Unassociated Document
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JULY 31, 2010
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934

Commission File No. 001-34618

CAPITAL GOLD CORPORATION
(Exact name of registrant as specified in its charter)
 
State of Delaware
 
13-3180530
(State or other jurisdiction of
 
(I.R.S. Employer
Incorporation or organization)
 
Identification No.)

76 Beaver Street, 14th Floor, New York, New York
10005
(Address of principal executive offices)
 (Zip Code)

Registrant’s telephone number, including area code:  (212) 344-2785

Securities registered under Section 12(b) of the Act:   none
Securities registered under Section 12(g) of the Act: Common Stock, par value $.0001 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o   No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
 Yes o  No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes x  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulations S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of "large accelerated filer,” “accelerated filer" and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
o Large accelerated filer             x Accelerated filer
o Non-accelerated filer               o Smaller Reporting Company
 

 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
 
Yes o  No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o  No x

The aggregate market value of the voting and non-voting common equity on January 31, 2010 held by non-affiliates computed by reference to the closing price of the issuer’s Common Stock on that date, was $95,199,958 based upon the closing price ($2.94) multiplied by the 32,380,938 shares of the issuer’s Common Stock held by non-affiliates.

The number of shares outstanding of each of the issuer’s classes of common equity as of October 1, 2010: 61,202,028.

The Proxy Statement of Capital Gold Corporation to be filed in connection with our 2011 Annual Meeting of Stockholders is incorporated in Part III hereof, as specified herein.

ii


CAPITAL GOLD CORPORATION
Form 10-K
July 31, 2010
 
Table of Contents
Page
Glossary of Technical Terms
(iv)
Part I
 
     
Item 1.
Business.
1
Item 1A.
Risk Factors.
3
Item 1B.
Unresolved Staff Comments.
14
Item 2.
Property.
14
Item 3.
Legal Proceedings.
37
Item 4.
(Removed and Reserved).
37
     
Part II
 
     
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
38
Item 6.
Selected Financial Data.
41
Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
42
Item 7A.
Quantitative and Qualitative Disclosure About Market Risk
63
Item 8.
Financial Statements and Supplementary Data.
65
Item 9.
Changes in and Disagreement with Accountants on Accounting and Financial Disclosure.
65
Item 9A
Controls and Procedures.
65
Item 9B
Other Information.
66
     
Part III
 
     
Item 10.
Directors, Executive Officers and Corporate Governance.
67
Item 11.
Executive Compensation.
68
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
69
Item 13.
Certain Relationships and Related Transactions and Director Independence
69
Item 14.
Principal Accounting Fees and Services.
69
     
Part IV
 
     
Item 15.
Exhibits, Financial Statement Schedules.
69
     
Signatures
74
     
Supplemental Information
N/A
     
Financial Statements
F-1
 
iii

 
GLOSSARY OF TECHNICAL TERMS

Reserve:
That part of a mineral deposit which could be economically and legally extracted or produced at the time of the reserve determination. Reserves must be supported by a feasibility study done to bankable standards that demonstrates the economic extraction  ("Bankable standards" implies that the confidence attached to the costs and achievements developed in the study is sufficient for the project to be eligible for external debt financing.) A reserve includes adjustments to the in-situ tonnes and grade to include diluting materials and allowances for losses that might occur when the material is mined.
   
Proven Reserve:
Reserves for which (a) quantity is computed from dimensions revealed in outcrops, trenches, workings or drill holes; grade and/or quality are computed from the results of detailed sampling and (b) the sites for inspection, sampling and measurement are spaced so closely and the geologic character is so well defined that size, shape depth and mineral content of reserves are well-established.
   
Probable Reserve:
Reserves for which quantity and grade and/or quality are computed from information similar to that used for proven (measured) reserves, but the sites for inspection, sampling, and measurement are farther apart or are otherwise less adequately spaced. The degree of assurance, although lower than that for proven reserves, is high enough to assume continuity between points of observation.
   
Mineralized Material
The term “mineralized material” refers to material that is not included in the reserve as it does not meet all of the criteria for adequate demonstration for economic or legal extraction.
   
Non-reserves
The term “non-reserves” refers to mineralized material that is not included in the reserve as it does not meet all of the criteria for adequate demonstration for economic or legal extraction.
   
Exploration Stage
An “exploration stage” prospect is one which is not in either the development or production stage.  
   
Development Stage
A “development stage” project is one which is undergoing preparation of an established commercially mineable deposit for its extraction but which is not yet in production.  This stage occurs after completion of a feasibility study.  
   
Production Stage
A “production stage” project is actively engaged in the process of extraction and beneficiation of mineral reserves to produce a marketable metal or mineral product.  
 
iv

 
ADDITIONAL DEFINITIONS
 
Caliche:
Sediment cemented by calcium carbonate near surface.
   
Diorite:
Igneous Rock (Rock formed from magma or molten rock).
   
Dore:
Bars of low purity precious metal (Gold & Silver) which represents final product of a gold mine typically weighing 25 kg per bar.
   
Dikes:
Tabular, vertical bodies of igneous rock.
   
Fissility:
Shattered, broken nature of rock.
   
Fracture Foliations:
Fracture pattern in rock, parallel orientation, resulting from pressure.
   
Heap Leaching:
Broken and crushed ore on a pile subjected to dissolution of metals by leach solution.
   
Hydrometallurgical Plant:
A metallurgical mineral processing plant that uses water to leach or separate and concentrate elements or minerals.
   
Intercalated:
Mixed in.
   
Lithostatic Pressure:
Pressure brought on by weight of overlaying rocks.
   
Major Intrusive Center:
An area where large bodies of intrusive igneous rock exist and through which large amounts of mineralizing fluids rose.
   
Mesothermal:
A class of hydrothermal ore deposit formed at medium temperatures and a depth over one mile in the earth’s crust.
   
Microporphyritic Latite:
Extremely fine grained siliceous igneous rock with a distribution of larger crystals within.
   
Mudstone:
Sedimentary bed composed primarily of fine grained material such as clay and silt.
   
PPM:
Part per million.
   
Pyritized:
Partly replaced by the mineral pyrite.
   
Reverse Circulation Drilling (or R.C. Drilling):
Type of drilling using air to recover cuttings for sampling through the middle of the drilling rods rather than the outside of the drill rods, resulting in less contamination of the sampled interval.
 
v

 
Sericitized:
Rocks altered by heat, pressure and solutions resulting in formation of the mineral sericite, a very fine grained mica.
   
Siltstone:
A sedimentary rock composed of clay and silt sized particles.
   
Silicified:
Partly replaced by silica.
   
Stockwork Breccia:
Earth's crust broken by two or more sets of parallel faults converging from different directions.
   
Stockwork:
Ore, when not in strata or in veins but in large masses, so as to be worked in chambers or in large blocks.
   
Surface Mine:
Surface mining by way of an open pit without shafts or underground working.
 
vi

 
PART I

Item 1.  Business

Capital Gold Corporation (the “Company”) is engaged in the mining, exploration and development of gold properties in Mexico.  Our primary focus is on the operation and development of the El Chanate project as well as the development of our Orion Project in the State of Nayarit Mexico.   Through our recent acquisition of Nayarit Gold, Inc. (“Nayarit”) on August 2, 2010, we control approximately 257,000 acres (104,000 hectares) of mining concessions known as the Orion Project.  The Orion Project lies in the Sierra Madre Occidental, a prolific mining district in Western Mexico.  We also conduct gold exploration in other locations in Sonora, Mexico. (The financial data in this discussion is in thousands, except where otherwise specifically noted.)

On February 10, 2010, Capital Gold Corporation entered into a business combination agreement (the “Nayarit Business Combination Agreement”), as amended and extended, with Nayarit, a corporation organized under the Ontario Business Corporation Act (“OBCA”) pursuant to which, on August 2, 2010, Nayarit became a wholly-owned subsidiary of Capital Gold (the “Nayarit Business Combination”). We effected the amalgamation (the “Amalgamation”) of Nayarit and a corporation, organized under the OBCA as a wholly-owned subsidiary of the Company (“Merger Sub”), to form a combined entity (“AmalgSub” or “Surviving Company”), with AmalgSub continuing as the surviving entity following the Amalgamation.  By virtue of the Amalgamation, the separate existence of each of Nayarit and Merger Sub cease, and AmalgSub, as the surviving company in the Amalgamation, continue its corporate existence under the OBCA as a wholly-owned subsidiary of the Company. Pursuant to the terms of the Nayarit Business Combination Agreement, all of the Nayarit shares of common stock (the “Nayarit Common Shares”) issued and outstanding immediately prior to the consummation of the Nayarit Business Combination Agreement (other than Nayarit Common Shares held by dissenting stockholders of Nayarit) were exchanged into the Company’s common stock on the basis of 0.134048 shares of Company common stock for each one (1) Nayarit Common Share (the “Amalgamation Consideration”).  

On October 1, 2010, the Company and Gammon Gold Inc. (“Gammon Gold”) entered into a definitive merger agreement pursuant to which, if consummated, Gammon Gold will acquire all of the issued and outstanding common shares of Capital Gold in a cash and share transaction (the “Gammon Transaction”). The total consideration for the purchase of 100% of the fully diluted shares of Capital Gold is approximately US$288 million or US$4.57 per Capital Gold share based on Gammon Gold’s closing price on September 24, 2010 on the NYSE. The Gammon Transaction has the unanimous support of both companies’ Boards of Directors and Officers.  Under the terms of the Gammon Transaction, each common share of Capital Gold will be exchanged for 0.5209 common shares of Gammon Gold and a cash payment in the amount of US$0.79 per share. Based on the September 24, 2010 closing price of Capital Gold’s shares on the NYSE EURONEXT, the acquisition price represents a 20% premium to the close on September 24th and a 30% premium to the 20-day volume weighted average price on the NYSE EURONEXT ending on that date.  The consummation of the Gammon Transaction is subject to numerous contingencies as described in the related merger agreement including, but not limited to, Capital Gold stockholder approval.

Sonora, Mexico Concessions

Through wholly-owned subsidiaries, Capital Gold Corporation owns 100% of 21 mining concessions located in the State of Sonora, Republic of Mexico totaling approximately 9,665 hectares (23,873 acres or 37.3 square miles).  We commenced mining operations on two of these concessions in late March 2007 and achieved gold production and revenue from operations in early August 2007. We sometimes refer to the operations on these two concessions as the El Chanate Project.
 
1

 
In April 2008, we leased 12 mining concessions totaling 1,789 hectares located northwest of Saric, Sonora. In addition, we own a claim for approximately 2,233 additional hectares adjacent to this property. The approximate 4,022 hectare area is accessible by paved roads and has cellular phone service from hilltops.  These concessions and this claim are about 60 miles northeast of the El Chanate project. Mineralization is evident throughout the concession group and is hosted by shear zones and stockwork quartz veins in volcanic and intrusive rocks. We have completed exploration work consisting of geological mapping, systematic geochemical sampling of rock and soils, geophysical surveys, trenching and 73 reverse circulation drill holes totaling 6,121 meters and more recently a one meter interval topographic survey over the concession area.  SRK of Lakewood, Colorado has visited the site and has monitored the quality assurance and quality control during these drill campaigns.  SRK will also assist on the next phase of the exploration program.  All of the drill hole samples have been assayed by ALS Chemex.  The ALS Chemex facility in Hermosillo does the sample preparation, and the assays are performed at the ALS Chemex’s Vancouver laboratory.

In January 2010, we initiated an additional drill campaign at Saric that consisted of 13 core holes totaling approximately 1,100 meters.  The drilling was completed on February 23, 2010 and targeted the existing mineralized structure to confirm the geologic interpretation and confirm the accuracy of previous reverse circulation drilling. The drill hole samples were assayed by ALS Chemex.  Currently, we are planning to initiate a geophysical survey in late 2010.  The intention of the geophysical survey is to assist us in determining the focus of our next drill campaign.   We are also continuing our work on an updated environmental report.

Orion Project

The Orion Project lies in the prolific Sierra Madre Occidental, which hosts numerous multi-million ounce gold-silver deposits. The Orion Project is one of the larger contiguous concessions in the Sierra Madre, composed of 257,000 acres (104,000 hectares).  The Orion Project is located on the southeast flank of the Sierra Madre, about 125km south of  the famous Tayoltita district which has reserves reported to be in excess of 20 million gold equivalent ounces.  The concessions are located approximately 110km north–northwest of Tepic, state capital of Nayarit, México, 150km southeast of Mazatlan, Sinaloa.  The Orion Project is located 13 km south–southeast of the town of Acaponeta, Nayarit, in the Motaje Mining District as identified by the Servicio Geologico Mexicano (formerly the Consejo de Recursos Minerales).  We anticipate to progress  this project to a pre-feasibility stage by the second quarter 2011.
 
For more information on our projects, please see  “Item 2. Property; Sonora Concessions and Orion Project in Nayarit Mexico”.

Competition

The acquisition of gold properties and their exploration and development are subject to intense competition. Companies with greater financial resources, larger staffs and more equipment for exploration and development may be in a better position than us to compete for such mineral properties.  Our limited financial resources in relation to companies with greater resources may hinder our ability to compete for and acquire additional mineral properties.

2

 
Human Resources

As of October 1, 2010, we had 174 full time and 17 temporary employees working at our El Chanate mine in Sonora, Mexico as well as 7 full time employees in the U.S. and Canada.  We also utilize a mining and other contractors at the El Chanate mine which comprised a total of 121 personnel onsite, including 28 related to leach pad construction.
 
A national labor union has expressed interest in organizing the workers at Capital Gold’s El Chanate Mine.
 
The workforce at El Chanate is currently non-unionized, however, a national labor union is seeking to permit workers to vote on whether or not they would like to organize under such labor union. Capital Gold is reviewing its options with respect to the union’s activities. If the workforce were permitted to unionize, such activity could result in higher production costs at the El Chanate mine; however the Company would work to execute a favorable union contract. In addition, although we have not experienced a work stoppage to date, if the workforce chose not to unionize, the national labor seeking to unionize may choose to illegally interrupt operations at El Chanate, which could have a material adverse effect on our business, financial condition or results of operations.
 
Cautionary Statement on Forward-Looking Statements

Certain statements in this report constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. Certain, but not necessarily all, of such forward-looking statements can be identified by the use of forward-looking terminology such as “believes,” “expects,” “may,” “will,” “should,” or “anticipates” or the negative thereof or other variations thereon or comparable terminology, or by discussions of strategy that involve risks and uncertainties.  All statements other than statements of historical fact included in this report regarding our financial position, business and plans or objectives for future operations are forward-looking statements.  Without limiting the broader description of forward-looking statements above, we specifically note that statements regarding exploration and mine development, construction and expansion plans, costs, grade, strip ratio, production and recovery rates, permitting, financing needs, the availability of financing on acceptable terms or other sources of funding, if needed, and the timing of additional tests, feasibility studies and environmental permitting are all forward-looking in nature.

Such forward-looking statements involve known and unknown risks, uncertainties and other factors, including but not limited to, the risk factors discussed below in “Item 1A. Risk Factors” which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements and other factors referenced in this report.  We do not undertake and specifically decline any obligation to publicly release the results of any revisions which may be made to any forward-looking statement to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events, except as required by law.

Available Information
 
For more information about us, visit our website at www.capitalgoldcorp.com.  The contents of the website are not part of this Annual Report on Form 10-K.  Our electronic filings with the U.S. Securities and Exchange Commission, or SEC (including all Forms 10-K, 10-Q and 8-K, and any amendments to these reports) are available free of charge through our website immediately after we electronically file with or furnish them to the SEC.  These filings may also be read and copied at the SEC’s Public Reference Room which is located at 100 F Street, N.E., Washington, D.C. 20549.  Information about the operation of the Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330.  The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers who file electronically with the SEC at www.sec.gov.

Item 1A.  Risk Factors

The risks described below should not be considered to be comprehensive and all-inclusive.  Additional risks that we do not yet know of or that we currently think are immaterial may also impair our business operations.  If any events occur that give rise to the following risks, our business, financial condition, cash flow or results of operations could be materially and adversely affected, and as a result, the trading price of our common stock could be materially and adversely impacted.  These risk factors should be read in conjunction with other information set forth in this report, including our Consolidated Financial Statements and the related Notes.

3

 
Risks related to our business and operations


While Capital Gold believes that it will continue to generate positive cash flow and profits from operations, if it encounters unexpected problems, it may need to raise additional capital.   If additional capital is required and Capital Gold is unable to obtain it from outside sources, Capital Gold may be forced to reduce or curtail its operations or its anticipated exploration activities.
 
Prior to the first fiscal quarter of 2008, Capital Gold was not able to generate cash flow from operations.  While it is now generating positive cash flow and profits, if Capital Gold encounters unexpected problems and it is unable to continue to generate positive cash flow and profits, it may need to raise additional capital.  Capital Gold also may need to raise additional capital for property acquisition and development and new exploration. To the extent that Capital Gold needs to obtain additional capital, management intends to raise such funds through the sale of its securities and/or joint venturing with one or more strategic partners.  Capital Gold cannot assure that adequate additional funding, if needed, will be available or on terms acceptable to it.  If Capital Gold needs additional capital and it is unable to obtain it from outside sources, Capital Gold may be forced to reduce or curtail its operations or its anticipated exploration activities.
 
Capital Gold’s Credit Agreement with Standard Bank plc (“Standard Bank”) imposes restrictive covenants on it.
 
