Comstock Inc.: Form 10-Q for the period ended Mar 31, 2013

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 condensed 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, 2012.

The following discussion addresses matters we consider important for an understanding of our financial condition and results of operations as of and for the three month periods ended March 31, 2013, as well as our future results.

Overview

The Company is a producing Nevada-based, gold and silver mining company with extensive, contiguous property in the historic Comstock and Silver City mining districts (collectively, the “Comstock District”). The Comstock District is located within the western portion of the Basin and Range Province of Nevada, between Reno and Carson City. 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 exploration projects into production.

Because of the Comstock District’s historical significance, the geology is well known and has been extensively studied by the Company, our advisors and many independent researchers. We have expanded our understanding of the geology of the project area through vigorous surface mapping and drill hole logging. The volume of geologic data is immense, and thus far the reliability has been excellent, particularly in the various Lucerne Mine areas. We have amassed a large library of historical and current data and detailed surface mapping of Comstock District properties. As we continue our detailed exploration mapping, close spaced drilling, and initial mine production, new details emerge that significantly influence our understanding of the local and regional geology.

Our Lucerne Resource Area is located in Storey County, Nevada, approximately three miles south of Virginia City and 30 miles southeast of Reno. Our Dayton Resource Area is located in Lyon County, Nevada, approximately six miles south of Virginia City. Access to the properties is by State Route 342, a paved highway.

The near term goal of our business plan is to deliver stockholder value by: 1) validating qualified resources (measured and indicated) and reserves (proven and probable) of at least 3,250,000 gold equivalent ounces from our first two resource areas, Lucerne and Dayton; 2) achieving initial commercial mining and processing operations in the Lucerne Mine with annual production rates of approximately 20,000 gold equivalent ounces; and 3) growing production through the commercial development and expansions of both the Lucerne and Dayton Mine plans.

As part of this plan, the Company has developed the exploration and development drilling programs intended to validate mine design for the Lucerne and Dayton Mines and also, to identify qualified resources and reserves in these two resource areas with three intermediate objectives of validating measured and indicated resources containing 1,000,000, 1,500,000 and 2,000,000 gold equivalent ounces, respectively and the remaining planned objective of 3,250,000 gold equivalent ounces. The Company has already met the first three intermediate resource validation objectives by validating measured and indicated resources containing over 2,000,000 gold equivalent ounces.

The Company has also developed a mine plan intended to achieving initial commercial mining and processing operations in the Lucerne Mine and ramp those annual production rates to approximately 20,000 gold equivalent ounces. The Company achieved initial production and held its first pour of gold and silver on September 29, 2012, with three remaining intermediate objectives from ramping up production to rates of 15,000, 17,500 and 20,000 gold equivalent ounces per annum, respectively.

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 5,900 acres of mining claims and parcels in the Comstock and Silver City Districts. The acreage is comprised of approximately 1,350 acres of patented claims (private lands) and surface parcels (private lands) and approximately 4,550 acres of unpatented mining claims, which the Bureau of Land Management (“BLM”) administers.

Current Projects

The Company’s headquarters, mine operations and heap leach processing facility are in Storey County, Nevada, at 1200 American Flat Road, approximately three miles south of Virginia City, Nevada and 30 miles southeast of Reno, Nevada. The Company has focused to date on the Lucerne Resource area (including the east-side target within this area), the Dayton Resource area and the Spring Valley exploration target. We also plan on focusing exploration on the Northern Extension, Northern Targets, and Occidental Target areas subsequent to the exploration and development of Lucerne, Dayton and Spring Valley. The Company’s existing heap leach processing facility for gold and silver will be redesigned and expanded to accommodate new production plans.

The Lucerne Resource area has been the focus of the Company’s exploration and development efforts since 2007. It includes the previously mined Billie the Kid, Hartford and Lucerne mining claims, and extends northeasterly to the area of the historic Woodville bonanza, and north to the historic Justice and Keystone mines, plus the extension of these areas down-dip to the east. The Company has the key mining permits required to resume mining in that area. The Lucerne Resource area is approximately 5,000 feet long, with an average width of 600 feet, representing less than three percent of the land holdings controlled by the Company. The east-side target within this area ranks as one of the Company’s top exploration and potential mine production targets.

The Dayton Resource area lies southwest of Silver City, generally from the Dayton, Kossuth and Alhambra claims, including the old Dayton mine workings, south to where the Kossuth claim crosses State Route 341. The historic Dayton mine was the last major underground mining operation in the Comstock District, before being closed after the War Production Board promulgated Limitation Order L-208, 7 F. R. 7992 on October 8, 1942, which closed down all gold mining operations in the United States and its territories. The Dayton Resource area ranks as one of the Company’s top exploration and potential mine production targets.

