Comstock Inc.: Form 10-Q for the period ended Sep 30, 2011

The following discussion provides information that we believe is relevant to an assessment and understanding of the consolidated results of operations and financial condition of the Company. It should be read in conjunction with the consolidated financial statements and accompanying notes also included in this 10-Q and our Annual Report on Form 10-K as of and for the fiscal year ended December 31, 2010.

The following discussion addresses matters we consider important for an understanding of our financial condition and results of operations as of and for the nine months ended September 30, 2011, as well as our future results.

Overview

The Company is a Nevada-based, gold and silver mining company with extensive, contiguous property in the historic Comstock District. The Company began acquiring properties and developing projects in the Comstock District in 2003. Since then, the Company has consolidated a substantial portion of the Comstock District, secured permits, built an infrastructure and brought the exploration project into test mining production. The Company produced over 12,000 ounces of gold and over 53,000 ounces of silver from 2004-2006, at our existing heap leach processing facilities. Our test mining activities were concluded in January 2007, when based on our longer-term production plans, we prioritized land consolidation and mine planning.

We continue acquiring additional properties in the Comstock District, expanding our footprint and creating opportunities for exploration and mining. The Company now owns or controls approximately 6,099 acres of mining claims in the Comstock District. The acreage is comprised of 999 acres of patented claims (private lands) and 5,100 acres of unpatented claims on land administered by the US Bureau of Land Management (“BLM”). The Company also owns a heap leach processing facility that is being redesigned to accommodate our new production plans.

Exploration and Mine Development

Our strategic plan calls for additional infill drilling and metallurgical testing prior to the resumption of mining. The information from these drill programs is being used in the development of a detailed mine design for reopening the mine, fine-tuning our mineral processing procedures to maximize gold and silver recovery and updating our global mineralized material estimates.

On September 30, 2011, the Company announced the cumulative results of exploration, metallurgical and mine development activities through its third National Instrument 43-101 technical report (the “NI Report”) delivered to the Company by Behre Dolbear & Company (USA) Ltd., during the third quarter of 2011. The full report and highlights of the results of this drilling are available on the Company website, www.comstockmining.com (http://www.comstockmining.com).

The most-recent drill program began October 25, 2010, and continued through August 19, 2011. The substantial majority of the drilling occurred in the first and second quarters of the year. During 2011, infill drilling for mine planning was completed on the Hartford, Lucerne and Justice claims in the Lucerne Resource Area; the second phase of development drilling was completed in the Dayton Resource Area; and the first phase of development drilling was completed on the East-Side target in the Lucerne Resource Area. A total of 133 reverse circulation holes were completed during the quarter, totaling 5,665 feet, using two drill rigs. A total of 374 reverse circulation holes were completed since the drill program’s inception, totaling 128,711 feet, using three drill rigs.

We did not drill any additional core holes during the third quarter of 2011. A total of 15 core holes were drilled since the drill program’s inception, totaling 3,584 feet. Two of the core holes were in the Dayton Resource Area, two were in the East-Side target, and eleven were for the Lucerne Resource Area starter pit. The core holes were drilled to meet three goals: to twin and confirm the results of specific reverse circulation holes, to provide core for metallurgical testing, and to provide geotechnical information for finalizing the pit slope design.

On October 4, 2011, the Company received unanimous approval from the Storey County Board of Commissioners passing Special Use Permit 2011-016 ("SUP") that grants the Company authorization to further develop its exploration drilling in the southern portion of the county. Under a previous mining permit in the county, the Company is already permitted for its Lucerne starter-mine operation. This approval affirms the unanimous recommendation from the Storey County Planning Commission on August 16, 2011. The SUP also defines operational protocols designed to accommodate the unique nature of the Comstock Historic District. The Company invested significant effort in cooperation with the Storey County Planning Department, the Planning Commission and the greater community to define a number of critical stipulations that prioritize public safety, value community resources and provide additional environmental protections to this uniquely historic mining district.