Capital Gold’s Credit Agreement with Standard Bank requires it, among other obligations, to meet certain financial covenants including, but not limited to, (i) a ratio of current assets to current liabilities at all times greater than or equal to 1.20:1.00, (ii) a quarterly minimum tangible net worth at all times of at least U.S. $30,000,000, (iii) maintain a ratio of  debt to cash flow from operations of no greater than 2.50:1.00, and (iv) a quarterly average minimum liquidity of U.S. $500,000.  In addition, the Credit Agreement restricts, among other things, Capital Gold’s ability to incur additional debt, create liens on its property, dispose of any assets, merge with other companies, enter into hedge agreements, organize or invest in subsidiaries or make any investments above a certain dollar limit.  A failure to comply with the restrictions contained in the Credit Agreement could lead to an event of default thereunder which could result in an acceleration of such indebtedness. As a condition to closing the Nayarit Business Combination, Capital Gold obtained the consent of Standard Bank.
 
Capital Gold’s mining contractor is using some reconditioned equipment which could adversely affect its cost assumptions and its ability to economically and successfully mine the project.
 
Sinergia Obras Civiles Y Mineras, S.A. de C.V. (“Sinergia”), Capital Gold’s mining contractor, is using a combination of fully functioning new and older equipment.  Such older equipment is subject to the risk of more frequent breakdowns and need for repair than new equipment.  If the equipment that Capital Gold or Sinergia uses breaks down and needs to be repaired or replaced, Capital Gold will incur additional costs and operations may be delayed, resulting in lower amounts of gold recovered.  In such event, Capital Gold’s capital and operating cost assumptions may be inaccurate and its ability to economically and successfully mine the El Chanate project may be hampered, resulting in decreased revenues and, possibly, a loss from operations.
 
4

 
The gold deposit Capital Gold has identified at El Chanate is relatively low-grade.  If Capital Gold’s estimates and assumptions are inaccurate, its results of operation and financial condition could be materially adversely affected.
 
The gold deposit Capital Gold is mining at its El Chanate mine is relatively low-grade.  If the estimates of ore grade or recovery rates turn out to be lower than the actual ore grade and recovery rates, if costs are higher than expected, or if Capital Gold experiences problems related to the mining, processing, or recovery of gold from ore at the mine, Capital Gold’s results of operation and financial condition could be materially adversely affected.  Moreover, it is possible that actual costs and economic returns may differ materially from Capital Gold’s best estimates.  There can be no assurance that Capital Gold’s operations at El Chanate will continue to be profitable.
 
Gold prices can fluctuate on a material and frequent basis due to numerous factors beyond Capital Gold’s control.  Capital Gold’s ability to generate profits from operations could be materially and adversely affected by such fluctuating prices.
 
The profitability of any gold mining operations in which Capital Gold has an interest will be significantly affected by changes in the market price of gold.  Gold prices fluctuate on a daily basis.  During the year ended July 31, 2010, the spot price for gold on the London Exchange has fluctuated between $932.75 and $1,261.00 per ounce.  Gold prices are affected by numerous factors beyond Capital Gold’s control, including:
 
 
·
industrial and commercial demand for gold,
 
·
the level of interest rates,
 
·
the rate of inflation,
 
·
central bank sales,
 
·
world supply of gold and
 
·
stability of exchange rates.

Each of these factors can cause significant fluctuations in gold prices. Such external factors are in turn influenced by changes in international investment patterns and monetary systems and political developments.  The current significant instability in the financial markets heightens these fluctuations.   The price of gold has historically fluctuated widely and, depending on the price of gold, revenues from mining operations may not be sufficient to offset the costs of such operations.
 
Capital Gold may not be successful in hedging against interest rate fluctuations and may incur mark-to-market losses and lose money through its hedging programs.
 
Capital Gold has entered into interest rate swap agreements.  The terms of Capital Gold’s Credit Agreement with Standard Bank require that it hedge at least 50% of its outstanding loan balance.  There can be no assurance that Capital Gold will be able to successfully hedge against interest rate fluctuations.
 
Further, there can be no assurance that the use of hedging techniques will always be to Capital Gold’s benefit.   Hedging contracts also are subject to the risk that the other party may be unable or unwilling to perform its obligations under these contracts.  Any significant nonperformance could have a material adverse effect on Capital Gold’s financial condition, results of operations and cash flows.
 
5

 
Capital Gold’s material property interests are in Mexico. Risks of doing business in a foreign country could adversely affect its results of operations and financial condition.
 
Capital Gold faces risks normally associated with any conduct of business in a foreign country with respect to its El Chanate Project in Sonora, Mexico, and its wholly owned subsidiary’s Orion Gold Project in the State of Nayarit, Mexico, including various levels of political and economic risk.  The occurrence of one or more of these events could have a material adverse impact on Capital Gold’s efforts or operations which, in turn, could have a material adverse impact on its cash flows, earnings, results of operations and financial condition.  These risks include the following:
 
 
·
labor disputes,
 
·
invalidity of governmental orders,
 
·
uncertain or unpredictable political, legal and economic environments,
 
·
war and civil disturbances,
 
·
changes in laws or policies,
 
·
taxation,
 
·
delays in obtaining or the inability to obtain necessary governmental permits,
 
·
governmental seizure of land or mining claims,
 
·
limitations on ownership,
 
·
limitations on the repatriation of earnings,
 
·
increased financial costs,
 
·
import and export regulations, including restrictions on the export of gold, and
 
·
foreign exchange controls.

These risks may limit or disrupt Capital Gold’s projects, restrict the movement of funds or impair contract rights or result in the taking of property by nationalization or expropriation without fair compensation.
 
A national labor union has expressed interest in organizing the workers at Capital Gold’s El Chanate Mine.
 
The workforce at El Chanate is currently non-unionized, however, a national labor union is seeking to permit workers to vote on whether or not they would like to organize under such labor union. Capital Gold is reviewing its options with respect to the union’s activities. If the workforce were permitted to unionize, such activity could result in higher production costs at the El Chanate mine; however the Company would work to execute a favorable union contract. In addition, although we have not experienced a work stoppage to date, if the workforce chose not to unionize, the national labor seeking to unionize may choose to illegally interrupt operations at El Chanate, which could have a material adverse effect on our business, financial condition or results of operations.
 
Capital Gold sells gold in U.S. dollars; however, it incurs a significant amount of its expenses in Mexican pesos.  If applicable currency exchange rates fluctuate, Capital Gold’s revenues and results of operations may be materially and adversely affected.
 
Capital Gold sells gold in U.S. dollars.  It incurs a significant amount of its expenses in Mexican pesos.  As a result, Capital Gold’s financial performance would be affected by fluctuations in the value of the Mexican peso to the U.S. dollar.
 
Changes in regulatory policy could adversely affect Capital Gold’s exploration and future production activities.
 
Any changes in government policy may result in changes to laws affecting:

6

 
 
·
ownership of assets,
 
·
land tenure,
 
·
mining policies,
 
·
monetary policies,
 
·
taxation,
 
·
rates of exchange,
 
·
environmental regulations,
 
·
labor relations,
 
·
repatriation of income and/or
 
·
return of capital.

Any such changes may affect Capital Gold’s ability to undertake exploration and development activities in respect of future properties in the manner currently contemplated, as well as its ability to continue to explore, develop and operate those properties in which it has an interest or in respect of which it has obtained exploration and development rights to date. The possibility, particularly in Mexico, that future governments may adopt substantially different policies, which might extend to expropriation of assets, cannot be ruled out.
 
As Capital Gold currently does not enter into forward sales, commodity, derivatives or hedging arrangements with respect to its future gold production, it is exposed to the impact of any significant decrease in the gold price.
 
As a general rule, Capital Gold sells its gold at the prevailing market price. Currently, Capital Gold generally does not enter into forward sales, commodity, derivative or hedging arrangements to establish a price in advance for the sale of future gold production, although it may do so in the future. As a result, Capital Gold may realize the benefit of any short-term increase in the gold price, but is not protected against decreases in the gold price, and if the price of gold decreases significantly, Capital Gold’s revenues may be materially adversely affected.
 
Compliance with environmental regulations could adversely affect Capital Gold’s exploration and future production activities.
 
With respect to environmental regulation, future environmental legislation could require:
 
 
·
stricter standards and enforcement,
 
·
increased fines and penalties for non-compliance,
 
·
more stringent environmental assessments of proposed projects and
 
·
a heightened degree of responsibility for companies and their officers, directors and employees.

There can be no assurance that future changes to environmental legislation and related regulations, if any, will not adversely affect Capital Gold’s operations. Capital Gold could be held liable for environmental hazards that exist on the properties in which it holds interests, whether caused by previous or existing owners or operators of the properties. Any such liability could adversely affect its business and financial condition.
 
7

 
Capital Gold has insurance against losses or liabilities that could arise from its operations.  If it incurs material losses or liabilities in excess of its insurance coverage, its financial position could be materially and adversely affected.
 
Mining operations involve a number of risks and hazards, including:
 
 
·
environmental hazards,
 
·
industrial accidents,
 
·
metallurgical and other processing,
 
·
acts of God, and/or
 
·
mechanical equipment and facility performance problems.

 
Such risks could result in:
 
 
·
damage to, or destruction of, mineral properties or production facilities,
 
·
personal injury or death,
 
·
environmental damage,
 
·
delays in mining,
 
·
monetary losses, and/or
 
·
possible legal liability.

Industrial accidents could have a material adverse effect on Capital Gold’s future business and operations.  Capital Gold currently maintains general liability, business interruption, auto and property insurance coverage.   Capital Gold cannot be certain that the insurance it has in place will cover all of the risks associated with mining or that it will be able to maintain insurance to cover these risks at economically feasible premiums. Capital Gold also might become subject to liability for pollution or other hazards which it cannot insure against or which it may elect not to insure against because of premium costs or other reasons. Losses from such events may have a material adverse effect on Capital Gold’s financial position.
 
Calculation of reserves and metal recovery dedicated to future production is not exact, might not be accurate and might not accurately reflect the economic viability of Capital Gold’s properties.
 
Reserve estimates may not be accurate.  There is a degree of uncertainty attributable to the calculation of reserves, resources and corresponding grades being dedicated to future production.  Until reserves or resources are actually mined and processed, the quantity of reserves or resources and grades must be considered as estimates only. In addition, the quantity of reserves or resources may vary depending on metal prices.  Any material change in the quantity of reserves, resource grade or stripping ratio may affect the economic viability of Capital Gold’s properties. In addition, there can be no assurance that mineral recoveries in small scale laboratory tests will be duplicated in large tests under on-site conditions or during production.
 
8

 
Capital Gold is dependent on the efforts of certain key personnel and contractors to develop Capital Gold’s El Chanate Project and Orion Project.  If Capital Gold loses the services of these persons and contractors and it is unable to replace them, Capital Gold’s operations at its El Chanate Project may be disrupted and/or materially adversely affected.
 
Capital Gold is dependent on a relatively small number of key personnel who oversee the El Chanate Project and the Orion Project.  The loss of any one of Capital Gold’s key personnel could have an adverse effect on Capital Gold.  Capital Gold also is dependent upon Sinergia to provide mining services.  Sinergia commenced mining operations on March 25, 2007, and transitioned from the pre-production to production phase of the mining contract in July 2007.  Sinergia’s mining fleet is comprised of new and reconditioned equipment.  If Capital Gold loses the services of its key personnel, or if Sinergia is unable to effectively maintain its fleet, operations at its El Chanate Project may be disrupted and/or materially adversely affected.
 
There are uncertainties as to title matters in the mining industry.  Capital Gold believes that it has good title to its properties; however, any defects in such title that cause Capital Gold to lose its rights in mineral properties could jeopardize its business operations.
 
Capital Gold has investigated its rights to explore, exploit and develop its concessions in manners consistent with industry practice and, to the best of Capital Gold’s knowledge, those rights are in good standing.  However, Capital Gold cannot assure that the title to or its rights of ownership in the El Chanate, Orion and Huajicari concessions will not be challenged by third parties or governmental agencies.  In addition, there can be no assurance that the concessions in which Capital Gold has an interest are not subject to prior unregistered agreements, transfers or claims and title may be affected by undetected defects.  Any such defects could have a material adverse effect on Capital Gold.
 
Capital Gold’s ability to maintain long-term profitability eventually will depend on its ability to find, explore and develop additional properties.  Capital Gold’s ability to acquire such additional properties could be hindered by competition. If Capital Gold is unable to acquire, develop and economically mine additional properties, it most likely will not be able to be profitable on a long-term basis.
 
Gold is a non-renewable resource and gold mines continue to deplete their reserves while in operation.  They eventually become depleted of ore or become uneconomical to sustain mining operations.  The acquisition of gold properties and their exploration and development are subject to intense competition.  Companies with greater financial resources and larger staffs for exploration and development may be in a better position than Capital Gold to compete for such mineral properties.  If Capital Gold is unable to find, develop and economically mine new properties, Capital Gold most likely will not be able to be profitable on a long-term basis.
 
Capital Gold’s ability on a going forward basis to discover additional viable and economic mineral reserves is subject to numerous factors, most of which are beyond Capital Gold’s control and are not predictable. If Capital Gold is unable to discover such reserves, it most likely will not be able to be profitable on a long-term basis.
 
Exploration for gold is speculative in nature, involves many risks and is frequently unsuccessful.  Few properties that are explored are ultimately developed into commercially producing mines.  As noted above, Capital Gold’s long-term profitability will be, in part, directly related to the cost and success of exploration programs.  Any gold exploration program entails risks relating to:
 
9

 
 
·
the location of economic ore bodies,
 
·
development of appropriate metallurgical processes,
 
·
receipt of necessary governmental approvals, and
 
·
construction of mining and processing facilities at any site chosen for mining.

 
 
The commercial viability of a mineral deposit is dependent on a number of factors including:
 
·  
the price of gold,
 
·  
the particular attributes of the deposit, such as its
 
o  
size
 
o  
grade, and
 
o  
proximity to infrastructure,
 
·  
financing costs,
 
·  
taxation,
 
·  
royalties,
 
·  
land use,
 
·  
water use,
 
·  
power use,
 
·  
importing and exporting gold, and
 
·  
environmental protection.
 
The effect of these factors cannot be accurately predicted.
 
Risks Related to Ownership of Capital Gold Stock
 
The issuance of a significant number of Capital Gold shares could adversely affect the market price of Capital Gold shares.
 
We completed the business combination with Nayarit on August 2, 2010; consequently, a significant number of additional shares of Capital Gold common stock became available for trading in the public market.  The increase in the number of Capital Gold shares may lead to sales of such shares or the perception that such sales may occur, either of which may adversely affect the market for, and the market price of, Capital Gold shares.
 
The NYSE EURONEXT may delist Capital Gold’s securities from its exchange which could limit investors’ ability to make transactions in Capital Gold’s common stock and subject it to additional trading restrictions.
 
Capital Gold’s common stock is listed on the NYSE EURONEXT, a national securities exchange.  Although Capital Gold expects to continue to meet the minimum continued listing standards, it cannot assure you that its securities will continue to be listed on the NYSE EURONEXT in the future.
 
10

 
If the NYSE EURONEXT delists Capital Gold’s common shares from trading on its exchange, Capital Gold could face significant material adverse consequences, including:
 
·  
a limited availability for market quotations for Capital Gold’s common stock;
 
·  
reduced liquidity with respect to Capital Gold’s common stock;
 
·  
a determination that Capital Gold’s common stock is a “penny stock,” which will require brokers trading in the common stock to adhere to more stringent rules and possibly result in a reduced level of trading activity in the secondary trading market for Capital Gold’s common stock;
 
·  
limited amount of news and analyst coverage for Capital Gold’s common stock; and
 
·  
a decreased ability to issue additional securities or obtain additional financing in the future.
 
In addition, Capital Gold would no longer be subject to NYSE EURONEXT rules, including rules requiring Capital Gold to have a certain number of independent directors and to meet other corporate governance standards.
 
Capital Gold does not intend to pay cash dividends in the near future.
 
Capital Gold’s board of directors determines whether to pay cash dividends on its issued and outstanding shares.  The declaration of dividends will depend upon Capital Gold’s future earnings, its capital requirements, its financial condition and other relevant factors.  Capital Gold’s board does not intend to declare any dividends on its shares for the foreseeable future.  Capital Gold anticipates that it will retain any earnings to finance the growth of its business and for general corporate purposes.
 
 
Additional Risks and Uncertainties related to the Business Combination with Nayarit completed August 2, 2010, and the combined entity
 
Having a reduced share position, as a result of the Nayarit Business Combination, may reduce the influence that Capital Gold’s stockholders have on the management of Capital Gold.
 
On August 2, 2010, Capital Gold issued approximately 12,454,354 shares of its common stock in the Nayarit Business Combination to Nayarit's then current stockholders and assumed warrants and options to purchase an additional approximately 1,621,981 and 903,483 shares of Capital Gold common stock held by Nayarit's warrant and option holders, respectively.  Based on the number of outstanding shares of Nayarit common stock and Capital Gold common stock, after the Amalgamation, the former stockholders of Nayarit own approximately 20.4% of Capital Gold.  Consequently, the ability of the continuing stockholders of Capital Gold following the Nayarit Business Combination to influence management of Capital Gold through the election of directors has been substantially reduced.
 
If the Nayarit Business Combination’s benefits do not meet the expectations of financial or industry analysts, the market price of Capital Gold’s securities may decline.
 
The market price of Capital Gold’s securities may decline as a result of the consummation of the Nayarit Business Combination if:
 
·  
the Company does not achieve the perceived benefits of the Nayarit Business Combination as rapidly, or to the extent anticipated by, financial or industry analysts; or
 
11

 
·  
the effect of the Nayarit Business Combination on Capital Gold’s financial results is not consistent with the expectations of financial or industry analysts.
 

Accordingly, investors may experience a loss as a result of a decline in the market price of Capital Gold’s securities.   A decline in the market price of Capital Gold’s securities also could adversely affect its ability to issue additional securities and its ability to obtain additional financing in the future.

The combined company may not realize the benefits currently anticipated due to challenges associated with integrating the operations of Capital Gold and Nayarit.
 