The Spring Valley exploration target lies at the southern end of the Comstock District, where the mineralized structures lie mostly concealed beneath a veneer of sediment gravels. The area includes the Kossuth claim south of State Route 341, the Dondero property, the New Daney lode mining claims, and the Company’s placer mining claims in Spring Valley and Gold Canyon.

The Northern Extension, Northern Targets and Occidental areas represent exploration target areas that contain many historic mining operations, including the Overman, Con Imperial, Caledonia, and Yellow Jacket mines, among others. Previous operators have explored the various mines in this area, some of which have led to mineralized material inventories. We believe that our consolidation of the Comstock District has provided us with opportunities to utilize the historical information available to identify drilling targets with significant potential.

Our Comstock exploration activities include open pit gold and silver test mining. As defined by the Securities Exchange Commission (“SEC”) Industry Guide 7, we have not yet established any proven or probable reserves at our Comstock Lode Project.

The Company’s hospitality segment owns and operates the Gold Hill Hotel and related cottages. The hospitality segment is not generally seasonal in nature except for November through February when operations are generally slow.

Financial information for each of our segments is disclosed in footnote 10 to the consolidated financial statements.

Exploration

The goal of our strategic plan includes validating qualified resources (measured and indicated) and reserves (proven and probable) of 3,250,000 gold equivalent ounces, requiring execution of planned exploration and development drilling. Mr. Larry Martin, our Vice President of Exploration and Mine Development and a Certified Professional Geologist (CPG), manages these drill programs. The Comstock Mining district is a well-known, historic mining district, with over 150 years of production-based history. We have access to extensive reports and maps on various properties in the district, but to-date, we have only conducted detailed geologic exploration and resource modeling on approximately 10% of our approximate 5,900 acre land position. We are conducting an ongoing exploration program to locate and test surface mineral targets as well as deep underground bonanza targets by using historic compilation, geological mapping, geochemical and geophysical investigations and drilling.

The drilling program over the next 12-24 months will continue with three significant objectives: 1) infill drilling in the Dayton Resource Area 2) step-out and infill drilling in the east-side of the Lucerne Resource Area and 3) exploration drilling on high priority targets, including Spring Valley.

The infill drilling in the Dayton Resource Area will provide detailed information needed to create a mine plan for the proposed Dayton mine, to be developed in parallel with the expanded Lucerne mine.

The step-out drilling phase in the east-side of the Lucerne Resource Area will test the continuity of mineralization to the north and south, and at greater depths to the east. The infill-drilling phase will then provide the detailed information needed to develop an expanded mine plan for the Lucerne mine. That mine plan will position the Company to complete an economic feasibility study, a prerequisite before any permitting for the expanded mine becomes foreseeable.

Production

During the first quarter of 2013, we completed the ramp up and stabilization activities of the production system, including improvements to the hauling, crushing and metal extraction processes. Metal sales in the first quarter 2013 totaled $4.2 million, with gold revenues of $3.7 million. We also produced $0.5 million of silver. Silver is accounted for as a by-product credit in costs applicable to mining revenue for financial reporting purposes. During the first quarter of 2013, the Company crushed and stacked over 234,000 dry tons of mineralized materials and shipped 2,261 ounces of gold and 15,599 ounces of silver. Material placed on the heap leach pad remains under solution until the target recovery rates are achieved.

The Company continues ramping up its production and exceeded its targeted production rate of 400 ounces per week, initially targeted for the end of April, and has averaged over 425 gold-equivalent ounces for the six weeks ended April 27, 2013. The Company is continuously adjusting its operations to improve grade, maximize yields and increase tons crushed and stacked.

Throughout the quarter ended March 31, 2013, the Company realized an average price of $1,626.74 price per ounce of gold and a $31.44 average sales price per ounce of silver. In comparison, commodity market prices in the first quarter of 2013 averaged $1,630.47 per ounce of gold and $30.08 per ounce of silver.

Operating Costs

During the first quarter of 2013, actual Lucerne Mine operating expenses were approximately $4.3 million, $3.8 million net of silver credits. Cost applicable to mining revenue include mining and processing labor, maintenance, blasting and assaying costs associated with higher production rates and higher absorbed inventory costing associated with costs incurred in advance of achieving the targeted production rate. Other costs applicable to mining revenue include higher hauling costs, including redundancy associated with our inability to use an existing haul road, for most of the first quarter, that crosses Lot 51 and the transition costs associated with renting new haul vehicles while transitioning out of the existing, temporary vehicles, as discussed below.

