**UNITED STATES SECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

| [X] | **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|-----|---------------------------------------------------------------------------------------------|

For the Quarterly Period Ended September 30, 2009

 

| o | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|---|----------------------------------------------------------------------------------------------|

For the Transition Period From ________ to _________

 

Commission File Number **0-50218**

 

**BEKEM METALS, INC.**

(Exact name of registrant as specified in its charter)

                

| **Utah**                                 |   | **87-0669131**      |
|------------------------------------------|--------|---------------------|
| (State or other jurisdiction of          |   | (I.R.S. Employer    |
| incorporation or organization)           |   | Identification No.) |
|                                     |   |                |
| **149 Kyz Zhibek Street, Office 11,**    |   |                |
| **Almaty, Kazakhstan**                   |   | **050020**          |
| (Address of principal executive offices) |   | (Zip Code)          |

 

**+7 (727) 227-94-05**

(Registrant's telephone number, including area code)

 

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 any 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 whether the registrant is a large accelerated filed, an accelerated filer, a non-accelerated filer or a smaller public company. See definition of “*large accelerated filer*,” “*accelerated filer*” and “*smaller reporting            company*” in Rule 12b-2 of the Exchange Act. 

 

|   | Large accelerated filer o | Accelerated filer o |
|--------|---------------------------|---------------------|

|   | Non-accelerated filer (Do not check if a smaller reporting company) o | Smaller reporting company [X] |
|--------|-----------------------------------------------------------------------|-------------------------------|

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.)  

 Yes oNo [X]

 

 

As of November 10, 2009, the registrant had 125,172,011 shares of common stock, par value $0.001, issued and outstanding.

 

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**BEKEM METALS, INC.**

**FORM 10-Q**

**TABLE OF CONTENTS**

 

PART I — FINANCIAL INFORMATION

 

| Item 1. Financial Statements                                                                          |                                                                                                                                                                                                                          |
|-------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                  |                                                                                                                                                                                                                          |   |
|                                                                                                  | Condensed Consolidated Balance Sheets (Unaudited) as of 

September 30, 2009 and December 31, 2008                                                                                                                            |  

3 |
|                                                                                                  |                                                                                                                                                                                                                          |   |
|                                                                                                  | Condensed Consolidated Statements of Operations (Unaudited) for the Three Months and Nine Months Ended September 30, 2009 and 2008, and for the Period from March 5, 2004 (Date of Inception) through September 30, 2009 |  

4 |
|                                                                                                  |                                                                                                                                                                                                                          |   |
|                                                                                                  | Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2009 and 2008, and for the Period from March 5, 2004 (Date of Inception) through September 30, 2009                       |  

5 |
|                                                                                                  |                                                                                                                                                                                                                          |   |
|                                                                                                  | Notes to Condensed Consolidated Financial Statements (Unaudited)                                                                                                                                                              | 6 |
|                                                                                                  |                                                                                                                                                                                                                          |
| Item 2. Management’s Discussion and Analysis of Financial Condition 

and Results of Operations |  

20                                                                                                                                                                                                                    |
|                                                                                                  |                                                                                                                                                                                                                          |
| Item 3. Qualitative and Quantitative Disclosures About Market Risk                                    | 32                                                                                                                                                                                                                            |
|                                                                                                  |                                                                                                                                                                                                                          |
| Item 4T. Controls and Procedures                                                                      | 33                                                                                                                                                                                                                            |
|                                                                                                  |                                                                                                                                                                                                                          |
| PART II — OTHER INFORMATION                                                                     |                                                                                                                                                                                                                          |
|                                                                                                  |                                                                                                                                                                                                                          |
| Item 1A. Risk Factors                                                                                 | 34                                                                                                                                                                                                                            |
|                                                                                                  |                                                                                                                                                                                                                          |
| Item 5. Other Information                                                                             | 34                                                                                                                                                                                                                            |
|                                                                                                  |                                                                                                                                                                                                                          |
| Item 6. Exhibits                                                                                      | 35                                                                                                                                                                                                                            |
|                                                                                                  |                                                                                                                                                                                                                          |
| Signatures                                                                                            | 35                                                                                                                                                                                                                            |

 

 

2

 

 