The success of the combined company will depend in large part on the success of management of the combined company integrating the operations of Nayarit with those of Capital Gold going forward.  The failure of the combined company to achieve such integration could result in the failure of the combined company to realize the anticipated benefits of the Nayarit Business Combination and could impair the results of operations, profitability, and financial results of the combined company.
 
There can be no assurance that Capital Gold or Nayarit uncovered every item that could have a material adverse effect on the combined company.
 
Although Capital Gold conducted business, financial and legal due diligence in connection with the Nayarit Business Combination, there can be no assurance that due diligence uncovered every item that could have a material adverse effect on the combined company.  Accordingly, there may be matters involving Nayarit and its financial statements that were not identified during their due diligence.  Any of these issues could materially and adversely affect the combined company’s financial condition.
 
 Additional risks and uncertainties related to our proposed merger with Gammon Gold Inc. which could materially adversely affect our business, financial condition or operating results.

Our merger with Gammon Gold is subject to certain conditions to closing that could result in the merger not being consummated or being delayed, either of which could negatively impact our stock price and future business and results of operations.

Consummation of the merger is subject to a number of customary conditions, including, but not limited to, the approval of the agreement and plan of merger by the stockholders of Capital Gold, the effectiveness of a Form F-4 registration statement to be filed by Gammon with the Securities and Exchange Commission to register the shares of Gammon common stock to be issued in connection with the merger and expiration of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976. There is no assurance that Capital Gold will receive the necessary approvals or satisfy the other conditions necessary for completion of the merger. If any of the conditions to the merger are not satisfied or, where waiver is permissible, not waived, the merger will not be consummated. Failure to complete the merger would prevent Capital Gold from realizing the anticipated benefits of the merger. Capital Gold has already and expects to continue to incur significant costs associated with transaction fees, professional services, taxes and other costs related to the merger. In the event that the merger is not completed, Capital Gold will remain liable for these costs and expenses. Furthermore, if the merger is not consummated, under some circumstances we may be required to promptly pay a $10.3 million breakup fee to Gammon, which could impact Capital Gold’s liquidity and results of operations. In addition, the current market price of Capital Gold common stock may reflect a market assumption that the merger will occur, and a failure to complete the merger could result in a negative perception by the market of us generally and a resulting decline in the market price of our common stock. Any delay in the consummation of the merger or any uncertainty about the consummation of the merger could also negatively impact Capital Gold’s stock price and future business and results of operations. We cannot assure you that the merger will be consummated, that there will be no delay in the consummation of the merger or that the merger will be consummated on the terms contemplated by the merger agreement.

12

 
Whether or not the merger is completed, the announcement and pendency of the merger could impact or cause disruptions in our business, which could have an adverse effect on our business and results of operations.

Whether or not the merger is consummated, the announcement and pendency of the merger could cause disruptions in or otherwise negatively impact our business and results of operations. Among others:

·  
our employees may experience uncertainty about their future roles with the combined company, which might adversely affect our ability to retain and hire key personnel and other employees;
 

·  
the attention of our management may be directed toward the completion of the merger and transaction-related considerations and may be diverted from the day-to-day operations and pursuit of other opportunities that could have been beneficial to our business; and
 

 
·  
distributors or other vendors or suppliers may seek to modify or terminate their business relationships with us.
 
These disruptions could be exacerbated by a delay in the completion of the merger or termination of the merger agreement and could have an adverse effect on our business, results of operations or prospects if the merger is not completed or the business, results of operations or prospects of the combined company if the merger is completed.

Several lawsuits have been filed against Capital Gold and other parties challenging the Gammon Transaction, and an adverse judgment in such lawsuits may prevent the Merger from becoming effective or from becoming effective within the expected timeframe.

Capital Gold, the members of Capital Gold’s board of directors, Gammon Gold, and in some instances Capital Gold’s CFO or Capital Gold AcquireCo have been named as defendants in purported class action lawsuits brought by Capital Gold stockholders challenging the proposed Gammon Transaction, seeking, among other things, to enjoin the defendants from consummating the Gammon Transaction on the agreed-upon terms.

The outcome of the pending and potential future litigation is difficult to predict and quantify and the defense of such claims or actions can be costly. In addition to diverting financial and management resources and general business disruption, we may suffer from adverse publicity that could harm our reputation, regardless of whether the allegations are valid or whether we are ultimately held liable. A temporary or permanent injunction could delay or prevent completion of the Gammon Transaction and such delay or failure of the transaction could cause the adverse results discussed above.

A judgment or settlement that is not covered by or is significantly in excess of our insurance coverage for any claims, or our obligations to indemnify the individual defendants, could materially and adversely affect our financial condition, results of operations and cash flows.

13

 
See "Item 3. Litigation" for more information about the putative class action lawsuits related to the Gammon Transaction that have been filed.

Item 1B.  Unresolved Staff Comments

None.

Item 2.  Property

Sonora Concessions
 

Through our wholly-owned subsidiary, Oro de Altar S. de R. L. de C.V. (“Oro”), we own 100% of the following 21 mining concessions, all of which are located in the State of Sonora United States of Mexico.

The 21 mining concessions are as follows:

 
Lot
Title #
 Hectars
Owner
1
SAN JOSE
200718
96.00
Oro
2
LAS DOS VIRGEN
214874
132.235
Oro
3
RONO #1
206408
82.1902
Oro
4
RONO #3
214224
197.218
Oro
5
LA CUCHILLA
211987
143.3481
Oro
6
ELSA
212004
2,035.3997
Oro
7
ELISA
214223
78.4717
Oro
8
ENA
217495
190.00
Oro
9
EVA
212395
416.8963
Oro
10
MIRSA
212082
20.5518
Oro
11
OLGA
212081
60.589
Oro
12
EDNA
219624
24.0431
Oro
13
LA TIRA
219324
1.7975
Oro
14
LA TIRA 1
219623
18.6087
Oro
15
LOS TRES
223634
8.00
Oro
16
EL CHARRO
206404
40.00
Oro
17
SANTA RITA 4 FRACCION I
233574
5.0728
Oro
18
SANTA RITA 4 FRACCION II
233575
4.7786
Oro
19
SANTA RITA 4 FRACCION III
233576
110.2725
Oro
20
SANTA RITA I
231373
3,765.9666
Oro
21
SANTA RITA III
232117
2,233.3163
Oro
   
Total
9,664.7559
 


At the El Chanate Project we are mining on two concessions, San Jose and Las Dos Virgens.  We are utilizing four other concessions for processing mined ores.  In the future, we plan to explore some or all of these concessions to determine whether or not further activity is warranted.
 
14

 


During fiscal 2009 and the first fiscal quarter ended October 31, 2009, we conducted exploration activities in the El Chanate pit area including, core drilling at depth to determine the potential of increasing its reserves further. The data obtained from geological mapping of the deposit’s mine pit areas, combined with assays from samples of the exploration drilling therein, were used to expand information in our mine database. SRK Consulting (U.S.), Inc. (“SRK”) of Lakewood, Colorado, an independent consulting firm, used this data to re-estimate El Chanate’s Mineral Reserves. These efforts resulted in a significant expansion of our reserve estimates, which we reported in our Form 10-K for the year ended July 31, 2009.  With the receipt of SRK’s technical report titled NI 43-101 Technical Report, Capital Gold Corporation, El Chanate Gold Mine, Sonora, Mexico and dated November 27, 2009 (the “SRK Report”), with respect to the updated reserve estimation and the updated mine plan and mine production schedule, current as of October 1, 2009, we re-published our previously announced reserve estimates along with additional information. The SRK Report complies with Canadian National Instrument 43-101 Standards of Disclosure for Mineral Projects (“NI 43-101”). Both Bart A. Stryhas PhD., Principal Resource Geologist, and Bret C. Swanson, BE(Mining), MAusIMM, are “Qualified Persons” as defined by NI 43-101.

Our proven and probable reserve tonnage increased to 70.6 million metric tonnes with an average gold grade of 0.66 grams per tonne (77.7 million US short tons at 0.0193 ounces per ton). The proven and probable reserve has 1,504,000 contained ounces of gold. The open pit strip ratio for the life of mine is 2.88:1 (2.88 tonnes of waste to one tonne of ore).  For the next year, our mine plan anticipates the open pit strip ratio will average 2:1. Determination of operational pre-stripping (increase in strip ratio) will be made after further geological drilling and determination of corporate strategy within the three year window of opportunity. There is also the potential to improve the life of mine strip ratio as the report identifies material within the pit design classified as waste that with additional drilling could be reclassified as ore. The updated pit design for the revised mine plan is based on a plant recovery of gold that varies by rock types, but is expected to average 58.25%. A gold price of US$800 (SEC three year average as of October 1, 2009) per ounce was used to re-estimate the reserves compared with a gold price of $750 per ounce used in the previous reserve estimate.  The stated proven and probable mineral reserves have been prepared in accordance with the Canadian Institute of Mining, Metallurgy and Petroleum (CIM).  CIM definitions for proven and probable reserves convert directly from measured and indicated mineral resources with the application of appropriate economic parameters. These reserves are equivalent to proven and probable reserves as defined by the United States Securities and Exchange Commission (SEC) Industry Guide 7.

15

 
The following summary is extracted from the SRK Report.   Please note that the reserves as stated are an estimate of what can be economically and legally recovered from the mine and, as such, incorporate losses for dilution and mining recovery.   The 1,504,000 ounces of contained gold represents ounces of gold contained in ore in the ground, and therefore does not reflect losses in the recovery process.  Total gold produced is estimated to be 876,000 ounces, or approximately 58.25% of the contained gold. The gold recovery rate is expected to average approximately 58.25% for the entire ore body.  Individual portions of the ore body may experience varying recovery rates ranging from about 48% to 65%.  Oxidized and sandstone ore types may have recoveries of about 65%; siltstone ore types recoveries may be about 48% and latite intrusive ore type recoveries may be about 50%.

El Chanate Mine






















16


Production Summary

 
Metric
U.S.
Materials
   
Reserves
   
Proven
22.4 Million Tonnes @   0.70   g/t(1)
24.7 Million Tons @   0.0204 opt(1)
Probable
48.2 Million Tonnes  @  0.65   g/t(1)
53.0 Million Tons @   0.0189 opt(1)
Total Reserves(2)
70.6 Million Tonnes  @  0.66   g/t(1)
77.7 Million Tons @   0.0193 opt(1)
Waste
203.5 Million Tonnes
224.3 Million Tons
Total Ore/Waste
274.1 Million Tonnes
302.0 Million tons
     
Contained Gold
46.78 Million grams
1,504,000  Oz
     
Production
   
Ore Crushed
5.4 Million Tonnes /Year
6.0 Million Tons/Year
 
14,868 Mt/d(1)
16,390 t/d(1)
     
Operating Days/Year
365 Days per year
365 Days per year
Gold Plant Average Recovery
58.25%
58.25%
Average Annual Production
2.1  Million grams
67,391  Oz
Total Gold Produced
27.25 Million grams
876,080  Oz

(1)  
 “g/t” means grams per metric tonne, “opt” means ounces per ton, “Mt/d” means metric tonnes per day and “t/d” means tons per day.
(2)  
The reserve estimates are mainly based on a gold cutoff grade of 0.15 g/t for sandstone and 0.19 grams for siltstone and latite within the pit design.

 
The SRK resource estimation is based on information from 371 holes for a total of 55,294 meters of drilling.  There are 333 reverse circulation holes and 38 core holes.  The drill holes were carefully logged, sampled and tested with gold fire assay (industry standard).  A geological model was constructed based on four general rock groups which are cut by thrust faults and normal faults.  The mineral resource model blocks are 6m (meters) x 6m x 6m. All block grade estimates were made using 6m bench composites.  An ordinary Kriging algorithm was employed to generate a categorical indicator grade shell based on a 0.1ppm gold threshold.  An inverse distance cubed algorithm was used for the gold grade estimation within the grade shells.
 

The life of mine plan used as the basis for the reserve is based on operating gold cutoff grades of 0.15 to 0.19 g/t, depending on the ore type to be processed.  The internal (in-pit) and break even cutoff grade calculations are as follows:
 
17


Cutoff Grade Calculation Basic Parameters
Internal Cutoff Grade
Break Even Cutoff Grade
Gold Price
 US$800/oz
 US$800/oz
Gold Selling Cost (4% Royalty,   Refining, Transport, Silver Credit, etc)
 $25.258/oz
 $25.258/oz
Gold Recovery*
58.25%
58.25%
     
Operating Costs per Tonne of Ore
   
Mining
 
$1.08/tonne
Processing – Heap leach
$2.357/tonne
$2.357/tonne
     
Total
$2.357/tonne
$3.44/tonne
     
Cutoff Grade
Grams per Tonne
 Grams per Tonne
Head Grade Cutoff (58.25% average recovery)
0.15 g/t gold
0.24 g/t gold
Recovered Gold Grade Cutoff
0.09 g/t gold
0.14 g/t gold
 
* Plant recovery of gold varies by rock type but weighted average gold recovery is expected to average 58.25% based on work done to date.

In August 2009, we initiated the construction of an additional leach pad area at El Chanate with capacity for eight million tonnes of ore, at an estimated cost of approximately $3,300.  Permitting and site clearing was completed, the construction contractor completed the earthworks and the geomembrane liners were applied to the new leach pad area.  We initiated leaching of ore on the new leach pad as of December 31, 2009.  Golder Engineering of Tucson, Arizona oversaw construction activities and quality control and assurance for the project. The final actual construction cost of this additional leach pad area was approximately $3,000.

In October 2009, we procured additional water rights at El Chanate that has enabled us to drill another water supply well.  The new well was completed in October 2010 and will allow for a further increase in solution flow to the leach pads.

In December 2009, we completed the procurement and commissioning of a new tertiary crusher for the El Chanate mine.  The cost for this equipment was approximately $1,100.  In addition, we increased the speed of the tertiary crushers by 20% which has resulted in a finer crush size which is anticipated to speed up the recovery time of the metal content.  We also made maintenance and scheduling improvements to the crushing circuit, including the design of the cone crushing liners, which have maximized the availability of the crushing plant and improved both crushing and stacking rates. Lastly, we upgraded the platform supports for three of our crushers in May 2010.  These upgrades cost approximately $800.

We commenced a drill campaign in April 2010 within the El Chanate pit area which consists of approximately 92 reverse circulation drill holes totaling approximately 11,586 meters.  The primary reason for the infill drilling  is to replace depleted reserves and improve the forecast accuracy of the mine plan.  In addition, some holes will test the north pit wall for mineralization as well as the outer limits of the pit.  The data from both the infill and exploration drilling will be used to update the resource estimate which we anticipate to be complete before the end of our fiscal year ended 2011.

18

 
In May 2010, we initiated the planning and permitting on the construction of an additional leach pad to the east of the existing leach pads.  The total capacity of this additional leach pad will be approximately 8.5 million tonnes (when stacked to six lifts) and cost approximately $7,500.  This pad will be expanded on the south, east and possibly west sides to accommodate the current ore reserve.  When combined with the original and west pads the aggregate capacity will be approximately 20.1 million tonnes.  This capital expenditure is anticipated to be expended over the next twelve months.  Site clearing was initiated in May 2010 and construction commenced in July 2010.  The first panel is anticipated to be ready for stacking towards the end of the calendar year with complete construction anticipated to be completed by May 2011 (See Note 8).

In July 2010, the Company commenced the use of belt agglomeration with cement which is added to the crushed ore at the El Chanate mine to improve the flow of leaching solution.   We have engaged an independent consultant with respect to heap leaching optimization, which has resulted in recommendations to increase the barren solution flow to the leach pad, increase the pregnant solution flow to the recovery plant, and redirect the low grade solution to the leach pads.  When fully implemented, these operational changes combined with the agglomeration with cement and barren solution may result in immediate improvements in leaching time.  We ordered two agglomeration drums which are expected to arrive by January 2011.  The current belt agglomeration is a temporary measure until the drums are delivered.  The use of agglomeration drums will allow for better mixing of cement and lime with the crushed ore, producing a consistent quality control of the product.  The cost of these agglomeration drums and an additional overland conveyor is anticipated to be $2,000 (See Note 23).


The following table represents a summary of cumulative activity in connection with our proven and probable mineral reserves:


 
Proven and probable mineral reserve (Ktonnes of ore)
 
July 31,
2010
   
July 31,
2009
   
July 31,
2008
 
Ore
    -       -       -  
  Beginning balance (Ktonnes)
    40,911       35,417       38,916  
Additions
    30,388       9,342       -  
Reductions
    (4,587 )     (3,848 )     (3,499 )
  Ending Balance
    66,712       40,911       35,417  
                         
Contained gold
                       
  Beginning balance (thousand of ounces)
    859       719       814  
Additions
    662       239       -  
Reductions
    (110 )     (99 )     (95 )
  Ending Balance
    1,411       859       719  


El Chanate is an open pit mining and heap leach processing operation.  Ore is hauled by truck from the pits to the processing plant.  The recovery of gold from certain gold ores is achieved through the heap leaching process. Under this method, ore is placed on impermeable leach pads where it is treated with dilute alkaline cyanide bearing solution, which dissolves gold and silver contained within the ore. The resulting “pregnant” solution is further processed in a plant where the gold is recovered.  The processing is a closed circuit, solution is reused, and the process is zero discharge. The mining and other mobile equipment is mostly refurbished as is the smaller of the two Adsorption, Desorption, Refinery (“ADR”) processing plants.  All other equipment and infrastructure at the El Chanate mine are new.  Management continuously analyzes production results and considers improvements and modernizations as deemed necessary.