Our expenses associated with mining operations do not include corporate administration or other general and administrative costs, nor do they include exploration and mine development costs.

The estimated operating expenses do not include corporate administration or other general and administrative costs, nor do they include exploration and mine development costs.

Haulage and the BLM

During February 2013, the Company announced that the United States Department of the Interior - Bureau of Land Management (BLM) made a determination to allow the Company to move forward with a Class 1 Color-of-Title Act claim ("CoT claim") with respect to Lot 51, a 25-acre parcel in Gold Hill, Nevada. As part of this process, the BLM is allowing for the Company's limited interim use of the existing haul road segment that crosses Lot 51, providing a more efficient connection to a previously granted, non-exclusive Right-of-Way ("RoW") for access to its processing facility in American Flat.

In order to comply with the guidelines in the currently authorized RoW grant, the Company will use different, highway-rated vehicles. The vehicles will travel a shorter distance while carrying a larger load, thus decreasing overall traffic on American Flat Road, while also reducing haul truck traffic on the State Route. These vehicles will also un-block the mine area from logistical constraints imposed by the previously used vehicles, increase throughput by increasing the haul per trip and reduce costs significantly by reducing the number of trips. We are renting eight of these highway-rated vehicles for one year, at a cost of $12,000 per month, per vehicle. Each vehicle is rented pursuant to a separate agreement that may be individually terminated by us at our discretion and returned to the lessor, subject to a termination fee, in certain instances. In February 2013, the Company sold five Caterpillar 773 Haul Trucks, a loader, two dozers and a fuel truck for a gross amount of $1.6 million. The Company transferred a portion of the proceeds to pay down approximately $1.0 million in debt and recorded a loss in the first quarter of 2013 of approximately $1.0 million associated with the transfer of those assets.

2013 Outlook

During the first quarter of 2013, modifications and optimizations have been engineered into the Company's mine planning, hauling, crushing and recovery systems. The Company’s current financial analysis for the Lucerne Mine anticipates annual operating expenses, including all mining and processing costs of approximately $15.9 million per annum, excluding approximately $1 million of additional haulage costs, with an anticipated production schedule currently processing at the rate of one million tons per annum, but also including plans for ramping up to a 1.5 million tons per annum run rate. Mine administration costs are anticipated to be approximately $1.5 million. The Company currently anticipates production rates beyond the 400 gold-equivalent ounces per week in the second half of the year, as it ramps up production with the goal of producing 20,000 gold-equivalent ounces in 2013.

Recent Developments

From March 31, 2013 through April 30, 2013, preferred shareholders converted 100 shares of convertible preferred stock into 60,606 common shares.

In January 2013, the Company determined that an accelerated payment may be required pursuant to the operating agreement of Northern Comstock Mining, LLC. Pursuant to the operating agreement, $5,000,000 in accelerated payments are triggered when an additional 200,000 gold equivalent ounces are estimated by the Company and validated by a third party technical report accepted by the Board. The payments are expected to be made in the form of Series A-1 convertible preferred stock. The Company expects to approve and issue the stock during the second quarter of 2013.

Land and Mineral Right Acquisitions

We did not have any material land or mineral right acquisitions during the three months ended March 31, 2013 and through the date of this report. We will continue to increase our footprint in the Comstock District through strategic acquisitions.

Comparative Financial Information

Since the Company just recently commenced production, and correspondingly, did not recognize revenues from gold and silver production and sales until late fiscal 2012, certain results associated with the three month period ended March 31, 2013 may not be comparable with the three months ended March 31, 2012. For these line items we have provided additional analysis as noted below.

The comparative financial information is reflected in the following table:

Three Months Ended:

18

Mining revenue from the sale of gold in the first quarter of 2013 was $3.7 million. We also produced and sold $0.5 million of silver in the first quarter of 2013. Silver is accounted for as a by-product credit in costs applicable to mining revenue for financial reporting purposes. We recorded our first mining revenue from gold sales in October 2012, and accordingly, we did not generate mining revenue during the three months ended March 31, 2012.

During the first quarter of 2013, we completed the ramp up and stabilization activities of the production system, including improvements to the hauling, crushing and metal extraction processes. During the first quarter of 2013, the Company crushed and stacked over 234,000 dry tons of mineralized material and shipped 2,261 ounces of gold and 15,599 ounces of silver. Material placed on the heap leach pad remains under solution until the target recovery rates are achieved.

Throughout the quarter ended March 31, 2013, the Company realized an average price of $1,626.74 price per ounce of gold and a $31.44 average sales price per ounce of silver. In comparison, commodity market prices in the first quarter of 2013 averaged $1,630.47 per ounce of gold and $30.08 per ounce of silver.