----

**PART I – FINANCIAL INFORMATION**

**Item 1. Financial Statements**

 

| **BEKEM METALS, INC. AND SUBSIDIARIES**                          |
|------------------------------------------------------------------|
| **(An Exploration Stage Company)**                               |
| **CONSOLIDATED BALANCE SHEETS**                                  |
| **(UNAUDITED)**                                                  |
|                                                             |   |   |   |
|                                                             |   | **September 30,** | **December 31,** |
|                                                             |   | **2009** | **2008** |
|                                                             |   |   |   |
| **ASSETS**                                                       |   |   |   |
|                                                             |   |   |   |
| **Current Assets**                                               |   |   |   |
| Cash                                                             |   | $        37,377   | $       115,644   |
| Trade accounts receivable                                        |   | 57,043   | 58,238   |
| VAT recoverable                                                  |   | 239,067   | 301,447   |
| Inventories                                                      |   | 555,734   | 737,810   |
| Note receivable from related party                               |   | 15,140,828   | 15,066,328   |
| Prepaid expenses and other current assets                        |   | 62,932   | 116,203   |
| Deferred compensation                                            |   | 118,043   | 351,779   |
| **Total Current Assets**                                         |   | 16,211,024   | 16,747,449   |
|                                                             |   |   |   |
| Property, plant and mineral interests (net of accumulated        |   |   |   |
| depreciation of $545,151 and $570,968)                           |   | 3,397,622   | 4,421,171   |
| Non-current deferred compensation                                |   | 32,703   |  109,011   |
| Other assets                                                     |   | 42,163   | 61,156   |
| **Total Assets**                                                 |   | $    19,683,512   | $     21,338,787   |
|                                                             |   |   |   |
| **LIABILITIES AND SHAREHOLDERS' DEFICIT**                        |   |   |   |
|                                                             |   |   |   |
| **Current Liabilities**                                          |   |   |   |
| Notes payable to related parties                                 |   | $    19,668,792   | $     19,668,792   |
| Advances received for prospective sale of subsidiary             |   | 500,000   |  -   |
| Accounts payable                                                 |   | 717,810   | 370,535   |
| Accrued expenses                                                 |   | 846,266   | 320,142   |
| Advances received                                                |   | 108,603   | 59,562   |
| Due to related party                                             |   | -   | 6,051   |
| **Total Current Liabilities**                                    |   | 21,841,471   | 20,425,082   |
|                                                             |   |   |   |
| Asset retirement obligations                                     |   | 1,253,551   | 1,455,423   |
| **Total Liabilities**                                            |   | 23,095,022   | 21,880,505   |
|                                                             |   |   |   |
| **Commitments and Contingencies**                                |   | -   | -   |
|                                                             |   |   |   |
| **Shareholders' Deficit**                                        |   |   |   |
| Preferred stock; $0.001 par value, 20,000,000 shares authorized, |   |   |   |
| no shares outstanding                                            |   | -   | -   |
| Common stock; $0.001 par value, 300,000,000 shares authorized,   |   |   |   |
| and 125,172,011 shares issued and outstanding                    |   | 125,172   | 125,172   |
| Additional paid-in capital                                       |   | 28,540,235   | 28,540,235   |
| Accumulated deficit                                              |   | (35,017,455) | (30,272,874) |
| Accumulated other comprehensive loss                             |   | 2,940,538   | 1,065,749   |
| **Total Shareholders' Deficit**                                  |   | (3,411,510) | (541,718) |
|                                                             |   |   |   |
| **Total Liabilities and Shareholders' Deficit**                  |   | $     19,683,512   | $    21,338,787   |
|                                                             |   |   |   |
|                                                             |   |   |   |

            

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3

 

 