19

 
Equipment and infrastructure include: A three stage crushing plant, a fleet of haul trucks, loaders and mining support equipment, a leach pad and solution holding ponds, two ADR processing plants, and a refinery.  In addition, there are numerous ancillary support facilities including warehouses, maintenance shops, roadways, administrative offices, power and water supply systems, and a fully equipped assay and metallurgical laboratory.

We commenced gold production at the El Chanate mine on July 31, 2007.  During the fiscal years ended July 31, 2010, 2009 and 2008, we sold 54,304, 48,418 and 39,102 ounces of gold, respectively.  Management has been and anticipates that it will continue to fund expansion costs with its cash flow from operations.  We believe that the improvements and enhancements in production being made at the El Chanate mine will elevate and maintain El Chanate’s production profile to 65,000 to 70,000 ounces per annum.

Surface Property Ownership

Anglo Gold purchased surface property ownership, consisting of 466 hectares in Altar, Sonora, on January 27, 1998.  The ownership was conveyed to our subsidiary, Oro de Altar S.A. de C.V., in 2002.  Minera Santa Rita S.A. de C.V. (“MSR”), one of our wholly-owned Mexican subsidiaries, has a lease on the property for the purpose of mining the Chanate gold deposit.  The purchase transaction was recorded as public deed 19,591 granted by Mr. Jose Maria Morera Gonzalez, Notary Public 102 of the Federal District, registered at the Public Registry of Property of Caborca, Sonora, under number 36026, book one, volume 169 of the real estate registry section on May 7, 1998.

We purchased additional surface property ownership, consisting of 220 hectares in Altar, Sonora, in March 2009, adjacent to the El Chanate mine in order to accommodate future leach pad expansion requirements.  The purchase transaction was recorded as public deed number 18,174, dated March 26, 2009, issued by Mr. José Antonio Dávila Payán, Notary Public number 3 in Caborca, Sonora.

General Information and Location

The El Chanate Project is located in the State of Sonora, Mexico, 37 kilometers (22 miles) northeast of the town of Caborca and nine kilometers from a paved road.  It is accessible by an all weather dirt road.  Driving time from Caborca is approximately 30 minutes.  Access from Caborca to the village of 16 de September  (“Ejido”) is over well maintained National highways. We acquired rights for service road access from the Ejido, and constructed this road.

The project is situated on the Sonora desert in a hot and windy climate, generally devoid of vegetation with the exception of cactus.  The terrain is generally flat with immense, shallow basins, scattered rock outcropping and low rocky hills and ridges.  The desert floor is covered by shallow, fine sediment, gravel and caliche.  The delineated ore zone and current mine plan covers an area of approximately 5,576 feet (1,700 meters) long by 2,558 feet (780 meters) wide.  There is evidence of potential additional mineralization within the El Chanate concessions that warrant further exploration.

In 2005, we acquired 15 year rights of way to access the El Chanate Project from the Ejido and local ranchers. We subsequently purchased an extension of our rights-of-way from 15 to 30 years.  We acquired a water allocation and water well that draws from a large regional aquifer.   The 2005 feasibility study indicated our average life of mine water requirements, at that time, for ore processing only, will be about 94.6 million gallons per year (358,333 cubic meters, or 11.4 liters per second).  The amount of water we were permitted to pump from the well was approximately 71.3 million gallons per year (270,000 cubic meters, or 8.6 liters per second).  During the fiscal years ended July 31, 2008 and 2009, on two occasions  we acquired additional water right permits that allow us to pump up to 149.5 million gallons (566 cubic meters) per year.  In October 2009, in preparation for future growth, we acquired additional water rights and a water well which allows us to allocate an additional 158.5 million gallons per year (600,000 cubic meters).  This gives us a total allocation of approximately 317.4 million gallons (1,202,270 cubic meters per year, or 38.1 liters per second).  Based on current and anticipated future water consumption, we believe we have sufficient water to meet our current development and production requirements.

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In December 2005, MSR entered into a Mining Contract with Sinergia.  The Mining Contract, as amended, became effective November 1, 2006 and work commenced on March 25, 2007 (the “Commencement Date”).  Pursuant to an amendment to the Mining Contract, the mining rates set forth in that contract are subject to adjustment for the rate of inflation between September 23, 2005 and the Commencement Date.  Pursuant to the Mining Contract, Sinergia, using its mining fleet, is obligated to perform all of the mining, blasting and mine maintenance work at the El Chanate Project for the life of the mine at a predetermined mining rate and fleet size.  Sinergia’s mining rates are subject to escalation on an annual basis.  This escalation is tied to the percentage escalation in Sinergia’s costs for equipment parts, interest rates and labor.  One of the principals of Sinergia (“FG’s Successor”) is one of the former principals of Grupo Minero FG S.A. de C.V. (“FG”).  FG was our former joint venture partner.

Historical workings suggest that the area has been mined for gold since the early 19th century.  A number of old underground workings are characterized by narrow shafts, to a depth of several tens of feet and connecting drifts and cross cuts.  The current open pit mine has been developed below the level of the historical small scale mining.

Geology

The project area is underlain by deformed sedimentary rocks of the Late Jurassic – Early Cretaceous Bisbee Group, and the Late Cretaceous Chanate Group, which locally are overlain by andesites of the Cretaceous El Charro volcanic complex.  The sedimentary strata are locally intruded by andesitic sills and dikes, a microporphyritic latite and by a diorite stock.  The sedimentary strata are comprised of mudstone, siltstone, sandstone, conglomerate, shale and limestone.    Sandstone, conglomerate and lesser mudstone that lies above the Chanate fault areof the Middle Cretaceous Chanate Group.  Below the Chanate fault siltstone,  and sandstone lenses are assigned to the Arroyo Sasabe Formation of the Lower Cretaceous Bisbee Group.  The Arroyo Sasabe formation overlies the Morita Formation of the Bisbee Group.  The Escalante, Arroyo Sasabe, and Morita formations are  mineralized proximal to the Chanate fault.

The main structural feature of the project area is the Chanate fault zone, a 7 km long (minimum) northwest-striking, variably southwest-dipping structure that has been interpreted to be a thrust fault.  The Chanate fault  is marked by brittle deformation and shearing which has created a pronounced fracture foliation and fissility in the host rocks.  In drill holes the fault is often marked the presence of andesite dikes, and a change from sandstone to siltstone.   The Chanate Fault Zone is offset by a series of high angle normal faults which also strike northwest. Intrusions of the microporphyritic latite are primarily below the Chanate fault zone, in the mine area, and also predate mineralization.

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Alteration/Mineralization

Alteration and mineralization, associated with the Chanate Fault zone, are exposed over a north 60 west strike length of over 3.5 km.  The final open pit mine dimensions are 1,700 meters along strike n60w, 775 meters normal to strike, and the pit will be 280 meters deep .  The rock units within this zone are altered to varying degrees by sericite, pyrite, ankerite and quartz veining.  In surface outcrop the mineralized zone is distinguished by its bleached appearance relative to unmineralized rock.  The mineralized zone contains only single digit ppm (parts per million) levels of gold.  Sub-parallel ‘sheeted’ zones of quartz veinlets form thick, mineralized lenses, within a larger area of sub-economic but anomalous gold concentrations.  Drill hole data indicates the mineralized lenses are sub-horizontal to gently southwest-dipping and are often parallel to the Chanate fault and the steep normal faults.  The fault zone itself is generally weakly mineralized, while rock units in the adjacent hanging and footwalls are well mineralized.

Our Acquisition and Ownership of the El Chanate Project

In June 2001, we purchased 100% of the issued and outstanding stock of Minera Chanate, S.A. de C.V. from AngloGold North America Inc. and AngloGold (Jerritt Canyon) Corp.  Minera Chanate’s assets at the time of the closing of the purchase consisted of 106 exploitation and exploration concessions in the States of Sonora, Chihuahua and Guerrero, Mexico. By June 2002, after property reviews and to minimize tax payments, the 106 concessions had been reduced to 12 concessions.  To cover certain non-critical gaps between concessions, four new concessions were acquired, and the number of concessions is now 16.  These concessions are contiguous, totaling approximately 3,543 hectares (8,756 acres or 13.7 square miles).   Although there are 16 concessions, we are only mining two of these concessions at the present time.  We also own outright 466 hectares (1,151 acres or 1.8 square miles) of surface rights at El Chanate and no third party ownership or leases exist on this fee land or the El Chanate concessions.  In the future, assuming adequate funding is available, we plan on conducting exploration activities on some of the other concessions.

Pursuant to the terms of the agreement with AngloGold, in December 2001, we made a $50 payment to AngloGold.  AngloGold will be entitled to receive the remainder of the purchase price by way of an ongoing percentage of net smelter returns of between 2% and 4% plus a 10% net profits interest (until the total net profits interest payment received by AngloGold equals $1,000).  AngloGold's right to a payment of a percentage of net smelter returns and the net profits interest will terminate when they aggregate $18,018.  During the first part of calendar 2008, Royal Gold, Inc. acquired from Anglo Gold the right to receive both the net smelter returns of between 2% and 4% plus and the 10% net profits interest which terminates at such point as they aggregate $18,018.  As of July 31, 2010, we have incurred approximately $5,567 with regard to the net smelter return.  In addition, in March 2009, we paid  the total $1,000 net profit interest to Royal Gold.  As of July 31, 2010, we have approximately $11,451 remaining to be incurred on the net smelter return.

Under the terms of the agreement, we had granted AngloGold the right to designate one of its wholly-owned Mexican subsidiaries to receive a one-time option to purchase 51% of Minera Chanate (or such entity that owns the El Chanate concessions at the time of option exercise).  That option was exercisable over a 180 day period commencing at such time as we notified AngloGold that we had made a good faith determination that we had gold-bearing ore deposits on any one of the identified groups of El Chanate concessions, when aggregated with any ore that we have mined, produced and sold from such concessions, in excess of a target number of troy ounces of contained gold.  The exercise price would equal twice our project costs on the properties during the period commencing on December 15, 2000 and ending on the date of such notice.  In January 2008, we made a good faith determination and notified AngloGold that the drill indicated resources at the El Chanate gold mine exceeded two million ounces of contained gold. The term "drill indicated resources" is defined in the agreement.  A drill indicated resource number does not rise to the level of, and should not be considered proven and probable reserves as those terms are defined under guidelines of the Securities Exchange Commission (“SEC”).   On July 1, 2008, AngloGold notified us that it would not be exercising its option.

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El Oso Project - Saric Properties – Sonora, Mexico

In April 2008, we leased 12 mining concessions totaling 1,789 hectares located northwest of Saric, Sonora. In addition, we own a claim for approximately 2,233 additional hectares adjacent to this property. The approximate 4,022 hectare area is accessible by paved roads and has cellular phone service from hilltops.  These concessions and this claim are about 60 miles northeast of the El Chanate project. Mineralization is evident throughout the concession group and is hosted by shear zones and stockwork quartz veins in volcanic and intrusive rocks. We have completed exploration work consisting of geological mapping, systematic geochemical sampling of rock and soils, geophysical surveys, trenching and 73 reverse circulation drill holes totaling 6,121 meters and more recently a one meter interval topographic survey over the concession area.  SRK of Lakewood, Colorado has visited the site and has monitored the quality assurance and quality control during these drill campaigns.  SRK will also assist on the next phase of the exploration program.  All of the drill hole samples have been assayed by ALS Chemex.  The ALS Chemex facility in Hermosillo does the sample preparation, and the assays are performed at the ALS Chemex’s Vancouver laboratory.

In January 2010, we initiated an additional drill campaign at Saric that consisted of 13 core holes totaling approximately 1,100 meters.  The drilling was completed on February 23, 2010 and targeted the existing mineralized structure to confirm the geologic interpretation and confirm the accuracy of previous reverse circulation drilling. The drill hole samples were assayed by ALS Chemex.  Currently, we are planning to initiate a geophysical survey in late 2010.  The intention of the geophysical survey is to assist us in determining the focus of our next drill campaign.   We are also continuing our work on an updated environmental report and clarifying the surface ranch land ownership.

The lease agreement required an initial payment of $45 upon execution of the lease.  We are required to pay an additional $250, consisting of ten payments of $25 every four months beginning six months after execution of the lease agreement (See Note 23). The agreement also contains an option to acquire the mining concessions for a cash payment of $1,500 at the end of the term (December 2011).  If we elect not to exercise this option, we would have the ability to mine the concessions by paying a 1% net smelter return to the owners of the leased concessions, capped at $3,000.  Prior payments made under this lease agreement would be deductible from the $3,000 cap.

Orion Project

Through our recent acquisition of Nayarit on August 2, 2010, we control approximately 257,000 acres (104,000 hectares) of mining concessions known as the Orion Project.  The Orion Project lies in the Sierra Madre Occidental, a prolific mining district in Western Mexico. Nayarit was a junior mineral exploration company that was incorporated in November, 2003 and became a public company by virtue of its amalgamation with Canhorn Chemical Corporation on May 2, 2005.  With this recent acquisition, our plan is to continue exploration work on the Orion Project in the State of Nayarit, Mexico. As an exploration stage project, the Orion Project currently does not produce any gold.  The original exploration focus was on the known mineralization of the La Estrella property, one of the original properties making up the Orion Gold Project. With expansion of the property area by almost 1200% in 2005 and 2006, other targets were identified and the strategy has taken on more of a district approach. A reconnaissance drill program initiated in 2007 throughout a small portion of the northern area in the concession resulted in the discovery of the Animas System, which was the focus of Nayarit's diamond drill program.
 
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Portions of the following disclosure relating to the Orion Project have been derived from two independent technical reports prepared for Nayarit entitled “National Instrument 43-101 Technical Report on Resources – Nayarit Gold Inc. – Orion Project, State of Nayarit, Mexico” dated December 29, 2009, and “National Instrument 43-101 Preliminary Economic Assessment – Nayarit Gold Inc. – Orion Project, Animas/Del Norte Zone, State of Nayarit, Mexico” dated February 5, 2010 authored by qualified persons (collectively, the “Authors”) of SRK Consulting (U.S.) Inc., 7175 W. Jefferson Avenue, Suite 3000, Lakewood, CO  80235.  These technical reports have been completed in accordance with the terms of National Instrument 43-101 and the Authors are “qualified persons” within the meaning of National Insturment 43-101 and are independent of Nayarit and Capital Gold.   The disclosure in this document has been reviewed by Mr. Ramon Hiram Luna Espinoza, P. Geonga, a consultant to Capital Gold who is a "qualified person" under National Instrument 4-3-101 and is not independent of Capital Gold.

The Orion Project lies in the prolific Sierra Madre Occidental, which hosts numerous multi-million ounce gold-silver deposits. The Orion Project is one of the larger contiguous concessions in the Sierra Madre, composed of 257,000 acres (104,000 hectares).  The Orion Project is located on the southeast flank of the Sierra Madre, about 125km south of  the famous Tayoltita district which has reserves reported to be in excess of 20 million gold equivalent ounces.  The concessions are located approximately 110km north–northwest of Tepic, state capital of Nayarit, México, 150km southeast of Mazatlan, Sinaloa.  The Orion Project is located 13 km south–southeast of the town of Acaponeta, Nayarit, in the Motaje Mining District as identified by the Servicio Geologico Mexicano (formerly the Consejo de Recursos Minerales).  We anticipate progressing  this project to a pre-feasibility stage by the second quarter 2011.

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Figure 1. Orion Project Concessions Area on Nayarit State.
 
 
 
Royalties, Agreements and Encumbrances
 
Nayarit Gold de Mexico, S.A. de C.V. (“Nayarit Mexico”), our wholly-owned subsidiary, has the exclusive right to explore and, as the case may be, exploit the “La Estrella” (title 196009) mining concession, in accordance with the terms of an exploration agreement (the “Exploration Agreement”) dated November 28, 2003 which was entered into by and between Mr. Adrian Evodio Prado Gomez and Minera Portree de Zacatecas, S.A. de C.V., which conveyed its rights to Nayarit Mexico in accordance with the terms of a Conveyance Agreement dated May 20, 2004 (the “Conveyance Agreement”) and amendments thereto dated May 17, 2004, July 29, 2004, November 28, 2007, November 28, 2008 and a letter of intent for a new amendment dated December 4, 2009 (the “Estrella Amendments”).
 
           For the exploration rights of La Estrella as described above, Nayarit Mexico has paid up to date the amount of $550 plus applicable Value Added Tax, and shall pay the following amounts in the dates indicated below, after which payment, Nayarit Mexico will acquire 100% interest to La Estrella concession:
 
 
(i)  
$100 plus applicable Value Added Tax, in December 8, 2010;
 
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(ii)  
$100 plus applicable Value Added Tax, in June 8, 2011;
 
 
(iii)  
$175 plus applicable Value Added Tax, in December 8;  2011
 
 
(iv)  
$175 plus applicable Value Added Tax, in June 8, 2012; and
 
 
(v)  
$350 plus applicable Value Added Tax, in December 8, 2012.
 

The Exploration Agreement and Amendments thereto may be terminated by Nayarit Mexico at any time through a written communication addressed to Prado.

Nayarit Mexico has the unlimited right to explore the following mining concessions (“Huajicari Concessions”), in accordance with the terms of and Exploration and Assignment Option Agreement of Mining Concessions (the “Option Agreement”) dated May 8, 2008, which was entered into by and between Compañía Minera Huajicari, S.A. de C.V. (“Huajicari”) and Nayarit Mexico and amendment thereto, dated December 10, 2009:
 
CLAIM
 
TITLE NUMBER
 
“San Juan Fracc. I”
    205392  
“San Juan Fracc. II”
    205393  
“San Francisco Tres”
    203136  
“San Juan I”
    221365  
“Isis”
    214395  
“San Miguel”
    224392  
 
For the exploration rights of the Huajicari Concessions as described above, Nayarit Mexico has paid up to date the amount of $2,250, and shall pay $250 by October 31, 2010, after which payment, Nayarit Mexico will acquire 100% interest to Huajicari Concessions.