The Company continues ramping up its production and exceeded its targeted production rate of 400 ounces per week, initially targeted for the end of April and has averaged over 425 gold-equivalent ounces for the six weeks ended April 27, 2013. The Company is continuously adjusting its operations to improve grade, maximize yields and increase tons crushed and stacked.

Hospitality revenue from the cottages, hotel rooms, restaurant and bar was stable for the three months ended March 31, 2013, compared to the same quarter in 2012. Consistent with current economic conditions and seasonal variations experienced during these periods, we do not expect material changes in our hospitality operational results. We further expect our hospitality results to become less material to our overall operations as we execute our mine development plans.

Costs applicable to mining revenue increased approximately 8% compared to the quarter ended December 31, 2012 (the Company was not producing during the comparable prior period quarter). The increases resulted from increased labor, maintenance, blasting and assaying costs associated with higher production rates and higher hauling associated with the redundancy of transitioning from hauling on the state route back onto our primary haul route, and higher absorbed inventory costing associated with costs incurred in advance of achieving the targeted production rate.

Hospitality operating costs increased approximately 36% to $206,341 for the quarter ended March 31, 2013 compared with the three months ended March 31, 2012. The hotel operating costs represents costs incurred for providing room, banquet, restaurant and bar services at the hotel. The increase was attributable to higher labor, maintenance and insurance costs in the quarter.

Reclamation and exploration expenses decreased by approximately 56% compared to the three month period ended March 31, 2012. The decrease is primarily the result of the completion of our 2012 drilling program that commenced in January 2012 and completed in December 2012, and has not yet resumed for 2013.

During the three months ended March 31, 2013, we sold mining equipment and vehicles with a remaining book value of $3,165,746 at a loss of $1,015,496. The loss is included in general and administrative expenses in the condensed consolidated statements of operations.

General and administrative expenses, inclusive of professional and consulting fees, increased by approximately 5% compared to the period ended March 31, 2012. The increase is primarily the result of an increase in headcount related to operating our mine.

Changes in other income and expenses remained relatively flat for the three months ended March 31, 2013 as compared to the prior three month period with the exception of our derivative liabilities which fluctuate primarily based on market conditions outside of our control.

Interest expense increased by $0.4 million, or approximately 925% for the three months ended March 31, 2013 from the three months ended March 31, 2012, primarily due to new equipment financing (Caterpillar Equipment Facility) and a new revolving debt facility (Auramet Facility) supporting our gold and silver production. During the three months ended March 31, 2013, we reduced our outstanding debt balance by $3.7 million or approximately 26%. The Auramet Facility is scheduled for full repayment by July 2013, and we anticipate continued reductions in our debt balances through year end, effectively reducing our prospective borrowing costs.

Liquidity and Capital Resources

Total current assets were $17.8 million at March 31, 2013. Cash and cash equivalents on hand at March 31, 2013, totaled $9.6 million. Inventories and stockpiles totaled $6.1 million, including $1.3 million of in-process and finished goods. In March 2013, the Company raised $10 million in gross proceeds (approximately $9.7 million, net of issuance costs) through an underwritten public offering of 5,000,000 shares of our common stock at a price of $2.00 per share.

Net cash used in operating activities for the three months ended March 31, 2013, was approximately $5.6 million as compared to a use of $4.5 million for the three months ended March 31, 2012. Our use of cash in the first quarter of 2013 was primarily from operating losses associated with ramping up production, including an increase of $1.2 million for inventory and an increase of $1.3 million in accounts receivable, net of $2.0 million of gold produced and directly transferred as payment on our Auramet Facility.

Net cash provided by investing for the three months ended March 31, 2013, was a net of $19,434, primarily as the result of $571,820 of proceeds from the transfer of equipment that was previously used in our mining development and production activities, net of capital asset purchases of $202,386 and bond deposit increases of $350,000. Cash used in investing for the three months ended March 31, 2012, was approximately $2.5 million, primarily $3.3 million for purchases of equipment used in our mining development and production activities, $0.6 million for increases in reclamation bond deposits offset by $1.5 million in proceeds from sale of available-for-sale securities.

Net cash provided by financing activities for the three months ended March 31, 2013, was $9.2 million comprised of net proceeds of approximately $9.7 million from the sale of securities through a public offering of 5,000,000 shares of our common stock at a price of $2.00 per share, partially off-set by the pay-down of our long-term debt obligations of approximately $0.5 million. Net cash provided by financing activities for the three months ended March 31, 2012, was $15.3 million, substantially all comprising net proceeds from the sale of public securities through an underwritten public offering of 9,078,948 shares of common stock at a price of $1.90 per share.