On October 15, 2011, our permit request for an expanded plan of exploration drilling on our Dayton and Spring Valley Areas, both in Lyon County, was submitted, by the Nevada Department of Environmental Protection, for public hearing scheduled on November 16, 2011. This permit will significantly expand our authorization for exploration drilling in Lyon County. We anticipate final approval of this permit in late 2011.

These two exploration permits provide the approvals required for expanded exploration drilling in Storey and Lyon County for our drilling programs in 2012 and 2013. This provides for the full exploration of our Lucerne, Dayton and Spring Valley Resource and target areas, consistent with our stated strategic objectives for expanding our validated resource.

Production

During the third quarter, the Company announced that it had hired a number of experienced mining professionals. These key additions to our staff brought demonstrated skills and experience, including operations management, mine engineering, and permitting and environmental, which will be invaluable as we prepare for mining production activities in late 2011 or early 2012. On September 1, 2011, the Company announced that Mr. Steven Tucker joined the Company as Senior Mine Planner, and Ms. Cynthia Byrns joined the Company as Director of Environmental and Regulatory Management. Each of these professionals brings over 25 years of experience. Cynthia is our thirteenth new hire this year bringing us to a current total of approximately 30 mining professionals.

The Company has utilized McClelland laboratories to provide base metallurgical testing on samples. The base testing included the bottle roll testing on a multitude of samples representing three different rock types. i.e., Alta-andesite, Rhyolite and -Meta-volcanic. Results of the bottle roll tests indicated favorable gold recoveries utilizing cyanide heap leaching. McClelland then designed and performed column heap leach tests on composites of high and low-grade materials intended to simulate and provide data for the final design of our crushing facility and Merrill-Crowe processing facility. Gold recoveries averaged 72.1% and silver recoveries averaged 47.9% and the facility designs were finalized and ordered.

On May 11, 2011, the Company engaged the Goodfellow Corporation of Boulder City, Nevada to provide a new, two-stage crushing facility, complementing our existing heap leach processing facility in American Flat. The plant will include a primary jaw crusher and a secondary cone crusher, and will be installed by Goodfellow after the Company receives the necessary permits. The new crushing plant will provide the capacity for the Company’s initial permitted production rate of 720,000 tons per year, with substantial additional capacity for increased production in the future.

On July 7, 2011, the Company signed an agreement with Scotia International of Nevada, Inc, to refurbish and upgrade our Merrill-Crowe processing plant and refinery. The upgraded plant will provide the capacity to meet our permitted initial production rate of 720,000 tons per year, with growth capacity for increased production rates in the future. Under the terms of the agreement, Scotia will transport existing components of the processing plant to their facility in Salt Lake City, where they will refurbish or upgrade each component, reassemble the plant, and test its operation.

Once all required permits have been received, the facilities will be assembled and operated at our American Flat facility.

On July 13, 2011, the Company received a certificate of occupancy for a new, 36’x60’ office building, installed next to our existing office building in American Flat. The new building added much-needed space for our growing professional mining staff.

On July 27, 2011, the Company received its Mercury Operating Permit #AP1041-2690, issued under a new air quality program that is administered by the Nevada Division of Environmental Protection (“NDEP”) – Bureau of Air Quality that requires all gold mining companies that use thermal processes for gold recovery to monitor and manage, through engineering controls, any mercury fumes or liquid metal that is derived from the precious metal ore as a by-product. This air permit ensures employee and public safety during the final stages of precious metals recovery. The Comstock ore has very little naturally occurring mercury content relative to many other gold mining operations in Nevada. Issuance of this new permit allows for the construction of a Melt Furnace and a Mercury Retort. This permit is a critical prerequisite for recommencing production. The Company does not use mercury at any time in the processing of gold and silver. All the equipment will be located at our American Flats processing location.