The term granted to Nayarit Mexico for the exploration of the above mentioned mining is 2 years commencing as of the date of execution of the Option Agreement but Nayarit Mexico may terminate the agreement at any time through a written communication addressed to Huajicari.

Nayarit Mexico has the option to acquire 100% interest to the Huajicari Concessions at any time as of the date of execution of the Option Agreement, provided it complies with the obligations set forth in the Option Agreement.

Nayarit Gold Inc. purchased the Orion Concession by Asset Purchase Agreement dated January 30, 2004. With respect to the Orión concession, Nayarit has granted a 3.5 percent net smelter return royalty payable to Belitung Limited, an Ontario incorporated company. Nayarit may purchase the royalty outright at any time for CDN$250 in cash or non-assessable common shares. In addition, Nayarit is also subject to a net profits interest on Orión of 10% payable to a previous property owner.

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Table: Mining Concessions Controlled by Nayarit Gold de Mexico, SA de CV
 
Concession Name
Title
File No.
 
Owner
Surface (ha)
BONANZA I
227603
6923
 
NAYARIT GOLD DE MÉXICO SA de CV
200.00
EL DORADO
228887
7013
 
NAYARIT GOLD DE MÉXICO SA de CV
23,001.85
EL MAGNIFICO
221592
6758
 
NAYARIT GOLD DE MÉXICO SA de CV
7,595.74
EL MAGNIFICO F-I
221588
6758
 
NAYARIT GOLD DE MÉXICO SA de CV
6.90
EL MAGNIFICO F-II
221589
6758
 
NAYARIT GOLD DE MÉXICO SA de CV
32.00
EL MAGNIFICO F-III
221590
6758
 
NAYARIT GOLD DE MÉXICO SA de CV
6.96
EL MAGNIFICO F-IV
221591
6758
 
NAYARIT GOLD DE MÉXICO SA de CV
8.84
GROSS F I
228826
7002
 
NAYARIT GOLD DE MÉXICO SA de CV
67,148.77
GROSS F- II
228827
7002
 
NAYARIT GOLD DE MÉXICO SA de CV
16.00
ORION
205616
6253
 
NAYARIT GOLD DE MÉXICO SA de CV
527.50
REESE
227775
6980
 
NAYARIT GOLD DE MÉXICO SA de CV
3,104.29
SAN JUAN I
221365
3/1/639
 
COMPAÑIA MINERA HUAJICARI SA de CV
45.63
SAN FRANCISCO 3
203136
3/1.3/243
 
COMPAÑIA MINERA HUAJICARI SA de CV
32.75
SAN JUAN F - II
205393
6250
 
COMPAÑIA MINERA HUAJICARI SA de CV
0.81
ISIS
214395
6617
 
COMPAÑIA MINERA HUAJICARI SA de CV
101.34
SAN JUAN F-I
205392
6250
 
COMPAÑIA MINERA HUAJICARI SA de CV
1,339.01
SAN MIGUEL
224392
3/1/723
 
COMPAÑIA MINERA HUAJICARI SA de CV
1,177.38
LA ESTRELLA
196009
3/1.3/232
 
ADRIAN EVODIO PRADO GÓMEZ
146.35
 
 
Environmental Liabilities and Permitting
 
Nayarit Gold has initiated the generation of an environmental impact assessment of the concession(s) (the “EIA”) which is substantially complete. There are no known environmental liabilities on the Concession.
 
Accessibility, Climate, Local Resources, Infrastructure and Physiography
 
Access to Property
 
Access to the Orion Project site is from Tepic, state capital of Nayarit, Mexico via 220km of multi-lane paved toll road to Acaponeta near the Nayarit–Sinaloa state border.  Primary access to the Orion Project is located 10km to the east, towards the El Motaje ranch, where a secondary dirt road passes northward towards the La Estrella mineralized area.  A second access road connecting the Motaje ranch and the La Estrella zone has been maintained by Nayarit Gold since 2005. A 1,000m long, unpaved fixed wing airstrip and two bus depots for local and external transportation are also available in Acoponeta.
 
Power and Water Supplies
 
Low voltage residential electrical power services are available at El Resbalón, Motaje and El Carrizo, while a major 115kV line which is part of the interconnected National Power line Net crosses the El Magnífico claim 2 km west of the La Estrella zone.  Water for industrial purposes has not been adequately investigated in the region, however surface water is abundant.
 
Climate and Length of Operating Season
 
The general climate in the region is warm and sub-humid with a well-defined primary rainy season between June and September, and which commonly extends through October. Average annual rainfall is in the order of 1,307mm, of which 92% falls from July to September.  The annual mean temperature is 26.7°C.  Exploration work can be carried out year round at the Orion Project.
 
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Surface Rights
 
According to Mexican legislation, surface rights are not part of mining concessions and require that specific purchase or rental agreements with property owners must be fulfilled.  At Animas/Del Norte, La Estrella, San Francisco and most of the northern exploration targets within the Orion Project surface rights are held by the Indigenous Community of San Blasito and annexes of the Acaponeta municipality based in the village of Motaje, southeast of La Estrella.  Nayarit Gold has established private agreements with local communities to obtain permission for exploration activities.  In all cases, the main responsibility agreed to by Nayarit Gold is to give priority to the local population for the non-specialized jobs created by the advancement of the Orion Project, provide them with mandatory Social Security registration and assist with mobile equipment support for improvement of access roads to the neighboring communities.
 
Topography, Elevation and Vegetation
 
Topography at the Motate Carrizo is characterized by moderate relief, with elevations ranging between 60m to a maximum of 620m above sea level (masl). In the area of the concessions, more than 40 different species of plants have been identified and can be generally grouped as oak tree forests and sub-caducifolia and sub-perennifolia scrub trees and bush forest.  The main use of vegetation in the region is for human consumption, wood for fuel, fence poles, furniture making and a few edibles.  It has been observed in some reports that local vegetation has partially been altered due to forest fires, as well as deforestation resulting from agriculture and the raising of cattle.
 
Physiography
 
The Orion project is located along the western flank of the Sierra Madre Occidental, a mountain range that defines the central spine of northern Mexico.  The north-northwest-trending Sierra Madre Occidental is composed of a relatively flat-lying sequence of Tertiary volcanic rocks that forms a volcanic plateau.  The Sierra Madre Occidental gives way to the west to an extensional terrane that represents the southward continuation of the Basin and Range Province of the western United States, and then further west to the coastal plain of western Mexico.  The property lies at the boundary between the Mexican Basin and Range Province and the coastal plain.  The Orion project area is hilly, but not mountainous, with densely vegetated, steep-sided slopes.  The hills are cut by a number of intermittent streams that flood in the June – September rainy season.
 
The area is sparsely populated and cattle raising and cultivation of market crops, are the main district land use.  Agriculture produced from the area includes corn, beans, nuts, sorghum, avocados and a variety of other fruits and vegetables.  Local activities in the municipality of Acaponeta include agriculture with 18,000ha of corn, beans, sorghum, chili pepper, avocado and mango production, cattle raising (32,000ha) and forestry (7,000ha) with minor artisanal mining activities.
 
History
 
Past Exploration and Development
 
The Orion project area lies within the Motaje mining district in the Municipality of Acaponeta, Nayarit, Mexico.  The district is reported to have had moderate but unknown quantities of gold and silver production dating from Spanish colonial times, possibly as early as the late 1500’s.  Many small adits and superficial workings along the district’s two main mineralized structural trends, the La Estrella – Animas - Pantaleona and the El Rey - La Escondida - Bonanza trends, attest to past mining activity.
 
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A small, 5t/d, operation was carried out between 1955 and 1970 at La Estrella. In 1973 a total of 15,000 tons was produced from the Bonanza Mine, 4.7 km east of La Estrella, while the Las Animas Mine was operated around 1998. Currently, Minerales Vane , S.A. de C.V. is carrying out small scale mining of 1500 TPM at the Diablito high grade mine in the neighboring Las Lumbres District, located 16km southwest of La Estrella.
 
Mineral exploration was carried out at La Estrella Concession area by Lac Minerals (USA) in 1993 – 1994 including the completion of 21 drill holes. Previously, exploration was carried out by Minas Caopas on the San Francisco – La Sebastianna mine areas in 1986-1987 located just south of La Estrella, when 21 drill holes were completed by Minas Caopas.
 
Geologic Setting
 
Regional Geology
 
The Sierra Madre Occidental metallogenic province, in which the Orión Gold Project is located, is one of the world’s largest epithermal precious metal terrains and hosts most of Mexico’s gold and silver deposits.  The general geology of the Orión Gold Project area is characterized by Early to Mid-Tertiary volcanic rocks, which can be divided geologically into two main units referred to as the Upper and Lower Volcanic Groups.  The Lower Volcanic Group is of a generally andesitic composition and hosts most of the mineral deposits.  The Upper Volcanic Group is of a generally dacitic to rhyolitic composition and covers the Lower Volcanic Groups except where erosion has removed it entirely, or deep river valleys have cut down to expose the underlying lower volcanics. Between the time of deposition of the Upper and Lower volcanics, the rocks were intruded by shallow, fine-grained to porphyritic igneous rocks of a generally felsic composition. This assemblage is typical and extends through the Sierra Madre Occidental in eastern Sonora, western Chihuahua, Durango, Sinaloa and Nayarit states.
 
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Figure 2. Regional geologic map illustrating geology, the Animas/Del Norte Resource area and various targets throughout the concession. A more detailed view of the Animas/Del Norte area is illustrated in Figure 3.
 
 
 
Local and Property Geology
 
The northern portion of Nayarit Gold’s concessions includes a number of epithermal veins which are developed along east-west fracture systems. Mineralized veins form two discrete mineralized corridors separated by about 2km from one another. Animas/Del Norte is the southernmost of two major mineralized corridors defined at the project, each more than 4 kilometers long. The southern mineralized corridor includes the Animas/Del Norte veins and the Pantaleona, San Francisco and La Estrella veins, which generally dip to the north and is more than 4 km long, as is the northern vein.  The La Estrella structure is a northwest striking splay off the Del Norte vein.  The northern corridor includes the El Rey, La Escondida, El Carmen, Bonanza 1 veins, which generally dip to the south and includes the previously producing Bonanza mine, which is in a competitor owned mining concession internal to Nayarit Gold’s land package.
 
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Figure 3. Northern portion of the concession where most of the exploration has been carried out to date. The mapped veins are illustrated in red with the various targets.
 
 
 
Exploration
 
Nayarit Gold has been exploring the Orion Project since 2004.  Exploration to date has focused in the northern portion of the concession where the company has identified two +4km parallel vein sets, which hosts most of the known mineral zones to date (see above image). Most of the focus has been on the Las Animas/Del Norte system, in the southern vein, which hosts the majority of mineral resources found to date. Exploration was initiated by underground and surface sampling and mapping of the Las Animas structure. Rock and soil programs over the area were carried out which was followed by a series of drill hole programs. All mapping and sampling was carried out by company personnel while drilling was contracted to HD Drilling.
 
To the east and west Animas/Del Norte the company has also explored several known zones and advanced exploration to an initial drill phase. These zones include San Francisco and San Sebastiana to the west and Pantaleona to the east. Drilling has identified mineral zones in all locations, although not as prominent as that at Animas/Del Norte. More work is necessary especially at San Sebastiana and Pantaleona areas.
 
The northern vein set which is host to El Rey, Escondida, Bonanza, El Carmen, Bonanza 1 has also been explored by surface and underground sampling and mapping, and drilling. Surface samples have shown promise in the area, however, drilling to date has been less consistent. More exploration is necessary to determine the best drill targets.
 
           Nayarit has also completed exploration on select targets throughout the southern portion of its Orion Concession (see Figure 2 for locations of the following targets). At Lazaro Cardenas, 22 km S-SE of Animas/Del Norte and Rosa Amarilla, 19 km south of Animas/Del Norte, the company has completed surface work and drilling, with drill results showing promise. Both areas show considerable promise and further exploration and drilling is needed.
 
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At El Frontal, 22 km southeast of Animas/Del Norte, the company has carried out a surface and minor underground sampling program. This target is a historic mine which according to COREMI, 1994, has 1.5 km of underground development. As with other targets, this one is an epithermal gold-silver prospect and needs additional exploration followed by drilling to assess its potential. Grab samples in the underground workings collected by Nayarit geologists assayed up to 6.18 g/t gold and 179 g/t silver.
 
Other targets that have been sampled but not drilled throughout the southern concession include El Chinacate (28 km southeast of the Animas/Del Norte), Las Camillas (22.5 km south from the Las Animas/Del Norte) and La Paloma (16 km south of the Animas/Del Norte). All zones have shown gold and silver grades from surface veins.
 
In general, Nayarit has not completed any significant exploration throughout the southern concession area, expect for the known historic target zones listed above.
 
All sampling and drilling has been carried out in such a manner that its reliability is high. A Quality Assurance/Quality Control (“QA/QC”) program for sampling including rocks, soils and drill core samples are submitted with commercial standards for assay check as well as blanks and duplicates.
 
Mineralization
 
           The mineralized zones at Animas/Del Norte are composed of a series of 2 to 4m wide discrete quartz veins within a zone of dense quartz stockwork and breccias, averaging 12m wide and reaching widths greater than 25m, generally enveloped in andesites of the lower volcanic series. Epithermal textures ranging from colloform banding in chalcedonic quartz to cockade texture in crystalline quartz are common.  Nayarit Gold personnel have observed that two different mineral assemblages occur in the veins and that one assemblage is more favorable for high-grade mineralization.  An early district wide event resulted in the formation of crystalline quartz and pyrite, observed in all the known veins in the district.  This event is characterized by well crystallized pyrite and low silver: gold ratios.  The event is gold dominant and does have potentially economically mineable grades in several drillholes in the La Estrella area.  A later event, characterized by very finely crystalline to chalcedonic quartz, is accompanied by very fine pyrite, acanthite/argentite, light colored sphalerite and very minor chalcopyrite and galena.  Dark, sulphide rich bands (ginguro bands) and breccia fragments containing remnants of such bands are common.  This event has high silver: gold ratios and is the dominant style of mineralization observed in the Del Norte and Pantaleona areas, and is less well developed in the San Francisco area.  Only traces of the younger fine-grained quartz/argentite event have been observed at La Estrella.  The more favorable silver rich event is present along the northern mineralized corridor, but has not been identified in significant volumes along at El Rey, La Escondida and Bonanza 1.  It is noted that along the northern vein system, the Bonanza mine appears to have this mineral assemblage well developed on rocks taken from the dumps.
 
Relevant Geological Controls
 
The principal geologic controls to mineralization at Animas/Del Norte are favorable, dilatant structural flexures and favorable host rocks.  The highest-grade mineralization for gold and silver in the Animas/Del Norte veins is localized in a 200m vertical range from 100m above sea level to 100m below sea level. A mineral assemblage including argentite/ginguro, light colored sphalerite and low temperature quartz locally alternates with a mineral assemblage including hypogene hematite (evidence of an oxidizing fluid) and kaolinite.  The hematite and kaolinite are best developed in zones with very high gold and silver grades.
 
32

 
A major bend in the mapped veins crossing the Animas hill is known as the Animas/Del Norte Flexure.  Most movement on the faults hosting the veins was normal dip slip movement, but a small component of left lateral movement formed a dilatant, permeable zone.  The widest and highest grade portions of the Animas/Del Norte deposit are in and adjacent to this structural flexure.
 
The andesite crystal-lithic tuff unit is an andesite lithic tuff with a sufficiently competent matrix to fracture well, and is favorable for mineralization.  This rock occurs in the hanging wall of the Del Norte vein throughout the vertical extent of the favorable horizon.  The rock unit is also present in the hanging wall at Pantaleona and is likely to occur at depth at La Estrella.
 
Drilling
 
Type and Extent of Drilling
 
Two hundred sixty-four diamond core holes, ten reverse circulation holes and eight holes started with reverse circulation and finished with core have been drilled by Nayarit Gold on the Orion Project.  A total of 51,927m of core have been drilled and a total of 11,860m of reverse circulation have been drilled.  Nayarit Gold’s database maintains information on hole diameter indicating which portions of each hole were drilled by reverse circulation, HQ diameter core or NQ diameter core.  Of the total meters drilled, 55,782m were included in the resource model and 8,005m were drilled on targets outside of the resource area.
 
Procedures
 
All drill sites were pre-selected by Nayarit Gold management before drilling.  Sites were located in the field by handheld GPS units and drill pads constructed using a D-7 Caterpillar tractor.  Drill alignment was established on the drill pads by handheld Brunton compass before the rig was moved onto the pad and alignment and inclination checked by the rig geologist before drilling commenced.  For diamond core drilling, all drill operations were carried out by the drill contractor’s personnel.  Rig geologists visited the drill a minimum of two times per day and were required to be present at the rig when difficult drilling or bad ground conditions were encountered.  Core is retrieved from the drill string using conventional wireline techniques.  Core is removed from the core tube by HD drilling personnel and carefully placed in plastic core boxes.  Filled core boxes are removed from the drill site twice daily (early morning and evening) by Nayarit Gold personnel to the secure core logging facility in Acaponeta, Nayarit, 40 km from the Orion Project site.  For reverse circulation drilling, the rig geologist was present at the drill during all drilling operations.  All drillhole collars have been surveyed with differential GPS for location and have down hole surveys to measure hole deviation at approximately 50m intervals taken with a Reflex EZ Shot digital survey tool.  All project coordinates are maintained in WGS 84 UTM zone 13R.
 
