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1. OPERATIONS, SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Operations
Royal Gold, Inc. (Royal Gold, the Company, we, us, or our), together with its subsidiaries, is engaged in the business of acquiring and managing precious metals royalties and similar interests. Royalties are passive (non-operating) interests in mining projects that provide the right to revenue or production from the project after deducting specified costs, if any.
Summary of Significant Accounting Policies
The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X under the Securities Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for annual financial statements. In the opinion of management, all adjustments which are of a normal recurring nature considered necessary for a fair presentation of our interim financial statements have been included in this Form 10-Q. Operating results for the three months ended September 30, 2011, are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2012. These interim unaudited financial statements should be read in conjunction with the Companys Annual Report on Form 10-K for the fiscal year ended June 30, 2011, filed with the Securities and Exchange Commission on August 18, 2011 (Fiscal 2011 10-K).
Reclassification
Costs and expenses previously classified as Exploration and business development are now included within the General and administrative caption. Further, certain amounts previously classified as Costs of Operations are now included within the General and administrative caption or the Production taxes caption in the Companys consolidated statements of operations and comprehensive income. The following table reflects these reclassifications for the three months ended September 30, 2010:
These reclassifications had no effect on reported operating income or net income attributable to Royal Gold stockholders for the prior period presented.
Recently Issued Accounting Standards
In June 2011, the Financial Accounting Standards Board issued ASU No. 2011-05, Presentation of Comprehensive Income. The ASU addresses the presentation of comprehensive income and provides entities with the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements.
The provisions of this ASU are effective for the Companys quarter beginning July 1, 2012. Since this ASU addresses financial presentation only, its adoption will not impact the Companys consolidated position or results of operations.
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2. ROYALTY INTERESTS IN MINERAL PROPERTIES
The following summarizes the Companys royalty interests in mineral properties as of September 30, 2011 and June 30, 2011.
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3. AVAILABLE FOR SALE SECURITIES
The Companys available for sale securities as of September 30, 2011 and June 30, 2011 consists of the following:
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4. DEBT
The Companys current and non-current debt as of September 30, 2011 and June 30, 2011 consists of the following:
As discussed in the Companys Fiscal 2011 10-K, the Company has financial covenants associated with its revolving credit facility and term loan. At September 30, 2011, the Company was in compliance with each financial covenant.
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5. STOCK-BASED COMPENSATION
The Company recognized stock-based compensation expense as follows:
Stock-based compensation expense is included within general and administrative in the consolidated statements of operations and comprehensive income.
There were 18,796 and 0 stock options granted during the three months ended September 30, 2011 and 2010, respectively. As of September 30, 2011, there was $0.9 million of unrecognized compensation expense related to non-vested stock options, which is expected to be recognized over a weighted-average period of 2.3 years.
There were 42,804 and 0 stock-settled stock appreciation rights granted during the three months ended September 30, 2011 and 2010, respectively. As of September 30, 2011, there was $2.2 million of unrecognized compensation expense related to non-vested stock appreciation rights, which is expected to be recognized over a weighted-average period of 2.1 years.
There were 44,950 and 0 shares of restricted stock granted during the three months ended September 30, 2011 and 2010, respectively. As of September 30, 2011, there was $7.3 million of unrecognized compensation expense related to non-vested restricted stock, which is expected to be recognized over a weighted-average vesting period of 4.0 years.
There were 49,600 and 0 shares of performance stock granted during the three months ended September 30, 2011 and 2010, respectively. During the three months ended September 30, 2011 and 2010, 0 and 74,500 shares of performance stock, respectively, vested at a weighted average grant date fair market value of $0 and $42.53, respectively. As of September 30, 2011, there was $3.7 million of unrecognized compensation expense related to non-vested performance stock, which is expected to be recognized over a weighted-average vesting period of 0.9 years.
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6. RESTRUCTURING ON ROYALTY INTERESTS IN MINERAL PROPERTIES
The Company owns a net smelter return royalty on the Relief Canyon property located in Nevada. From November 2010 to October 2011, the Company has been involved in managing this interest in bankruptcy proceedings of the owner of the Relief Canyon project. On August 24, 2011, the Company entered into an Amended and Restated Net Smelter Return Royalty Agreement with the property owner, pursuant to which the royalty rate was reduced from 4% to 2%, and the ten mile area of interest was eliminated. The Company elected to amend the royalty agreement in order to enhance project economics and the probability of recognizing royalty revenue. As a result of the amendment to the Relief Canyon royalty agreement, the Company recorded a restructuring charge of approximately $1.3 million during the quarter ended September 30, 2011, which was based on the Companys estimate of fair value. The Companys carrying value for the Relief Canyon royalty interest was approximately $1.2 million as of September 30, 2011.