----

 

| **BEKEM METALS, INC. AND SUBSIDIARIES**             |
|-----------------------------------------------------|
| **(An Exploration Stage Company)**                  |
| **CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS** |
| **(UNAUDITED)**                                     |
|                                                |   |   |   |   |   |
|                                                |   | **For the Three Months****Ended September 30,** |   | **For the Nine Months****Ended September 30,** | **For the Period from March 5, 2004 (Date of Inception) through** |
|                                                |   | **2009** | **2008** |   | **2009** | **2008** | **September 30, 2009** |
|                                                |   |   |   |   |   |   |   |
| **Revenue**                                         |   | $               -   | $               -  |   | $               -  | $               -  | $                  -  |
|                                                |   |   |   |   |   |   |   |
| **Operating Expenses**                              |   |   |   |   |   |   |   |
| General and administrative expenses                 |   | 716,250   | 966,815  |   | 2,127,911  | 3,312,138  | 15,248,327  |
| Research and development costs                      |   | -   | 44,749   |   | -  | 229,298  | 1,329,070   |
| Exploratory costs                                   |   | 25,705   | 395,345   |   | 62,487  | 512,727  | 6,464,653   |
| Loss from impairment of property                    |   | -   | -   |   | -  | -  | 10,525,156   |
| Accretion expense on asset retirement obligations   | 29,743   | 21,337   |   | 91,801  | 63,978  | 394,046   |
| Grant compensation expense                          |   | 72,416   | 154,295   |   | 310,044  | 431,450  | 1,476,307   |
|                                                |   |   |   |   |   |   |   |
| **Total Operating Expenses**                        |   | 844,114   | 1,582,541   |   | 2,592,243   | 4,549,591  | 35,437,559   |
|                                                |   |   |   |   |   |   |   |
| **Loss From Operations**                            |   | (844,114) | (1,582,541) |   | (2,592,243) | (4,549,591) | (35,437,559) |
|                                                |   |   |   |   |   |   |   |
| **Other Income/(Expense)**                          |   |   |   |   |   |   |   |
| Exchange gain/(loss) from remeasurement             |   | 52,039  | (31,611) |   | 1,453,303   | 10,650  | 1,241,773 |
| Exchange gain/(loss)                                |   | (99,823) | 14,186   |   | (3,967,595) | 16,198  | (4,276,173) |
| Interest income                                     |   | 377   | 82,738   |   | 75,077   |  145,313  | 706,474   |
| Interest expense                                    |   | -   | -   |   | -   | -  | (1,677,441) |
| Other income, net                                   |   | 79,287   | 106,639   |   | 286,877   | 354,216  | 893,662   |
|                                                |   |   |   |   |   |   |   |
| **Net Other Income/(Expense)**                      |   | 31,880   | 171,952   |   | (2,152,338) | 526,377  | (3,111,705) |
|                                                |   |   |   |   |   |   |   |
| **Net Loss Before Minority Interest and Taxes**     |   | (812,234) | (1,410,589) |   | (4,744,581) | (4,023,214) | (38,549,264) |
| Deferred tax benefit                                |   | -   | -   |   | -   | -  | 3,390,601  |
| Loss in minority interest                           |   | -   | -   |   | -   | -  | 141,208   |
|                                                |   |   |   |   |   |   |   |
| **Net Loss**                                        |   | $ (812,234) | $ (1,410,589) |   | $ (4,744,581) | $ (4,023,214) | $ (35,017,455) |
|                                                |   |   |   |   |   |   |   |
|                                                |   |   |   |   |   |   |   |
| **Basic Loss per Common Share**                     |   | $ (0.01) | $ (0.01) |   | $ (0.04) | $ (0.03) |   |
| **Weighted-Average Shares used in**                 |   |   |   |   |   |   |   |
| **Basic Loss per Common Share**                     |   | 125,172,011  | 125,172,011   |   | 125,172,011   | 125,041,169  |   |

 

The accompanying notes are an integral part of these condensed, consolidated financial statements.

 

4

----

 