At the core logging facility, the core is cleaned and the broken core pieces reassembled to a best fit.  For logging and sample interval marking, the core is laid out on workbenches.  A technician, under supervision of the drill geologist, completes a hardcopy geotechnical log of the core including recovery and RQD.  The drill geologist then logs the core and creates a hardcopy geologic log including a graphic representation of rock type, vein orientation, and mineralized zones and a detailed descriptive log including rock type, alteration, structure, mineralization and vein density/percentage.  Digital photographs are taken of all cores.
 
33

 
Interpretation of Results
 
Drilling has confirmed that the project is host to a series of epithermal gold-silver veins. These veins have been traced for lengths up to +4 km in length along surface, with deeper drilling showing the veins consistently present up to 400 metres below surface. Mineralization is not ubiquitous throughout the veins and structural and geochemical parameters play an important part in the deposition of metals at levels considered to be potentially economic. Of the rock types observed in drill core, the andesite crystal-lithic tuff illustrates the tendency for fracturing and thus prime target for mineralization, especially where the unit shows dilatant flexure.
 
Sampling and Analysis
 
Sample Methods and Location
 
Core is transported from the drill site to Nayarit Gold’s secure core logging facility in Acaponeta by company personnel.  Core box numbers are checked and core is cleaned and re-assembled by technicians prior to measurement of total core recovery. Technicians measure total core recovery, RQD, fracture characteristics and rock strength as estimated using the method from as 1726 geotechnical site investigation code 1993.  After re-assembly and geotechnical logging geologists make a geological log of the core and mark the sample intervals directly on the core.  Geologists are instructed to collect sample lengths with a minimum length of 0.5m and a maximum length of 1.5m sample with a nominal 1m interval adjusting based on rock type changes so that wall rock is not mixed with vein material except in cases of small, isolated veins.  Sample intervals are adjusted to vein and breccia zone boundaries and rock type changes.  Sample intervals are marked on the core and adjacent to the core in the box.  A cut line is drawn along the length of the core by the geologists.  All sampled core is sawn in half and returned to the box.  After sawing core samples were collected by technicians always taking the left hand side of the core and leaving the right hand side in the box.  Samples have an approximate 4kg weight.  Samples were shipped to ALS Chemex using a commercial freight service contracted by ALS Chemex.  All core handling from retrieval from the core tube through washing, re-assembly, geotechnical and geologic logging and sampling is done under the supervision of Nayarit Gold’s geologists.  Nayarit Gold has implemented a QA-QC procedure as described below.
 
Factors Impacting Accuracy of Results
 
As with all drill programs recovery issues can impact accuracy of results. Drilling of mineralized zones, such as the Del Norte zone, which is clay altered in places can result in loss of heavier fractions and lower percentage core recoveries, which can affect the obtained results. Generally, Nayarit has not observed such recovery issues that would raise concern except for several drill holes at Lazaro where core recoveries through what was believed to be a mineralized zone were low.
 
Quality Controls and Quality Assurance
 
Prior to May 2008, Nayarit Gold’s Quality Assurance/Quality Control (QA/QC) sample program consisted of blank and duplicate samples.  After this date Nayarit Gold implemented a program that included blank, duplicate and standard samples.  Approximately 10% of all samples submitted to the primary assay laboratory are for QA/QC purposes.
 
34

 
The QA/QC program includes insertion of commercially prepared gold and silver pulp standards at a frequency of 4 per 100 samples.  Standards used cover a range of gold and silver concentrations.  The standard samples have color-coded tags which are placed in the core boxes and in the sample number booklets which can be used to confirm which standard was submitted for any specific sample number.  
 
Security of Samples
 
           Samples are shipped from Nayarit Gold’s core processing facility in Acaponeta, Nayarit to ALS Laboratory Group (ALS) located in Hermosillo, Sonora Mexico.  Sample shipment from the Orion Project to this facility is part of the service provided by ALS and is contracted by ALS to a third party shipping company.  At ALS Hermosillo, samples are entered into the Laboratory Information Management System (LIMS) and prepared for analysis.  Once sample preparation is completed, the sample pulps are shipped on to ALS Vancouver for analysis by Fire Assay and inductively coupled atomic emission spectrometry (ICP-AES).
 
ALS Hermosillo and ALS Vancouver are in compliance for the requirements of ISO 9001:2000 through February 12, 2011 (ALS Laboratory Group, 2009).  ALS Vancouver is accredited through the Standards Council of Canada (SCC) for Metallic Ores and Products Mineral Analysis testing for several techniques including Fire Assay with an Atomic Absorption (AA) finish, Fire Assay with a gravimetric finish and ICP-AES using a four acid digestion.  This is under CAN-P-1579 Guidelines for the Accreditation of Mineral Analysis Testing Laboratories and CAN-P-4E (ISO/IEC 17025) General Requirements for the Competence of Testing and Calibration Laboratories.  This accreditation is valid through May 18, 2013 (Standards Council of Canada, 2009).
 
Samples are in the custody and control of Nayarit Gold, the shipping contractor or ALS at all times.
 
           On arrival at ALS Hermosillo, samples are inventoried, weighed, assigned a barcode and entered into the LIMS.  Once these activities are completed the samples are prepared for as follows: 1. Samples are dried in a drying oven, 2. The entire sample is crushed to 90% passing -2mm;  3. A 1,000g split is pulverized to 85% -75 microns; and 4. This pulp is sent to ALS Vancouver for analysis.
 
ALS Chemex returns all pulps and coarse rejects to Nayarit Gold.  Pulps and rejects are stored in the company warehouse in Acaponeta, Nayarit.  It is Nayarit Gold’s intention to discard all coarse rejects collected through the end of 2008 upon completion of preliminary metallurgical studies and publication of the relevant technical report.
 
 
 
Mineral Resources and Mineral Reserve Estimates
 
SRK Consulting (U.S.), Inc (“SRK”) was contracted by the Company to complete a Canadian National Instrument (“NI”) 43-101 compliant Preliminary Economic Assessment (“PEA”) for the Company's Animas/Del Norte Deposit.

This study is based extraction of indicated and inferred resources using underground mining methods with milling and tank leaching for processing. The Orion Resource Statement (using an underground extraction based assessment with a 2.0 g/t gold equivalent cutoff) as estimated by SRK is 1.107 million tonnes with a gold grade of 3.66 g/t and silver grade of 309 g/t in the Indicated category, and an additional 0.181 million tonnes with a gold grade of 3.33 g/t and silver grade of 95 g/t in the Inferred category.

35

 
The results of the PEA have identified the underground mining of 1.182 million tonnes with a gold grade of 2.79 g/t and silver grade of 267 g/t.

Assuming 100% equity financing, the PEA indicates a pre-tax Internal Rate of Return (“IRR”) of 38%. The estimated payback period is approximately 2.3 years (Base Case).

The following table illustrates the Base Case data and NPVs at various discount rates.

PEA base data:
Base Case
Life-of-Mine Mill Recovered Equivalent Gold Ounces*
246k oz AuEq
Production Rate
750 tpd
20k oz Au/yr
1.785M oz Ag/yr
Development Timeline
2 Years
                Initial Capital
US$35 Million
                Cash Costs
 US$320/gold equivalent ounce
Payback Period (NPV 8% Case)
2.3 years
                Mine Life
5 years
                Gold Price
US$900/oz
                Silver Price
US$15/oz
NPV’s and IRR
                Pre-tax NPV 3%
US$55.3 million
                Pre-tax NPV 5%
US$46.5 million
                Pre-tax NPV 8%
US$35.4 million
                Pre-tax IRR
38%
*Gold Equivalent Values were calculated based on 60 ounces of silver = 1 ounce of gold. Metallurgical recoveries for mill processing are based on previous metallurgical analysis and are 92% for gold and 88% for silver.

The PEA is founded on underground resources at the Animas/Del Norte Deposit. SRK examined different mining and processing options, and trade-off scenarios to identify the optimum mining scenario. This examination determined that an underground bulk mining method as the optimized mining method for the Animas/Del Norte Deposit. The deposit has an Indicated resource of 967,000 tonnes with a gold grade of 3.63 g/t and a silver grade of 347 g/t (or 9.42 g/t gold equivalent) containing 113,000 ounces of gold and 10.79M ounces of silver (or 293,000 gold equivalent ounces). An additional Inferred resource contains 39,000 tonnes with 3.74 g/t Au and 349 g/t silver (or 9.55 g/t gold equivalent) containing 5,000 ounces of gold and 436,000 ounces of silver (or 12,000 gold equivalent ounces). These resources are based on a 2.0 g/t gold equivalent cutoff and a gold price of US$850/oz and a silver price of US$13/oz.

The Deposit is located within and surrounded by high-priority exploration targets, where the company believes additional mineralization will be discovered which could enhance the project economics. The Deposit is in a very favorable location with excellent infrastructure with access to industrial power, roads and a skilled work force.

36

 
Mining Operations

There are no current mining operations on the Orion Project.

We continue to investigate other exploration projects in northern Mexico
and other locations.

Other Properties

We currently lease our headquarters located in New York, New York consisting of a suite of offices of approximately 3,800 square feet.  We also lease an administrative office in Caborca, Sonora, Mexico located near our El Chanate mine as well as an exploration office in Hermosillo, Sonora, Mexico.

In connection with our acquisition of Nayarit Gold on August 2, 2010, we assumed a lease for office space in Halifax, Nova Scotia, Canada of approximately 1,480 square feet.


Item 3.  Legal Proceedings

On October 4, 2010, Walter Earl Jenkins and Jonathan Schroeder, each represented by the same law firm, filed identical lawsuits against Capital Gold, its directors and Gammon Gold in New York Supreme Court claiming, among other things, that the directors of Capital Gold breached their fiduciary duties to Capital Gold in connection with the approval of the merger agreement between Capital Gold and Gammon Gold. The plaintiffs purport to represent a class of all stockholders of Capital Gold stock other than stockholders who are affiliates of Capital Gold. The plaintiffs have asked the Court to enjoin Capital Gold from consummating its merger with Gammon Gold.

On October 7, 2010, Mel Leone filed a lawsuit against Capital Gold, its directors and Gammon Gold in New York Supreme Court.

On October 8, 2010, W. Jeffrey Kramer filed a lawsuit against Capital Gold, its directors, its Chief Financial Officer and Gammon Gold in New York Supreme Court.

On October 8, 2010, Helmut Boehm filed a lawsuit against Capital Gold, its directors, Gammon Gold and Capital Gold AcquireCo, Inc., a wholly-owned subsidiary of Gammon Gold, in the Court of Chancery in the state of Delaware.

Each of the above-referenced complaints state claims and seek relief substantially identical to the claims made and relief sought in the Jenkins and Schroeder lawsuits. Capital Gold believes all plaintiffs’ allegations are without merit and intends to vigorously defend itself against such allegations.


Item 4.  (Removed and Reserved)

37

 
PART II

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

(a) Marketing Information -- The principal U.S. market in which our common shares (all of which are of one class, $.0001 par value common stock) are traded or will trade is in the NYSE EURONEXT (Symbol: “CGC”).

The following table sets forth the range of high and low closing bid quotes of our common stock per quarter for the past two fiscal years as reported by the OTC Bulletin Board and NYSE EURONEXT (which reflect inter-dealer prices without retail mark-up, mark-down or commission and may not necessarily represent actual transactions).


MARKET PRICE OF COMMON STOCK
 
Quarter Ending  
High and Low
 
July 31, 2010
    4.24       3.16  
April 30, 2010
    3.90       3.66  
January 31, 2010
    4.24       2.94  
October 31, 2009
    3.12       2.36  
                 
July 31, 2009
    2.88       2.12  
April 30, 2009
    2.84       2.08  
January 31, 2009
    2.52       1.20  
October 31, 2008
    2.60       1.08  

Our common stock also trades on the Toronto Stock Exchange under the symbol "CGC."  The high and low closing prices for our common stock for the periods indicated below are as follows:
 
Quarter Ending  
High and Low
 
   
US$/CDN$
   
US$/CDN$
 
Quarter ended July 31, 2010
    4.24 / 4.39       3.12 / 3.31  
Quarter ended April 30, 2010
    3.90 / 4.00       3.19 / 3.38  
Quarter ended January 31, 2010
    4.19 / 4.40       2.94 / 3.12  
Quarter ended October 31, 2009
    3.09 / 3.32       2.39 / 2.56  
                 
Quarter ended July 31, 2009
    2.84 / 3.16       2.12 / 2.48  
Quarter ended April 30, 2009
    2.84 / 3.60       2.08 / 2.52  
Quarter ended January 31, 2009
    2.48 / 3.04       1.16 / 1.40  
Quarter ended October 31, 2008
    2.60 / 2.72       1.00 / 1.28  

 (b)  Holders -- The approximate number of record holders of our Common Stock, as of October 1, 2010 amounts to 390, inclusive of those brokerage firms and/or clearing houses holding our common shares for their clientele (with each such brokerage house and/or clearing house being considered as one holder).  The aggregate number of shares of Common Stock outstanding is 61,202,028 as of October 1, 2010.
 
38

 
(c)  Dividends – We have not paid or declared any cash dividends upon our Common Stock since inception and, by reason of our present financial status and our contemplated financial requirements, do not contemplate or anticipate paying any cash dividends upon our Common Stock in the foreseeable future.

We did not repurchase any of our securities during the fiscal year ended July 31, 2010.

The following table gives information about our Common Stock that may be issued upon the exercise of options, warrants and rights under all of our equity compensation plans as of July 31, 2010.

   
 
 
Number of Securities to be issued upon exercise of outstanding options, warrants and rights
 
 
 
Weighted-average
Exercise price of
Outstanding options,
warrants and rights
   
Number of securities Remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
 
 Plan Category
               
   
(a)
 
(b)
   
(c)
 
Equity compensation plans approved by security holders:
     618,750     $ 2.84        2,819,766  
                         
Equity compensation plans not approved by security holders:
       -     $  -          N/A  
                         
Total
     618,750     $ 2.84       2,819,766  
 
39

 
Performance Graph

   
    Total Return To Shareholders
               
   
(Includes reinvestment of dividends)
               
                           
                           
       
QUARTERLY RETURN PERCENTAGE
           
         
Quarter Ending
             
                           
Company / Index
 
10/31/07
1/31/08
4/30/08
7/31/08
10/31/08
1/31/09
4/30/09
7/31/09
10/31/09
1/31/10
4/30/10
7/31/10
     
Capital Gold Corporation
 
36.07
10.48
-6.61
-0.77
-55.04
115.52
-13.60
12.04
27.27
-4.55
24.49
1.91
     
Russell 3000 Index
 
6.44
-10.83
1.14
-7.12
-24.31
-14.01
7.61
13.92
5.14
4.78
12.28
-7.22
     
S&P SmallCap 600 Index
 
5.12
-12.65
1.20
-1.48
-22.43
-18.20
11.89
13.71
1.43
7.69
18.99
-8.31
     
Peer Group
 
5.64
-18.49
1.12
14.03
-63.09
62.24
5.86
22.80
14.28
19.89
40.62
-26.66
     
                                 
                                 
                                 
         
INDEXED RETURNS
                   
 
Base
     
   Quarter Ending
                   
 
Period
                             
Company / Index
8/1/07
10/31/07
1/31/08
4/30/08
7/31/08
10/31/08
1/31/09
4/30/09
7/31/09
10/31/09
1/31/10
4/30/10
7/31/10
     
Capital Gold Corporation
100
136.07
150.32
140.39
139.31
62.63
134.99
116.63
130.67
166.31
158.75
197.62
201.40
     
Russell 3000 Index
100
106.44
94.91
95.99
89.16
67.48
58.03
62.44
71.14
74.79
78.36
87.98
81.63
     
S&P SmallCap 600 Index
100
105.12
91.82
92.92
91.55
71.01
58.09
65.00
73.91
74.96
80.73
96.06
88.08
     
Peer Group
100
105.64
86.10
87.07
99.28
36.64
59.45
62.93
77.28
88.32
105.89
148.90
109.20
     
                           
                           
Peer Group Companies:
                         
ALAMOS GOLD INC
                         
GAMMON GOLD INC
                         
MINEFINDERS CORP
                         
NEW GOLD INC
                         
 
40

 


ITEM 6. Selected Financial Data.

The selected consolidated financial data set forth below should be read in conjunction with our consolidated financial statements, and the related notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in this Annual Report.  The statement of operations and balance sheet data presented below for, and as of the end of, each of the years in the five year period ended July 31, 2010 are derived from our audited consolidated financial statements.  Historical results are not necessarily indicative of the results to be expected in the future.  The Selected Financial Data is in thousands except for share and per share data.

   
Fiscal Year Ended July 31
 
   
2010
   
2009
   
2008
   
2007
   
2006
 
Statement of Operations data:
                             
  Revenues
  $ 60,645     $ 42,757     $ 33,104     $ -     $ -  
  Net Income (loss)
  $ 11,994     $ 10,407     $ 6,364     $ (7,472 )   $ (4,805 )
  Income (loss) per share – Basic*
  $ 0.25     $ 0.22     $ 0.15     $ (0.20 )   $ (0.17 )
                                         
Balance Sheet data:
                                       
  Total Assets
  $ 72,495     $ 52,484     $ 50,578     $ 27,368     $ 9,546  
  Long-term Debt
  $ 800     $ 4,400     $ 8,375     $ 12,500     $ -  
  Reclamation and Remediation Liability
  $ 2,373     $ 1,594     $ 1,666     $ 1,249     $ -  

* - All Income (loss) per share – Basic amounts have been restated to reflect the impact of the 4 to 1 reverse stock split enacted during the fiscal year ended July 31, 2010.

41


Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion relates to the three fiscal years ended July 31, 2010, 2009 and 2008.  As disclosed in greater detail elsewhere in this report, we commenced mining operations and began to receive operating revenues in August 2007, shortly after the end of the fiscal year ended July 31, 2007. (the financial data in this discussion is in thousands, except where otherwise specifically noted).