The Company has applied for an Air Quality Permit, primarily associated with our new crushing facilities. This permit, to be issued by the Nevada Division of Environmental Protection (“NDEP”), is required before mining and processing can recommence and will require a public notice period identical to our recently issued Mercury Operating to Construct Permit, making issuance most likely in December. Once issued, the Company has approximately six months of preparatory activities including land clearing, excavation and leveling associated with the installation of the crushing facility, installation of the expanded Merrill Crowe facility and expansion of the heap leach, operating ponds and associated liners.

On October 14, 2011, the Company was granted authorization, through a Notice and Findings Order # 2011-22, to fully construct and line a process solution pond. This pond is a prerequisite for production but also enables compliance with our recently modified Water Pollution Control Permit #NEV 2000109. On October 24, we commenced, with third parties construction contractors, constructing the process solution pond.

The Company’s near term production plans include expanding the existing heap leach to a capacity of approximately 4 million tons of capacity. We have accrued a long-term liability of approximately $1.4 million as of September 30, 2011, for our obligation to reclaim our mine facility based on our 2008 reclamation plan approved by the Nevada State Environmental Commission and Division of Environmental Protection. We are currently updating this three-year plan and anticipate the approval of our 2011 reclamation plan in the first quarter of 2012, including the associated increase in the reclamation bond requirement for the updated plan, including these expansions, estimated at approximately $2 million - $4 million.

Corporate

We will continue to increase our footprint in the Comstock District through strategic acquisitions. We consider the historic Comstock district central to our growth strategy. We work collaboratively with federal, state, and local regulatory agencies and zoning boards to ensure that we obtain all permits needed to resume mining.

On August 26, 2011 and August 31, 2011, respectively, the Company acquired a property for $90,000 consisting of a $45,941 cash payment and a $44,059 long-term debt obligation and a property for $150,000 cash payment. These properties were part of the hospitality segment.

On October 7, 2011, the Company exercised its purchase option on the “Dondero” property (previously announced in 2009) in Lyon County, Nevada just south and contiguous to the Company’s “Dayton” resource area. The property consists of 84.05 acres of mining patents and surface lots. The Company paid $710,000 consisting of $280,000 in cash and $430,000 in common stock (192,600 shares).

During the nine month period ended September 30, 2011, 1,710 shares of Series A-2 convertible preferred stock and 4,525 shares of Series B convertible preferred stock were converted into 2,625,514 and 2,742,568 shares of common stock, respectively. Subsequent to September 30, 2011, and through November 14, 2011, preferred shareholders converted 17 shares of convertible preferred stock into 10,303 common shares. Common shares and convertible preferred shares outstanding at November 14, 2011, totaled 28,202,752 and 60,516, respectively.

Effective October 17, 2011, the Company elected to exercise its option to purchase the Dayton, effectively purchasing the 4 patented lode claims totaling 95 acres known as the “Dayton.” These mineral claims are contiguous with our Spring Valley mineral holdings. The purchase price is $3,000,000 plus a 3% NSR. In addition, the NSR will be reduced by 75% until the Company receives credit through the reduction of NSR for the $3,000,000 purchase price. The revised agreement calls for a $500,000 upfront payment in two installments, $50,000 in November 2011, and $450,000 in January 2012. The seller will finance $2,500,000 with a 0% interest seller’s note. The note will be payable with equal quarterly installments of $50,000.

Comparative Financial Information

Below we set forth a summary of comparative financial information for the three and nine months ended September 30, 2011 and 2010.

Three Months Ended September 30, 2011 and September 30, 2010:

On May 1, 2011, we acquired the historic Gold Hill Hotel and five related cottages. The Hotel had revenues from the cottages, hotel rooms, restaurant and bar totaling $179,071 during the quarter ended September 30, 2011. We did not produce or sell any gold or silver at our Comstock project in Nevada during the three months ended September 30, 2011 and September 30, 2010.

Hotel operating costs were $219,159 for the quarter ended September 30, 2011. There were no hotel operating expenses for the same period in 2010. The $219,159 represents cost incurred for providing room, restaurant and bar services at the hotel during the quarter ended September 30, 2011.