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7. EARNINGS PER SHARE (EPS)
Basic earnings per common share were computed using the weighted average number of shares of common stock outstanding during the period, considering the effect of participating securities. Unvested stock-based compensation awards that contain non-forfeitable rights to dividends or dividend equivalents are considered participating securities and are included in the computation of earnings per share pursuant to the two-class method. The Companys unvested restricted stock awards contain non-forfeitable dividend rights and participate equally with common stock with respect to dividends issued or declared. The Companys unexercised stock options, unexercised SARs and unvested performance stock do not contain rights to dividends. Under the two-class method, the earnings used to determine basic earnings per common share are reduced by an amount allocated to participating securities. Use of the two-class method has an immaterial impact on the calculation of basic and diluted earnings per common share.
The following tables summarize the effects of dilutive securities on diluted EPS for the period:
Our calculation of weighted average shares includes all of our outstanding stock: common stock and exchangeable shares. Exchangeable shares are the equivalent of common shares in that they have the same dividend rights and share equitably in undistributed earnings and are exchangeable on a one-for-one basis for shares of our common stock.
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8. INCOME TAXES
The decrease in the effective tax rate for September 30, 2011 is primarily related to (i) the decrease in tax expense from changes in estimates of uncertain tax positions, and (ii) the decrease in tax expense relating to the decrease in unrealized foreign exchange gains.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. With few exceptions, the Company is no longer subject to U.S. Federal, state and local, and non-U.S. income tax examinations by tax authorities for fiscal years before 2007.
As of September 30, 2011 and June 30, 2011, the Company had $19.1 million and $18.8 million of total gross unrecognized tax benefits, respectively. The increase in gross unrecognized tax benefits was primarily related to tax positions of International Royalty Corporation entities taken prior to or upon the acquisition by the Company during fiscal year 2010. These increases were offset by a decrease in the unrecognized tax benefits as a result of statute of limitations expiring during the quarter. If recognized, these unrecognized tax benefits would impact the Companys effective income tax rate.
The Companys continuing practice is to recognize potential interest and/or penalties related to unrecognized tax benefits as part of its income tax expense. At September 30, 2011 and June 30, 2011, the amount of accrued income-tax-related interest and penalties was $1.6 million and $1.5 million, respectively.
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9. SEGMENT INFORMATION
The Company manages its business under a single operating segment, consisting of royalty acquisition and management activities. Royal Golds royalty revenue and long-lived assets (royalty interests in mineral properties, net) are geographically distributed as shown in the following table.
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10. FAIR VALUE MEASUREMENTS
FASB ASC 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy under FASB ASC 820 are described below:
Level 1: Quoted prices for identical instruments in active markets;
Level 2: Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and
Level 3: Prices or valuation techniques requiring inputs that are both significant to the fair value measurement and unobservable (supported by little or no market activity).
The following table sets forth the Companys financial assets measured at fair value on a recurring basis (at least annually) by level within the fair value hierarchy.
(1) Included in Cash and equivalents in the Companys consolidated balance sheets. (2) Included in Available for sale securities in the Companys consolidated balance sheets.
The carrying amount of our long-term debt (including the current portion) approximates fair value as of September 30, 2011.
The Company invests in money market funds, which are traded by dealers or brokers in active over-the-counter markets. The Companys money market funds, which are invested in United States treasury bills or United States treasury backed securities, are classified within Level 1 of the fair value hierarchy.
The Companys marketable equity securities classified within Level 1 of the fair value hierarchy are valued using quoted market prices in active markets. The fair value of the Level 1 marketable equity securities is calculated as the quoted market price of the marketable equity security multiplied by the quantity of shares held by the Company.
As of September 30, 2011, the Company also had assets that, under certain conditions, are subject to measurement at fair value on a non-recurring basis like those associated with royalty interests in mineral properties, intangible assets and other long-lived assets. For these assets, measurement at fair value in periods subsequent to their initial recognition are applicable if any of these assets are determined to be impaired; however, no triggering events have occurred relative to any of these assets during the three months ended September 30, 2011. If recognition of these assets at their fair value becomes necessary, such measurements will be determined utilizing Level 3 inputs.