We utilize certain non-GAAP performance measures and ratios in managing the business.  We believe these measures may provide users with additional meaningful comparisons between current results and results in prior operating periods. Non-GAAP financial measures should be viewed in addition to, and not as an alternative to, the reported operating results or cash flow from operations or any other measure of performance prepared in accordance with accounting principles generally accepted in the United States. In addition, the presentation of these measures may not be comparable to similarly titled measures other companies use  "Cash costs per ounce sold" is a non-GAAP measure which includes all direct mining costs, refining and transportation costs and by-product credits as well as royalties as reported in the Company's financial statements.  “Total cost per ounce sold” is a non-GAAP measure which includes “cash costs per ounce sold” as well as depreciation and amortization as reported in the Company's financial statements.

Overview

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our financial statements and related notes included elsewhere in this report.

Our financial position was as follows:


   
As of
   
As of
 
   
July 31,
2010
   
July 31,
2009
 
             
Total debt
  $ 4,400     $ 8,000  
Total stockholders’ equity
  $ 50,929     $ 35,765  
Cash and cash equivalents
  $ 12,125     $ 6,448  
Working capital
  $ 31,857     $ 20,646  

 
During our fiscal year ended July 31, 2010 our debt and liquidity positions were affected by the following:

 
·  
Net cash provided from operations of $14,731;
 
·  
Capital expenditures of $6,515;
 
42

 
·  
Repayments on Credit Facility of $3,600;
 
·  
Proceeds from the issuance of common stock upon the exercising of warrants of $565;

 
Looking Forward
 
Certain key factors will affect our future financial and operating results. These include, but are not limited to, the following (the financial data in this discussion is in thousands except for ounces and cash cost data):

 
·  
Fluctuations in gold prices;
 
·  
We expect fiscal 2011 gold sales of approximately 65,000 to 70,000 ounces;
 
·  
Cash costs per ounce sold for fiscal 2011 are expected to be approximately $485 per ounce;
 
·  
We anticipate capital expenditures of approximately $12,500 in fiscal 2011 with approximately $7,200 being allocated to leach pad expansion, approximately $1,500 for the addition of agglomeration equipment, $750 in property interest payments; and $600 for additional conveyors;
 
·  
Repayments on Credit Facility of $3,600 during fiscal 2011.
 
·  
Our fiscal year 2011 expectations, particularly with respect to sales volumes and cash costs per ounce sold, may differ significantly from actual quarter and full fiscal year results due to variations in: ore grades and hardness, metal recoveries, waste removed, commodity input prices, foreign currencies and gold sale prices.
 


Result of Operations

Fiscal year ended July 31, 2010 compared to the year ended July 31, 2009

Net income for the year ended July 31, 2010 and 2009 was approximately $11,994 and $10,407, respectively, representing an increase of approximately $1,587 or 15% over the prior period.  Income before taxes was $24,019 and $15,949 for the year ended July 31, 2010 and 2009, respectively, which represented an increase of 51%.  Income before taxes increased primarily as a result of higher revenues from a higher gold price being realized on ounces sold during the current period as well as higher production results during the year ended July 31, 2010, as compared to the same period a year ago.

As a result of management changes during the year ended July 31, 2010, we incurred severance related charges to executives and employees of approximately $2,710 within general and administrative expense.  If we exclude these charges, net income for the year ended July 31, 2010 would have been approximately $14,704 representing an increase of approximately $4,297 or 41% over the prior period.

Revenues & Costs Applicable to Sales

Gold sales for the year ended July 31, 2010 totaled approximately $60,645 as compared to $42,757 in the prior period representing an increase of approximately $17,888 or 42%.  We sold 54,304 ounces at an average realizable price per ounce of approximately $1,117 in the current period.  We sold 48,418 ounces at an average realizable price per ounce of $883 during the same period last year.

43

 
Costs applicable to sales were approximately $22,017 and $13,883, respectively, for the year ended July 31, 2010 and 2009, an increase of approximately $8,134 or 59%.  Cash costs were $391 per ounce of gold sold for the year ended July 31, 2010 as compared to $271 for the year ended July 31, 2009.   The primary reasons for this increase in cash cost per ounce sold in the current period were attributable to:

·  
An increase in mining costs of approximately $4,764 or 55% over the prior period.  This was primarily due to higher mining contractor costs of approximately $2,637 compared to the prior period primarily due to an increase in tonnage mined of 3,216,468 tonnes or 39%, higher diesel fuel consumption of $1,156 due to an increase in tonnage mined and longer haul distance as the pit deepens, and higher explosive costs of $750 due to the increase in tonnage mined as well as a change in the type of explosive utilized by the mine;

·  
Higher crushing costs of approximately of $946, an increase of 36% over the prior period, mainly due to an increase in maintenance and the usage of crusher parts and supplies.  This increase was attributable to the addition of our new secondary and tertiary crusher in May and December 2009, respectively, which increased tonnage going through the circuit by 13% or 516,000 tonnes as compared to the prior year. In addition, labor costs rose as a result of the hiring of additional crusher operators.

·  
An increase in leaching and ADR plant costs of approximately $1,975 or 37% mainly due to an increase in consumption of certain chemicals ($1,209) as well as consumption and price increase in cost of lime ($352) in the processing of ore as well as an increase in both water ($103) and electricity  ($137) usage  (the increased consumption was mainly the result of increasing the chemical concentration and solution flow to the leach pad as we increased the level of lifts or height of the leach pad as well as the surface area under leach with the additional leach pad.

·  
Higher heavy equipment maintenance costs of approximately $559 or 53% over the same period in the prior year.  This was primarily due to an increase in repair and maintenance costs associated with our three trucks and two loaders.  The additional tonnage moved in the current year as well as higher repairs and maintenance costs experienced with the procurement of used equipment has factored into the increase as compared to the prior year.

Total costs were $444 per ounce of gold sold for the year ended July 31, 2010 as compared to $314 total cost per ounce sold in the prior period.  The primary reason for this increase in total costs can be attributable to the reasons detailed above as well as the increase in depreciation and amortization resulting from capital expenditures during the current period.

Revenues from by-product sales, which consist of silver, are credited to Costs applicable to sales as a by-product credit. By-product sales amounted to $1,400 and $1,076 for the year ended July 31, 2010 and 2009, on silver ounces sold of 80,941 and 86,523, respectively.

44


Depreciation and Amortization

Depreciation and amortization expense during the year ended July 31, 2010 and 2009 was approximately $2,939 and $2,041, respectively, an increase of $898 or 44%.  The primary reason for the increase in the current period was attributable to an increase in depreciation and amortization charges related to property, plant and equipment additions.

General and Administration Expense

General and administrative expenses during the year ended July 31, 2010 were approximately $8,573, an increase of approximately $3,109, or 57%, from the year ended July 31, 2009.  This increase resulted primarily from one-time severance related charges to executives and employees of approximately $2,710.  In addition, we experienced higher legal and professional fees associated with merger and acquisition activity including our acquisition with Nayarit Gold of approximately $996.

Exploration Expense

Exploration expense during the year ended July 31, 2010 and 2009 was approximately $1,616 and $1,600, respectively, or a increase of $16, or 1%.  Both periods presented include activity associated with on-going exploration, drilling and geochemical work being conducted on our leased and owned concessions located northwest of Saric, Sonora as well as on-going drilling at our El Chanate mine.

Other Income and Expense

Our loss on the change in fair value of derivative instruments during the year ended July 31, 2010 and 2009, was approximately $0 and $1,975, respectively, and was reflected as Other Expense. The primary reason for the decrease can be attributed to the close out, on February 24, 2009, with Standard Bank, Plc., of the remaining 58,233 ounces of gold hedged under the original Gold Price Protection arrangements originally entered into in March 2006.

Interest expense was approximately $1,365 for the year ended July 31, 2010 compared to approximately $1,575 for the same period a year earlier.  This decrease was due to lower interest charges incurred during the current period, based on a lower average debt balance compared to the prior period offset by cost of interest rate swaps.  As of July 31, 2010 and 2009, there was $4,400 and $8,000, respectively, outstanding on our term note with Standard Bank.  Interest expense also includes amortization of deferred financing costs resulting from the credit arrangements entered into with Standard Bank.  This accounted for approximately $993 and $978 of amortization expense during the year ended July 31, 2010 and 2009, respectively.

Income Tax Expense
 
Income tax expense was $12,025 during the fiscal year ended July 31, 2010, compared to $5,542 in 2009 with an effective tax rate of 50% and 35%, respectively.  The factors that most significantly impact our effective tax rate are operating losses generated by the Company’s U.S. parent for which no benefit has been recognized. Current year income tax expense and deferred income tax expense amounted to $8,062 and $3,963 as of July 31, 2010, respectively.  Prior year income tax expense and deferred income tax expense amounted to $3,909 and $1,633 as of July 31, 2009, respectively.
 
45


Mining operations are primarily conducted in Mexico. Mexico has tax laws, tax incentives and tax rates that are significantly different than those of the United States.  On October 1, 2007, the Mexican Government enacted legislation which introduces certain tax reforms as well as a new minimum flat tax system, which was effective for tax year 2008.  This flat tax system integrates with the regular income tax system and is based on cash-basis net income that includes only certain receipts and expenditures.  The flat tax is set at 17.5% of cash-basis net income for tax year 2010, which increased from 17% for tax year 2009.  If the flat tax is positive, it is reduced by the regular income tax and any excess is paid as a supplement to the regular income tax.  For the tax year 2010, the Mexican Government introduced a reform where if the flat tax is negative, companies will not be permitted to reduce the income tax, as it may only serve to reduce the regular flat tax payable in that year or can be carried forward for a period of up to ten years to reduce any future flat tax.

On January 1, 2010, the Mexican government enacted legislation, which increases the regular income tax rate from 28% to 30%.  The regular income tax rate will decrease to 29% in 2013 and then back to 28% in 2014, according to legislation.

Companies are required to prepay income taxes on a monthly basis based on the greater of the flat tax or regular income tax as calculated for each monthly period.  There is the possibility of implementation amendments by the Mexican Government and the estimated future income tax liability recorded at the balance sheet date may change.

Deferred income tax assets and liabilities are determined based on differences between the financial statement reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws in effect when the differences are expected to reverse. In accordance with ASC guidance for income taxes, the measurement of deferred income tax assets is reduced, if necessary, by a valuation allowance for any tax benefits, which are, on a more likely than not basis, not expected to be realized. Net deferred tax assets related to the U.S. operations have been fully reserved. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in the period that such tax rate changes are enacted.
 
Based on the uncertainty and inherent unpredictability of the factors influencing our effective tax rate and the sensitivity of such factors to gold and other metals prices as discussed above, the effective tax rate is expected to be volatile in future periods.
 
For more information concerning income taxes, please see Note 22 within the consolidated financial statements contained herein.
 

Changes in Foreign Exchange Rates

During the years ended July 31, 2010 and 2009, we recorded equity adjustments from foreign currency translations of approximately $1,463 and $(8,355), respectively.  These translation adjustments are related to changes in the rates of exchange between the Mexican Peso and the U.S. dollar and are included as a component of other comprehensive income.  The Mexican Peso and the U.S. dollar exchange rate as of July 31, 2010 was 12.7012.  As of July 31, 2009, such exchange rate was 12.9933.

46

 
Summary of Annual Results
(000’s except per share Data and ounces sold)

   
For the year
   
For the year
   
For the year
 
   
ended
   
ended
   
ended
 
   
July 31,
2010
   
July 31,
2009
   
July 31,
2008
 
Revenues
    60,645       42,757       33,104  
Net Income
    11,994       10,407       6,364  
Basic net income per share
    0.25       0.22       0.15  
Diluted net income per share
    0.25       0.21       0.13  
Gold ounces sold
    54,304       48,418       39,102  
Average price received
  $ 1,117     $ 883     $ 847  
Cash cost per ounce sold(1)
  $ 391     $ 271     $ 276  
Total cost per ounce sold(1)
  $ 444     $ 314     $ 335  

(1)  
"Cash costs per ounce sold" is a Non-GAAP measure, which includes all direct mining costs, refining and transportation costs, by-product credits and royalties as reported in the Company's financial statements divided by ounces sold during the applicable period.  It also excludes intercompany management fees.  “Total cost per ounce sold” is a Non-GAAP measure which includes “cash costs per ounce sold” as well as depreciation and amortization as reported in the Company's financial statements.

The following table reconciles the Non-GAAP measure “Cash costs per ounce sold” to the GAAP measure of “Costs applicable to sales per ounce sold”:

   
For the year
   
For the year
   
For the year
 
   
ended
   
ended
   
ended
 
Reconciliation from non-GAAP measure to US GAAP
 
July 31,
2010
   
July 31,
2009
   
July 31,
2008
 
                   
Cash cost per ounce sold
  $ 391     $ 271     $ 276  
Intercompany management fee
    12       14       10  
Other
    2       2       (13 )
Costs applicable to sales per ounce sold*
  $ 405     $ 287     $ 273  
 
*This measurement excludes depreciation and amortization.
 
Summary of Results of Operations

   
For the year
ended
   
For the year
ended
   
For the year
ended
 
   
July 31,
2010
   
July 31,
2009
   
July 31,
2008
 
Tonnes of ore mined
    4,586,875       3,847,883       3,498,612  
Tonnes of waste removed
    6,797,425       4,319,949       2,627,318  
Ratio of waste to ore
    1.48       1.12       0.75  
Tonnes of ore processed
    4,515,152       3,999,346       3,529,699  
Grade (grams/tonne)
    0.74       0.78       0.85  
Gold (ounces)
                       
- Produced(3)
    55,746       49,921       39,242  
- Sold
    54,304       48,418       39,102  
(3)Gold produced each year does not necessarily correspond to gold sold during the year, as there
is a time delay in the actual sale of the gold.

47


Fiscal year ended July 31, 2009 compared to fiscal year ended July 31, 2008

Net income for the years ended July 31, 2009 and 2008 was approximately $10,407 and $6,364, respectively, representing an increase of approximately 64% over the prior period.  Net income before income taxes was $15,949 and $9,871 for the years ended July 31, 2009 and 2008, respectively, which represented an increase of 62%.  Net income and net income before taxes increased primarily as a result of higher revenues from more ounces of gold being sold during the year ended July 31, 2009, as compared to the same period a year ago. Income tax expense increased in conjunction with the increase in net income before tax, which was anticipated.

Revenues & Costs Applicable to Sales

Gold sales for the fiscal year ended July 31, 2009 totaled approximately $42,757 as compared to $33,104 in the prior period representing an increase of approximately $9,653 or 29%.  We sold 48,418 ounces at an average realizable price per ounce of approximately $883 in the current period.  We sold 39,102 ounces at an average realizable price per ounce of $847 during the same period last year.

Costs applicable to sales were approximately $13,883 and $10,690, respectively, for the year ended July 31, 2009 and 2008, an increase of approximately $3,193 or 30%, which increased in conjunction with our increase in revenues.  Cash costs of $271 per ounce of gold sold for the year ended July 31, 2009 was 2% lower than the $276 for the year ended July 31, 2008.   The primary reason for this decrease in cash costs in the current year can be attributed to the 10% net profit interest paid to Royal Gold which was primarily incurred in the prior fiscal year.  This was offset by a higher waste-to-ore strip ratio of 1.12 to 1 experienced during the fiscal year ended July 31, 2009 as compared to the prior fiscal year of 0.75 to 1.  Our increased production profile in the current fiscal year advanced the removal of more waste tonnes than in the prior year.   Total costs of $314 per ounce of gold sold for the year ended July 31, 2009, was 6% lower than the $335 total cost in the prior period.  The primary reason for this decrease in total costs was attributed to higher amortization charges recorded in the prior period related to the repurchase of the 5% net profit interest acquired from FG in 2006 for $500.

Revenues from by-product sales, which consist of silver, are credited to Costs applicable to sales as a by-product credit. By-product sales amounted to $1,076 and $707 for the year ended July 31, 2009 and 2008, on silver ounces sold of 86,523 and 40,461, respectively.

Depreciation and Amortization

Depreciation and amortization expense during the year ended July 31, 2009 and 2008 was approximately $2,041 and $2,350, respectively.  The primary reason for the decrease of approximately $309, or 13%, was due to amortization charges recorded in the prior period related to the repurchase of the 5% net profit interest acquired from FG in 2006 for $500.  The $500 was fully amortized during the quarterly period ended April 30, 2008.  This was slightly offset by an increase in Units-of-Production depreciation and amortization mainly attributable to additional ounces being produced in the current period versus the same period in the prior year.
 
48

 
General and Administration Expense

General and administrative expenses during the year ended July 31, 2009 were approximately $5,464, a decrease of approximately $122, or 2%, from the year ended July 31, 2008. The decrease in general and administrative expenses resulted primarily from: 1) lower salaries and wages primarily due to a decrease in cash bonuses of approximately $345 during the current fiscal year compared to the prior year, 2)  lower equity based compensation of approximately $93 as compared to the prior year, 3) lower investor relations and travel expenses of approximately $87.  Offsetting these decreases were higher legal and financial advisor fees incurred as a result of merger and acquisition activity during the current year  as well as higher audit  fees associated with the  attestation report issued on the effectiveness of our internal controls during the current period.  

Exploration Expense

Exploration expense during the year ended July 31, 2009 and 2008 was approximately $1,600 and $938, respectively, or an increase of $662, or 71%.  The primary reason for the increase can be attributed to increased activity during the current period associated with on-going exploration, drilling and geochemical work being conducted on our leased and owned concessions located northwest of Saric, Sonora.  Exploration expense for the current period also included costs incurred from a 10 hole, deep core drilling campaign at our El Chanate mine totaling 2,500 meters.  Exploration expense in the prior period included a drilling campaign initiated in December 2007 at El Chanate which consisted of 26 reverse circulation holes amounting to 4,912 meters.  These drill holes were mainly positioned to test the outer limits of the currently known ore zones within the pit.