When pouring commenced in late 2012, the Company averaged approximately 200 gold-equivalent ounces poured per week. The Company is successfully and continuously adjusting its operations to improve grade, maximize yields and increase tons crushed and stacked. The Company continues ramping up its production and exceeded its targeted production rate of 400 ounces per week, initially targeted for the end of April and has averaged over 425 gold-equivalent ounces for the six weeks ended April 27, 2013 or a run rate of more than 20,000 gold equivalent ounces per annum.

Assuming that planned future revenues continue to meet management's expectations, the Company believes that it would have sufficient liquidity to fund operations for the next twelve months through the use of current cash resources and existing financing arrangements. However, in the event that production or other factors impacting future operating results are delayed or otherwise fall below management's expectations, the Company would be required to obtain additional debt or equity financing to sustain operations, and the availability of such financing on acceptable terms, if at all, cannot be assured. Our recurring losses and negative cash flow from operations require ongoing assessment regarding our ability to continue as a going concern.

With our recently completed public offering of 5,000,000 shares of our common stock, resulting in net proceeds of approximately $9.7 million, we intend to increase our current production capacity (primarily through additional permitting), acquire additional mining claims and rights, and pay-down our on-going corporate obligations.

For the next twelve months, we plan on spending $3 to 4 million in capital expenditures, primarily to expand our heap leaching and related production capacity. We will also pay down an additional $6 million in debt obligations, including the Auramet Facility. The Auramet Facility is being repaid through the delivery of 3,720 ounces of gold payable in 12 semi-monthly deliveries of 310 ounces each, which began in February 2013, and is scheduled to end in July 2013, or December 2013, if any amounts are redrawn under the agreement. Through April 30, 2013, the Company has delivered its first six installments, or 1,860 ounces.

Due to a recent decline in gold prices, the Company has prioritized the repayment of ounces on this facility and may opportunistically purchase some of the remaining ounces of gold to be delivered to RIF under the Auramet Facility from the market. We expect to complete the repayment of the Auramet Facility earlier than originally scheduled. Once repaid, the RIF’s security interest in our assets and the negative covenants under the Auramet Facility will be terminated. We believe that this will enhance our liquidity and flexibility.

Contractual Obligations

Our contractual obligations at March 31, 2013 are summarized as follows:

(1) Amounts represent principal of $10,512,883 and estimated interest payments of $4,459,660, assuming no early extinguishment.

(2) The Company leases certain properties under operating leases expiring at various dates through 2049. Amounts include minimum rental and minimum advance royalty payments.

(3) We are required to mitigate long-term environment impacts by stabilizing, contouring, re-sloping, and re-vegetating various portions of a site after mining and mineral processing operations are completed. These reclamation efforts are conducted in accordance with plans reviewed and approved by the appropriate regulatory agencies. The estimated undiscounted cash outflows of these reclamation and remediation obligations are reflected here.

(4) In July 2012, the Company placed a $4.67 million reclamation surety bond, through the Lexon Surety Group (“Lexon”) with the State of Nevada’s Bureau of Mining Regulation Reclamation (“BMRR”). The initial cash collateral percentage due to Lexon is approximately 50% of the total state bond amount of $4.67 million. At March 31, 2013, accrued expenses include $1.3 million and other liabilities include $0.4 million remaining due to Lexon for the initial cash collateral.

Critical Accounting Policies And Estimates

There have not been any material changes to the critical accounting policies and estimates previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2012.

Metal Price – Changes in the market price of gold may significantly affect our profitability and cash flow. Gold prices fluctuate widely due to factors such as; demand, global mine production levels, investor sentiment, central bank reserves, and the value of the U.S. dollar.

With exception of the above, there have been no material changes in the market risks discussed in Item 7A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012.

A. Disclosure

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Quarterly Report on Form 10-Q, management performed, with the participation of our Principal Executive Officer (who also serves as 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 Securities Exchange Act of 1934 (“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 Exchange Act and SEC’s rules, and that such information is accumulated and communicated to our management, including our Principal Executive, to allow timely decisions regarding required disclosures. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Our Principal Executive Officer concluded that, as of March 31, 2013, our disclosure controls and procedures were effective.

B. Internal Control over Financial Reporting

No change in our internal control over financial reporting, as such term is defined in Exchange Act Rule 13(a)-15 occurred during the fiscal quarter ended March 31, 2013, that materially affected or is reasonably likely to materially affect our internal control over 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, 2012.