Reclamation, exploration and test mining expenses increased by approximately $1.7 million in the third quarter of 2011 when compared to the same quarter in 2010. The increase was primarily caused by expenditures associated with increased reverse circulation development drilling and related metallurgical, assay and mine development activity in and for our Lucerne and Dayton Resource Areas in the third quarter 2011, including higher labor costs related to the expansion of the geological staff.

General and administrative expenses increased by $424,676 in the third quarter of 2011 as compared to the third quarter of 2010. This increase resulted primarily from an increase in payroll and the related costs of an increased number of general and administrative employees.

Consulting and professional fees decreased by $198,363 in the third quarter of 2011 as compared to the third quarter of 2010. This decrease resulted primarily from reduced legal fees.

Derivative changes in fair values decreased by approximately $19.0 million in the third quarter of 2011, as compared to the third quarter in 2010. This decrease includes $17.3 million resulting from eliminating the embedded beneficial conversion feature and warrant derivative liabilities in the fourth quarter of 2010, when we exchanged all our convertible debt for equity and also includes a decrease of $1.7 million in the contingent dividend payment derivative embedded in the preferred stock outstanding during the three months ended September 30, 2011. There was no contingent dividend payment derivative liability outstanding during the three month period ended September 30, 2010.

Interest income totaled $11,304 for the third quarter of 2011 as compared to $0 for the third quarter of 2010. Third quarter 2011 interest income originates from the cash and cash equivalents, and available-for-sale securities that were purchased with the proceeds from the issuance of Series B Preferred Stock in the fourth quarter of 2010.

Interest expense decreased approximately $1.1 million in the third quarter of 2011 as compared to the third quarter of 2010. This decrease resulted from the extinguishment of our senior secured convertible indentures, promissory notes and associated interest obligations totaling $29.4 million during the fourth quarter of 2010.

Nine Months Ended September 30, 2011 and September 30, 2010:

22

On May 1, 2011, we acquired the historic Gold Hill Hotel and five related cottages. The Hotel had revenues from the cottages, rooms, restaurant and bar totaling $299,246 for the period ended September 30, 2011. We did not produce or sell any gold or silver at our Comstock project in Nevada during the nine months ended September 30, 2011 and September 30, 2010.

Hotel operating costs were $319,154 for the nine months ended September 30, 2011. There were no hotel operating expenses for the same period in 2010. The $319,154 represents cost incurred for providing room, restaurant and bar services at the hotel.

Reclamation, exploration and test mining expenses increased by approximately $5.2 million in the first nine months of 2011 when compared to the same nine month period in 2010. The increase was primarily caused by expenditures associated with increased reverse circulation development drilling and related metallurgical, assay and mine development activity in and for our Lucerne and Dayton Resource Areas in 2011, including higher labor costs related to the expansion of the geological staff.

General and administrative expenses increased by approximately $1.8 million in the first nine months of 2011 as compared to the first nine months of 2010. This increase resulted from stock grants issued to our outside directors valued at $980,000, labor from increased professional staff and higher travel costs.

Consulting and professional fees increased by $292,025 in the first nine months of 2011 as compared to the first nine months of 2010. This increase resulted primarily from an increase in accounting consultant services.

Derivative changes in fair values decreased by approximately $21.7 million in the first nine months of 2011, as compared to the same period in 2010. This decrease includes $18.8 million resulting from eliminating the embedded beneficial conversion feature and warrant derivative liabilities in the fourth quarter of 2011, when we exchanged all our convertible debt for equity and also includes a decrease of $2.9 million in the contingent dividend payment resulting primarily from a decrease in the underlying convertible preferred stock outstanding during the nine months ended September 30, 2011, the passage of time since the issuance of the convertible preferred stock in October 2010 and a lower common stock price. There was no contingent dividend payment derivative liability outstanding during the nine month period ended September 30, 2010.

Interest income totaled $65,354 during the first nine months of 2011 as compared to $0 for the first nine months of 2010. 2011 interest income originates from the cash and cash equivalents, and available-for-sale securities that were purchased with the proceeds from the issuance of Series B Preferred Stock in the fourth quarter of 2010.

