, Kye Abraham, elected to convert $75,378 in accrued wages and $5,653 in accrued interest into 405,157 shares of LKA common stock, or the market price of the common stock on the date of issuance of $0.20 per share. At September 30, 2018 and December 31, 2017, LKA owed Kye Abraham $49,989 and $113,257 in unpaid salary, respectively.

During the nine months ended September 30, 2018, an affiliated entity lent LKA $18,000 on a short-term note, due upon demand. During March 2018, the affiliate entity elected to convert $12,798 in note principal and $960 in interest into 68,789 shares of common stock, or the market price of the common stock on the date of issuance of $0.20 per share. The balance of the note is $12,702 at September 30, 2018.

Common Stock

During March 2018, LKA issued 1,750,000 shares of common stock to its President and Chairman, Kye Abraham, as a performance bonus valued at $201,425, or the market price of the common stock on the date of issuance of $0.12 per share.

During April 2018, LKA sold 2,702,703 shares of its common stock to members of the Koski family, the Company's largest shareholders ("Koski"), for $500,000 cash.

Convertible Debentures

During March 2018, members of the Koski family, LKA's President and Chairman, Kye Abraham, and an entity controlled by LKA's President and Chairman, Kye Abraham, elected to convert a total of $600,000 in convertible debt principal and $44,998 in accrued interest into 3,224,990 shares of common stock at a price of $0.20 per share. As of September 30, 2018 and December 31, 2017, there was $0 and $600,000 in outstanding convertible debentures, respectively. As the conversion price was lower than the stated conversion rate in the convertible debt instruments, LKA recognized a loss on debt conversion of $309,406 during the nine months ended September 30, 2018.

During the nine months ended September 30, 2018 and 2017, LKA recognized $8,970 and $2,065 of interest expense from the amortization of debt issuance costs, respectively. During the nine months ended September 30, 2018 and 2017, LKA recognized $528,939 and $31,754 of interest expense from the amortization of debt discounts, respectively.

 

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 due in semi-annual payments, 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, which were paid in 2016.

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 three 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 and LKA is required to maintain a reserve of proceeds equal to the first two semi-annual payments, which were paid in 2016 and 2017.

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 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.

For all the above noted 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 ASC 815 and LKA recognized a debt discount of $199,369. During the nine months ended September 30, 2018 and 2017, LKA recognized $61,542 and $60,295 of interest expense from the amortization of the debt discount, respectively.

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 nine months ended September 30, 2018 and 2017, LKA recognized $620 and $4,515 of interest expense from the amortization of debt issuance costs, respectively.

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.  Upon the date of issuance of the convertible notes (see Notes 2 and 3), $350,000 was recorded as debt discount and $162,046 was recorded as day one loss on derivative liability

 

During the nine months ended September 30, 2018 , holders of $600,000 in convertible notes payables elected to convert their outstanding principal into common stock (see Note 2). Upon conversion of the debt principal, the related derivative liabilities were extinguished to additional paid-in capital.

During the nine months ended September 30, 2018 , LKA recorded a gain of $35,473 on mark-to-market of the conversion options. During the nine months ended September 30, 2017 , LKA recorded a loss of $494,995 on mark-to-market of the conversion options.

The following table summarizes the derivative liabilities included in the consolidated balance sheets at September 30, 2018 and December 31, 2017:

The Company valued its derivatives liabilities using the Black-Scholes option-pricing model.  Assumptions used during the nine months ended September 30, 2018 include (1) risk-free interest rates of 1.93% - 2.88%, (2) lives of between 0.06 and 3.07 years, (3) expected volatility between 119% - 404%, (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, 2018. 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 -        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. Additional work is going to be required to modify and upgrade the mine's water treatment process in 2017 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.  It is currently expected that discussions with the CDPHE will be concluded by the end of 2018 and 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 a liability of $99,974 and $99,974 as of September 30, 2018 and December 31, 2017, respectively, as there is no better estimate of the amount of loss within this range.

NOTE 7 -        COMMON STOCK

During March 2018, Abraham & Co., Inc., an affiliate entity, agreed to exchange $23,805 in outstanding accounts payable and $1,785 in accrued interest for 127,952 shares of LKA common stock at the market price of the common stock on the date of issuance of $0.20 per share.

During March 2018, LKA's President, Chairman of the Board and Director, Kye Abraham, elected to convert $75,378 in accrued wages and $5,653 in accrued interest into 405,157 shares of LKA common stock, or the market price of the common stock on the date of issuance of $0.20 per share.

During March 2018, an affiliated entity elected to convert $12,798 in note principal and $960 in interest into 68,789 shares of common stock, or the market price of the common stock on the date of issuance of $0.20 per share.

During March 2018, members of the Koski family, the Company's largest shareholders, LKA's President and Chairman, Kye Abraham, and an entity controlled by LKA's President and Chairman, Kye Abraham, elected to convert a total of $600,000 in convertible debt principal and $44,998 in accrued interest into 3,224,990 shares of common stock at the market price of the common stock on the date of issuance of $0.20 per share.

During April 2018, LKA sold 2,702,703 shares of common stock for $500,000, or the market price of the common stock on the date of issuance of $0.185 per share to related parties. Funds are to be used to restart exploration activity at the Golden Wonder mine.

During April 2018, LKA issued 100,000 shares of common stock for consulting services valued at $18,970, or the market price of the common stock on the date of issuance of fair market value of $0.19 per share.

During June 2018, LKA issued 100,000 shares of common stock for promotion services valued at $17,990, or the market price of the common stock on the date of issuance of fair market value of $0.18 per share.

During the nine months ended September 30, 2018, LKA recognized $309,406 in loss on debt conversion based on the fair market value of the common stock issued compared to debt and interest converted.

NOTE 8 -        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 the 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 completed a $500,000 capital funding raise in April 2018 and will need raise additional funds to support operations during 2018. 

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.