Other Income and Expense

Our loss on the change in fair value of derivative instruments during the year ended July 31, 2009 and 2008, was approximately $1,975 and $1,356, respectively, and was reflected as Other Expense. The primary reason for the increase can be attributed to the settlement, on February 24, 2009, with Standard Bank, Plc., the remaining 58,233 ounces of gold under the original Gold Price Protection arrangements entered into in March 2006. The purpose of these arrangements at the time was to protect us in the event the gold price dropped below $500 per ounce. Total remuneration to unwind these arrangements was approximately $1,906. In conjunction with the settlement of the gold price protection agreements, we incurred an Other Expense of approximately $1,391 during the current period.  These contracts were not designated as hedging derivatives; and therefore, special hedge accounting does not apply.

Interest expense was approximately $1,575 for the year ended July 31, 2009 compared to approximately $2,295 for the same period a year earlier.  This decrease was mainly due to lower interest charges incurred during the current period related to our credit arrangements with Standard Bank.  As of July 31, 2009, there was $8,000 outstanding on our term note.  Interest expense also includes deferred financing costs resulting from the credit arrangements entered into with Standard Bank.  This accounted for approximately $978 and $1,088 of depreciation and amortization expense during the year ended July 31, 2009 and 2008.

49

 
Income Tax Expense
 
Income tax expense was $5,542 during the fiscal year ended July 31, 2009, compared to $3,507 in 2008 with an effective tax rate of 35% and 35%, respectively.  The factors that most significantly impact our effective tax rate are valuation allowances related to deferred tax assets offset partially by lower statutory tax rates in Mexico. Current year income tax expense and deferred income tax expense amounted to $3,909 and $1,633 as of July 31, 2009, respectively.  Prior year income tax expense and deferred income tax expense amounted to $2,111 and $1,396 as of July 31, 2008, respectively.
 
Mining operations are primarily conducted in Mexico. Mexico has tax laws, tax incentives and tax rates that are significantly different than those of the United States.  On October 1, 2007, the Mexican government enacted legislation which introduced certain tax reforms as well as a new minimum flat tax system.  This new flat tax system integrates with the regular income tax system and is based on cash-basis net income that includes only certain receipts and expenditures.  The flat tax is set at 17.5% of cash-basis net income as determined, with transitional rates of 16.5% and 17.0% in 2008 and 2009, respectively.  If the flat tax is positive, it is reduced by the regular income tax and any excess is paid as a supplement to the regular income tax.  If the flat tax is negative, it may serve to reduce the regular income tax payable in that year or can be carried forward for a period of up to ten years to reduce any future flat tax.
 
Companies are required to prepay income taxes on a monthly basis based on the greater of the flat tax or regular income tax as calculated for each monthly period.  Annualized income projections indicate that we will not be liable for any excess flat tax for calendar year 2009 and, accordingly, have recorded a Mexican income tax provision as of July 31, 2009.
 

As the new legislation was recently enacted, it remains subject to ongoing varying interpretations.  There is the possibility of implementation amendments by the Mexican government and the estimated future income tax liability recorded at the balance sheet date may change.
 
Deferred income tax assets and liabilities are determined based on differences between the financial statement reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws in effect when the differences are expected to reverse. In accordance with ASC guidance for income taxes, the measurement of deferred income tax assets is reduced, if necessary, by a valuation allowance for any tax benefits, which, on a more likely than not basis, are not expected to be realized. Net deferred tax assets related to the U.S. operations have been fully reserved.  The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in the period that such tax rate changes are enacted.
 
During the fiscal years ended July 31, 2009 and 2008, we completed a reconciliation of our U.S. book and tax basis assets and liabilities as well as a detailed analysis of our income taxes payable.
 
Based on the uncertainty and inherent unpredictability of the factors influencing our effective tax rate and the sensitivity of such factors to gold and other metals prices as discussed above, the effective tax rate is expected to be volatile in future periods.
 
For more information concerning income taxes, please see Note 22 within the consolidated financial statements contained herein.
 
50

 
Changes in Foreign Exchange Rates

During the years ended July 31, 2009 and 2008, we recorded equity adjustments from foreign currency translations of approximately $(8,355) and $2,504, respectively.  These translation adjustments are related to changes in the rates of exchange between the Mexican Peso and the U.S. dollar and are included as a component of other comprehensive income.  The Mexican Peso and the U.S. dollar exchange rate as of July 31, 2009 was 12.9933 to 1.  As of July 31, 2008, such exchange rate was 10.0483 to 1.

Liquidity and Capital Resources
 
Operating activities
 
Cash provided by operating activities during the year ended July 31, 2010 and 2009 was $14,731 and $7,536, respectively.  Cash provided by operating activities increased $7,195 as compared to the year ended July 31, 2009, primarily due to higher net income resulting from an increase in the average gold price received for ounces sold , an increase in the change in inventory balances between periods of $5,537, and an increase in accrued expenses of $4,447 mainly due to the accruals associated with one-time severance related charges to executives and employees as well as an increase in our income tax accrual during the year ended July 31, 2010.
 
In addition, on January 25, 2010, we entered into a Collateral Agreement (the “Collateral Agreement”) with Metal Recovery Solutions, LLC (“MRS”), a privately-held Nevada company, in which it was proposed that we would acquire twenty-five percent of all of the issued and outstanding equity of MRS for aggregate investment of $2,000.  The Collateral Agreement required us to promptly pay $500 to MRS, with the intention to invest the remaining $1,500 set forth in a letter of intent (the “LOI”) entered into on January 25, 2010, the material terms of which were non-binding. Our obligation to invest the remaining $1,500 was contingent upon the execution of a definitive Investment Agreement (the “Investment Agreement”).  Because the Investment Agreement was not consummated, the Collateral Agreement provides that the $500 payment to MRS would be repaid with interest (the “MRS Repayment”). Such repayment is secured by cash flows from MRS’s Consulting / Services Agreement with a third-party gold mining company, the expected value of which is $1,275 to MRS.  
 
On March 25, 2010, we elected not to pursue the implementation of the MRS technology at the El Chanate mine.  Accordingly, we demanded repayment of the amounts paid to MRS in accordance with the letter agreement between MRS and us. On May 12, 2010, the parties agreed to reduce the MRS Repayment to $450 and we are currently receiving repayment based on the original Collateral Agreement.  We recorded the remaining receivable amount of $210 as of July 31, 2010 as an Other Current Asset.
 

Investing Activities

Cash used in investing activities during the year ended July 31, 2010, amounted to approximately $6,515, primarily for the acquisition of an additional tertiary crusher and screen plant, additional water rights, additional leach pad expansion, as well as new platform upgrades for three of our crushers.

51

 
In May 2010, we initiated the planning and permitting on the construction of an additional leach pad to the east of the existing leach pads.  The total capacity of this additional leach pad will be approximately 8.5 million tonnes (when stacked to six lifts) and cost approximately $7,500.  This pad will be expanded on the south, east and possibly west sides to accommodate the current ore reserve.  When combined with the original and west pads the aggregate capacity will be approximately 20.1 million tonnes.  This capital expenditure is anticipated to be expended over the next twelve months.  Site clearing was initiated in May 2010 and construction commenced in July 2010.  The first panel is anticipated to be ready for stacking towards the end of the calendar year with complete construction anticipated to be completed by May 2011.

In July 2010, the Company commenced the use of belt agglomeration with cement which is added to the crushed ore at the El Chanate mine to improve the flow of leaching solution.   We have engaged an independent consultant with respect to heap leaching optimization, which has resulted in recommendations to increase the barren solution flow to the leach pad, increase the pregnant solution flow to the recovery plant, and redirect the low grade solution to the leach pads.  When implemented, these operational changes combined with the agglomeration with cement and barren solution may result in immediate improvements in leaching time.  We ordered two agglomeration drums which are expected to arrive by January 2011.  The current belt agglomeration is a temporary measure until the drums are delivered.  The use of agglomeration drums will allow for better mixing of cement and lime with the crushed ore, producing a consistent quality control of the product.  The cost of these agglomeration drums and an additional overland conveyor is anticipated to be $2,000.

Cash used in investing activities during the year ended July 31, 2009, amounted to approximately $5,174, primarily from the acquisition of an additional secondary crusher and tunnel conveyor, mobile equipment, conveyors and ADR plant equipment, including the carbon regeneration kiln.
 
Financing Activities
 
Cash used in financing activities during the year ended July 31, 2010 amounted to approximately $3,148, primarily from the repayment of our term loan of $3,600.  We also received proceeds of approximately $565 in the current period from the issuance of common stock upon the exercise of 31,250 options and 150,000 warrants.  In addition, we paid $113 in finance costs to amend our Amended and Restated Credit Agreement with Standard Bank (See “Term loan and Revolving Credit Facility” section below).  Cash used in financing activities during the year ended July 31, 2009 amounted to approximately $4,175, primarily from the repayment of the term loan of $4,500.
 
Business Combination Agreements

On October 1, 2010, the Company and Gammon Gold Inc. (“Gammon Gold”) entered into a definitive merger agreement pursuant to which Gammon Gold offered to acquire all of the issued and outstanding common shares of Capital Gold in a cash and share transaction (the “Gammon Transaction”). The total consideration for the purchase of 100% of the fully diluted shares of Capital Gold is approximately US$288 million or US$4.57 per Capital Gold share based on Gammon Gold’s closing price on September 24, 2010 on the NYSE. The Gammon Transaction has the unanimous support of both companies’ Boards of Directors and Officers.  Under the terms of the Gammon Transaction, each common share of Capital Gold will be exchanged for 0.5209 common shares of Gammon Gold and a cash payment in the amount of US$0.79 per share. Based on the September 24, 2010 closing price of Capital Gold’s shares on the NYSE EURONEXT, the acquisition price represents a 20% premium to the close on September 24th and a 30% premium to the 20-day volume weighted average price on the NYSE EURONEXT ending on that date.  The consummation of the Gammon Transaction is subject to numerous contingencies as described in the related merger agreement including, but not limited to, Capital Gold stockholder approval.

52

 
On August 2, 2010, the Company acquired Nayarit Gold, Inc. (“Nayarit”). As a result of the Business Combination, Nayarit became a wholly-owned subsidiary of the Company.  In connection with the Business Combination, each outstanding share of Nayarit common stock was converted into 0.134048 shares of Capital Gold common stock, with cash paid in lieu of any fractional share.   Capital Gold issued 12,454,354 shares of its common stock in the Business Combination to Nayarit's current stockholders and has reserved for issuance an additional 1,621,981 and 903,483 shares of Capital Gold common stock upon the exercise of former Nayarit warrants and options, respectively.  Based on the number of outstanding shares of Nayarit common stock and Capital Gold common stock, after the consummation of the Business Combination, the stockholders of Nayarit own approximately 20.4% of Capital Gold on a non-diluted basis.

Based on the closing price of the Company’s common stock on August 2, 2010, the consideration received by Nayarit shareholders had a value of approximately $47.6 million as detailed below.

   
Conversion
Calculation
   
Estimated
Fair Value
 
Form of
Consideration
   
(In thousands, except per share amounts)
               
Number of Nayarit shares outstanding as of the Amalgamation date
   
92,910
         
                 
Exchange ratio(1)
   
0.134048
         
                 
Number of shares issued to Nayarit shareholders
   
12,454
         
                 
Value of Capital Gold common shares
issued(1)
 
$
3.71
   
$
46,206
 
Capital Gold
Common stock
                   
Value of Nayarit’s options and warrants to be exchanged for Capital Gold options and warrants (2)
           
1,393
 
Capital Gold Options
and Warrants
                   
Total consideration transferred
         
$
47,599
   

(1) In accordance with ASC 805, the fair value of equity securities issued as part of the consideration transferred was the closing market price of Capital Gold’s common stock on the effective date of the Amalgamation. The pro forma shares issued was 12,454,354 common shares, which is calculated by multiplying 0.134048 by 92,909,659, being the number of shares of Nayarit common stock outstanding on August 2, 2010.  Nayarit shareholders own approximately 20.4% of the issued and outstanding shares of Capital Gold common stock.

(2) Represents the fair value to acquire 1,621,981 and 903,483 shares of Capital Gold common stock upon the exercise of former Nayarit warrants and options, respectively. The fair value of the warrants and options were estimated using the Black-Scholes valuation model utilizing the assumptions noted below.

Stock price
 
$3.71
Post conversion strike price
 
$3.28 - $9.92
Average expected volatility
 
70%
Dividend yield
 
None
Average risk-free interest rate
 
0.29%
Average contractual term
 
.79 years
Black-Scholes average value per warrant and option
 
$0.57
 
53

 
The expected volatility of Capital Gold’s stock price is based on the average historical volatility which is based on daily observations and duration consistent with the expected life assumption and implied volatility.  The average contractual term of the warrants and options is based on the remaining contractual exercise term of each warrant and option.  The risk free interest rate is based on U.S. treasury securities with maturities equal to the expected life of the warrants and options

The transaction has been accounted for using the acquisition method of accounting which requires, among other things, the assets acquired and liabilities assumed to be recognized at their fair values as of the acquisition date. The following table summarizes the estimated fair values of major assets acquired and liabilities assumed on August 2, 2010:
 
  
   
Fair Value
(in thousands)
 
Cash and cash equivalents
 
$
50
 
Short-term investments
   
2
 
Prepaid expenses and sundry receivables
   
1,238
 
Property, plant and equipment
   
196
 
Mineral interests – indicated and inferred
   
43,822
 
Exploration interests
   
3,627
 
Accounts payable and liabilities assumed
   
(1,336)
 
Net assets acquired
 
$
47,599
 


A single estimate of fair value results from a complex series of judgments about future events and uncertainties and relies heavily on estimates and assumptions. The Company’s judgments used to determine the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, can materially impact the Company’s results from operations. The Company’s management allocated the acquisition cost to the assets acquired and liabilities assumed based on the estimated fair value of Nayarit’s tangible and identifiable assets and liabilities.  The amount allocated to the mineral and exploration interests was based on a valuation report prepared by a third party appraisal firm.  The allocation is not considered final as of the date of this report as management is still reviewing certain of the underlying assumptions and calculations used in the allocation to the assets and liabilities of Nayarit that were acquired.  However, the Company believes the final purchase price allocation will not be materially different than presented herein.

During the twelve months ended July 31, 2010, the Company incurred transaction costs consisting primarily of legal, professional, investment advisory and accounting fees of $2.4 million.  These costs are included in general and administrative expenses on the consolidated statement of operations.

 
Pro forma Information
 
 
The following unaudited pro forma results of operations of the Company for the fiscal years ended July 31, 2010 and 2009 assume that the acquisition of the operating assets of the significant businesses acquired during 2010 and 2009 had occurred on August 1 of the respective year in which the business was acquired and for the comparable period only (i.e., 2010 acquisitions are reflected in 2009). These unaudited pro forma results are not necessarily indicative of either the actual results of operations that would have been achieved had the companies been combined during these periods, or are they necessarily indicative of future results of operations.
 
54

 
(in thousands)
       
   
Year Ended
July 31,
2010
 
Year Ended
July 31,
2009
Revenues
 
$
60,645
   
$
42,757
 
Net income (loss)
 
$
10,905
   
$
2,270
  
Income (loss) per common share:
   
  
     
  
 
Basic – net income (loss)
 
$
0.18
   
$
0.04
   
Diluted – net income (loss)
 
$
0.18
   
$
0.03
   


2010 Pro forma Results – Twelve Months Ended July 31, 2010

The 2010 pro forma results were calculated by combining the results of Capital Gold with the stand-alone historical results of Nayarit Gold for the year ended June 30, 2010. The elimination of $2.4 million in transaction related costs were made which would have been incurred during the twelve months ended July 31, 2010 had the acquisition commenced on August 1, 2009.

 
Term loan and Revolving Credit Facility

In September 2008, we closed an Amended And Restated Credit Agreement (the “Credit Agreement”) involving our wholly-owned Mexican subsidiaries MSR and Oro, as borrowers (“Borrowers”), us, as guarantor, and Standard Bank PLC (“Standard Bank”), as the lender.  The Credit Agreement amends and restates the prior credit agreement between the parties dated August 15, 2006.  Under the Credit Agreement, MSR and Oro borrowed money in an aggregate principal amount of up to $12,500 (the “Term Loan”) for the purpose of constructing, developing and operating the El Chanate gold mining project in Sonora State, Mexico.  We guaranteed the repayment of the Term Loan and the performance of the obligations under the Credit Agreement.  As of July 31, 2010, the outstanding amount on the term note was $4,400 and accrued interest on this agreement was approximately $11.

Term Loan principal shall be repaid quarterly and commenced on September 30, 2008 and consisted of four payments in the amount of $1,125, followed by eight payments in the amount of $900 and two final payments in the amount of $400. There is no prepayment fee.  Principal under the Term Loan shall bear interest at a rate per annum equal to the LIBO Rate, as defined in the Credit Agreement, for the applicable Interest Period plus the Applicable Margin. An Interest Period can be one, two, three or six months, at the option of the Borrowers. The Applicable Margin for the Term Loan is 2.5% per annum. Pursuant to the terms of the Credit Agreement, operating accounts remain subject to an account pledge agreement between MSR and Standard Bank.

The Loan is secured by all of the tangible and intangible assets and property owned by MSR and Oro.  As additional collateral for the Loan, the Company, together with its subsidiary, Leadville Mining & Milling Holding Corporation, pledged all of its ownership interest in MSR and Oro.

On September 17, 2009, our $5,000 revolving loan contained within the Credit Agreement expired. The Company had not drawn on this facility during the term period.

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