Interest expense decreased approximately $3.0 million in the first nine months of 2011 as compared to the first nine months of 2010. This decrease resulted from the extinguishment of our senior secured convertible indentures, promissory notes and associated interest obligations totaling $29.4 million during the fourth quarter of 2010.

The Company recorded a deferred tax benefit of $76,081 for the nine-month period ended September 30, 2011. After consideration of the allocation and the projected consolidated results and available taxable differences from the acquisition of Gold Hill Hotel, the Company determined it would be able to realize approximately $76,000 of tax benefits from its deferred tax assets. The Company did not recognize any other net tax benefits from its losses because full valuation allowances are provided on the Company’s net deferred tax assets.

Liquidity and Capital Resources

On October 20, 2010, the Company raised approximately $35.75 million in gross proceeds (approximately $33.2 million, net of issuance costs) by issuing shares of a newly created Series B Preferred Stock to fund the Company’s business plan to accelerate mine development and production and enhance exploration and exchanged all of our $29.4 in senior secured convertible debentures, promissory notes and related interest obligations for shares of a newly created Series A Preferred Stock. This funding meets our capital and working capital needs for production start up in late 2011 or early 2012, exploration drilling under our three-year strategic plan and certain additional land purchases. Through September 30, 2011, of the $35.75 million proceeds raised in October 2010, we have used approximately $19.8 million of those proceeds to advance our strategic operating plan. Specifically, we expended $6.0 for exploration and mine development, $2.4 million for mineral and other properties, $3.9 million for general corporate matters, which includes $1.1 million for legacy payables. We also spent $4.3 million towards the crushing facility, mobile mine equipment and related production expenses. We also used $3.2 million for the direct transaction fees and related costs. Cash, cash equivalents and available-for-sale securities on hand at December 31, 2010 and September 30, 2011, totaled $29.8 million and $15.9 million, respectively. However, we did not generate operating cash flows and we have yet to realize an operating profit at the Company. Although the Company is still an exploration stage mine, we believe that our current positive working capital and cash investment positions are sufficient to fund the operations for the next 12 months. Our management also believes it would be able to raise additional capital, if needed. Our recurring losses and negative cash flow from operations require ongoing assessment about our ability to continue as a going concern.

For the nine-month period ended September 30, 2011, we used cash from operating activities of approximately $9.4 million compared to $4.5 million in 2010. Operating cash flow decreased approximately $4.9 million due to an increased net loss primarily as a result of increased 2011 drilling activities. We used cash in investing activities to acquire approximately $3.2 million of additional mineral rights and properties, plant and equipment and $500,000 to acquire the Gold Hill Hotel and related cottages. We used cash in investing activities to purchase approximately $2.2 million of available-for-sale securities and proceeds from maturity of available-for-sale securities were approximately $3.7 million. We expended approximately $0.8 million in financing activities related to principal payments on long-term debt obligations.

To date, the Company has spent approximately $4 million in capital expenditures, primarily for the crusher, Merrill Crowe and rolling stock equipment purchases. During the next twelve months, the Company anticipates purchasing an additional $10 million for this equipment, with substantially of all those assets leased or equipment financed, resulting in approximately $3 million of remaining, net cash outlays for capital items, including installing the crushing facility, the final expansion of the Merrill Crowe processing facility and labs, and the rolling stock for production. This also includes expanding the existing heap leach to a capacity of approximately 4 million tons. We are currently bonded for approximately $1.2 million for our obligation to reclaim our mine facility based on our prior reclamation plan. We are currently updating the reclamation plan and anticipate increasing the bond, including for these expansions, by approximately $2-$4 million in the next nine months.