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11. COMMITMENTS AND CONTINGENCIES
Mt. Milligan Gold Stream Acquisition
As discussed in more detail in the Companys Fiscal 2011 10-K, on October 20, 2010, the Company entered into a Purchase and Sale Agreement (the Purchase and Sale Agreement) pursuant to which a wholly-owned subsidiary of the Company, RGLD Gold AG, acquired the right to 25% of the payable gold produced from the Mt. Milligan copper-gold project in British Columbia (the Gold Purchase Transaction) from Terrane Metals Corp. (Terrane), a wholly-owned subsidiary of Thompson Creek Metals Company Inc. (Thompson Creek). Pursuant to the Purchase and Sale Agreement, RGLD Gold AG paid $226.5 million at the closing of the Gold Purchase Transaction. In the future, upon satisfaction of certain conditions set forth in the Purchase and Sale Agreement, RGLD Gold AG will make additional payments (each, an Additional Payment) to Terrane in an amount not to exceed $85 million in the aggregate to fund a portion of the development costs of the Mt. Milligan project. The Company did not make any Additional Payments to Thompson Creek during the three months ended September 30, 2011. On October 13, 2011, the Company made a $13.7 million Additional Payment to Thompson Creek, resulting in a remaining commitment of $71.3 million as of that date.
Voiseys Bay
The Company owns a royalty on the Voiseys Bay mine in Newfoundland and Labrador owned by Vale Newfoundland & Labrador Limited (VNL). The royalty is owned by the Labrador Nickel Royalty Limited Partnership (LNRLP), in which the Companys wholly-owned indirect subsidiary, Canadian Minerals Partnership, is the general partner and 89.99% owner. The remaining interests in LNRLP are owned by Altius Investments Ltd. (10%), a company unrelated to Royal Gold, and the Companys wholly-owned indirect subsidiary, Voiseys Bay Holding Corporation (0.01%).
On October 16, 2009, LNRLP filed a claim in the Supreme Court of Newfoundland and Labrador Trial Division against Vale Inco Limited (Vale Inco) and its wholly-owned subsidiaries, Vale Inco Atlantic Sales Limited (VIASL) and VNL, related to calculation of the NSR on the sale of concentrates, including nickel concentrates, from the Voiseys Bay mine to Vale Inco. The claim asserts that Vale Inco is incorrectly calculating the NSR and requests an order in respect of the correct calculation of future payments. The claim also requests specific damages for underpayment of past royalties to the date of the claim in an amount not less than $29 million, together with additional damages until the date of trial, interest, costs and other damages. The litigation is in the discovery phase.
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12. RELATED PARTY
Crescent Valley Partners, L.P. (CVP) was formed as a limited partnership in April 1992. It owns a 1.25% net value royalty (NVR1) on production of minerals from a portion of Cortez. Denver Mining Finance Company (DMFC), our wholly-owned subsidiary, is the general partner and holds a 2.0% interest in CVP. In addition, Royal Gold holds a 29.6% limited partner interest in the partnership, while our Chairman of the Board of Directors, the Chairman of our Audit Committee and one other member of our board of directors hold an aggregate 35.56% limited partner interest. The general partner performs administrative services for CVP in receiving and processing the royalty payments from the operator, including the disbursement of royalty payments and record keeping for in-kind distributions to the limited partners.
CVP receives its royalty from the Cortez Joint Venture in-kind. The Company, as well as certain other limited partners, sell their pro-rata shares of such gold immediately and receive distributions in cash, while CVP holds gold for certain other limited partners. Such gold inventories, which totaled 12,735 and 15,255 ounces of gold as of September 30, 2011 and June 30, 2011, respectively, are held by a third party refinery in Utah for the account of the limited partners of CVP. The inventories are carried at historical cost and are classified within Other assets on the Companys consolidated balance sheets. The carrying value of the gold in inventory was approximately $6.9 million and $8.1 million as of September 30, 2011 and June 30, 2011, respectively, while the fair value of such ounces was approximately $20.6 million and $23.0 million as of September 30, 2011 and June 30 2011, respectively. None of the gold currently held in inventory as of September 30, 2011 and June 30, 2011, is attributed to Royal Gold, as the gold allocated to Royal Golds CVP partnership interest is typically sold within five days of receipt.
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Costs and expenses previously classified as Exploration and business development are now included within the General and administrative caption. Further, certain amounts previously classified as Costs of Operations are now included within the General and administrative caption or the Production taxes caption in the Companys consolidated statements of operations and comprehensive income. The following table reflects these reclassifications for the three months ended September 30, 2010:
These reclassifications had no effect on reported operating income or net income attributable to Royal Gold stockholders for the prior period presented.
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The following table reflects these reclassifications for the three months ended September 30, 2010:
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(1) Included in Cash and equivalents in the Companys consolidated balance sheets. (2) Included in Available for sale securities in the Companys consolidated balance sheets.
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