On July 1, 2011, the Registration Statement was declared effective by the SEC. The Registration Statement covers the offer and resale by certain stockholders of the Company of up to 6,325,691 shares of our common stock that are either presently outstanding or that are issuable upon the conversion of currently outstanding Series B Convertible Preferred Stock. The Registration Statement also allows the Company to issue common stock in payment of dividends on our presently issued and outstanding convertible preferred shares or for other offers or sale by us up to $25,000,000. The Company may offer and sell to the public any of such shares that are not issued in payment of such dividends. Such shares may be offered and sold from time to time, in one or more offerings, in amounts, at prices and on terms to be determined at the time of sale and set forth in an accompanying prospectus supplement and other offering materials.

On October 11, 2011, the Company entered into the consent with the holders of the Series A-1 convertible preferred stock and DWC Resources, Inc. Pursuant to the terms of the Consent, the Company and the other parties agreed to extend the due dates by which a registration statement will be filed with respect to common shares underlying the Series A-1 convertible preferred stock, and waive certain rights related thereto.

On October 20, 2011, the Company issued an additional 862.5 shares of Series A-1 convertible preferred stock to Northern Comstock in prepayment of the annual mineral rights lease pursuant to the Northern Comstock operating agreement.

Critical Accounting Policies And Estimates

A summary of our significant accounting policies and estimates is discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations and in Note 2 of our Annual Report on Form 10-K for the year ended December 31, 2010. The preparation of the financial statements in accordance with U.S. generally accepted accounting principles requires us to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities. Significant areas of uncertainty that require judgments, estimates and assumptions include the accounting for impairment of long-lived assets, reclamation and remediation obligations, stock-based compensation, derivative instruments, income taxes and other contingent liabilities. We use historical and other information that we consider to be relevant to make these judgments and estimates. However, actual results may differ from those estimates and assumptions that are used to prepare our financial statements.

A. Disclosure

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, our management performed, with the participation of our Principal Executive Officer and Principal Financial Officer and our Principal Accounting Officer, an evaluation of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Our disclosure controls and procedures are designed to ensure that information required to be disclosed in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s forms, and that such information is accumulated and communicated to our management including our Principal Executive Officer and Principal Financial Officer and our Principal Accounting Officer, to allow timely decisions regarding required disclosures. Based on the evaluation as described above, our internal control over certain procedures as of September 30, 2011 were not effective.

Description of Material Weaknesses at December 31, 2010

The Company did not maintain effective monitoring controls over the calculation of complex accounting transactions. The Company did not accurately calculate the derivative liability associated with embedded beneficial conversion features on the debentures and notes at September 30, 2010 and did not classify certain defaulted debt as current. Our financial statements as of, and for the three and nine-month-periods ended, September 30, 2010 were restated to reflect the correction of this error.

Remediation Actions Relating to Material Weaknesses

Beginning in 2011, we initiated a quarterly process to review complex accounting matters with the Chief Executive Officer and the Chief Accounting Officer. We also engaged a third-party valuation specialist to calculate the fair value of all embedded derivatives and will engage other specialists as needed to address complex accounting matters. In addition, we have engaged a third-party consultant to review our financial reporting controls and procedures to ensure timely and accurate reporting. Since July 2011, we have hired three additional accounting and finance resources to manage the accounting, financial reporting, and treasury functions.

Conclusion

We believe the measures described above will facilitate remediation of the material weaknesses we have identified and will continue to strengthen our internal controls over financial reporting. We are committed to continually improving our internal control processes and will diligently and vigorously review our financial reporting controls and procedures. As we continue to evaluate and work to improve our internal controls over financial reporting, we may determine that additional measures are necessary to address control deficiencies. Moreover, we may decide to modify certain of the remediation measures described above.

B. Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company in accordance with as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that:

(i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets;

(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements; and

(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized transactions.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control - Integrated Framework and Internal Control over Financial Reporting-Guidance for Smaller Public Companies.

Except as described above, there have been no changes during the quarter ended September 30, 2011 in the Company's internal control over financial reporting identified in connection with the evaluation required by Exchange Act Rules 13a-15(d) and 15d-15(d) that have material affected, or are reasonably likely to materially affect, our internal controls over our financial reporting.

There have not been any material changes to the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010.