| **BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)** |
|---------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                              |   |   |   |   |   |   |
|                                                                                                                                              |   | **For the Nine Months****Ended September 30,** |   | **For the Period from March 5, 2004 (Date of Inception) through** |
|                                                                                                                                              |   | **2009** |   | **2008** |   | **September 30, 2009** |
|                                                                                                                                              |   |   |   |   |   |   |
| **Cash Flows from Operating Activities**                                                                                                          |   |   |   |   |   |   |
| Net loss                                                                                                                                          | $  | (4,744,581) | $ | (4,023,214) | $ | (35,017,455) |
| Adjustments to reconcile net loss to                                                                                                              |   |   |   |   |   |   |
| net cash provided by operating activities:                                                                                                        |   |   |   |   |   |   |
| Depreciation and amortization                                                                                                                     |   | 177,089  |   | 223,393   |   | 931,312  |
| Accretion expense on asset retirement obligations                                                                                                 |   | 91,801  |   | 63,978   |   | 394,046  |
| Interest expense from debt discount                                                                                                               |   | -  |   | -   |   | 963,231  |
| Shares issued on option modification                                                                                                              |   | -  |   | -   |   | 19,426  |
| Deferred tax benefit                                                                                                                              |   | -  |   | -   |   | (3,390,601) |
| Foreign currency exchange loss / (gain) and loss / (gain) from remeasurement                                                                      |   | 2,785,157  |   | 18,664   |   | 2,886,424  |
| Purchased exploration costs                                                                                                                       |   | -  |   | -   |   | 251,286  |
| Impairment loss on property, plant and mineral interests                                                                                          |   | -  |   | -   |   | 10,525,156  |
| Loss / (gain) on disposal of property and equipment                                                                                               |   | 35,814  |   | 20,905   |   | (92,572) |
| Stock grant compensation expense                                                                                                                  |   | 310,044  |   | 431,450   |   | 1,476,307  |
| Loss recognized on minority shareholders' interest                                                                                                |   | -  |   | -   |   | (141,208) |
| Change in operating assets and liabilities:                                                                                                       |   |   |   |   |   |   |
| Trade accounts receivable                                                                                                                         |   | (8,443) |   | (97,066) |   | (54,948) |
| VAT recoverable                                                                                                                                   |   | 16,264  |   | (13,768) |   | (212,562) |
| Inventories                                                                                                                                       |   | 35,806  |   | (4,490) |   | 105,801   |
| Prepaid expenses and other current assets                                                                                                         |   | (9,176) |   | (456,091) |   | (42,914) |
| Change in related party receivables / payables                                                                                                    |   | -  |   | -   |   | (152,180) |
| Accounts payable                                                                                                                                  |   | 318,806  |   | (198,876) |   | 371,927   |
| Advances received                                                                                                                                 |   | (29,233) |   | -   |   | 30,562   |
| Accrued expenses                                                                                                                                  |   | 321,945  |   | 91,092  |   | 400,108   |
| **Net Cash From Operating Activities**                                                                                                            |   | (698,707) |   | (3,944,023) |   | (20,748,854) |
|                                                                                                                                              |   |   |   |   |   |   |
| **Cash Flows from Investing Activities**                                                                                                          |   |   |   |   |   |   |
| Purchase of property and equipment                                                                                                                |   | (53,167) |   | (131,851) |   | (4,073,035) |
| Purchase of intangible assets                                                                                                                     |   | (624) |   | (2,560) |   | (67,988) |
| Proceeds from disposal of property and equipment                                                                                                  |   | 77,213  |   | -  |   | 457,553   |
| Advances received for sale of PPE                                                                                                                 |   | 100,446  |   | -  |   | 100,446   |
| Advances received for sale of subsidiary                                                                                                          |   | 500,000  |   | -  |   | 500,000   |
| Loans provided to related parties                                                                                                                 |   | -  |   | (14,900,000) |   | (14,900,000) |
| Notes receivable                                                                                                                                  |   | -  |   | -  |   | (56,983) |
| Cash acquired in acquisitions                                                                                                                     |   | -  |   | -  |   | 50,475   |
| **Net Cash From Investing Activities**                                                                                                            |   | 623,868  |   | (15,034,411) |   | (17,989,532) |
|                                                                                                                                              |   |   |   |   |   |   |
| **Cash Flows from Financing Activities**                                                                                                          |   |   |   |   |   |   |
| Proceeds from notes payable                                                                                                                       |   | -  |   | -  |   | 14,706,914   |
| Payments on notes payable                                                                                                                         |   | -  |   | -  |   | (22,745,753) |
| Proceeds from loans / notes payable - related parties                                                                                             |   | -  |   | 19,698,150  |   | 24,025,062   |
| Payments on loans / notes payable - related parties                                                                                               |   | -  |   | -  |   | (4,326,912) |
| Issuance of shares for cash                                                                                                                       |   | -  |   | -  |   | 26,728,842   |
| **Net Cash From Financing Activities**                                                                                                            |   | -  |   | 19,698,150  |   | 38,388,153   |
|                                                                                                                                              |   |   |   |   |   |   |
| **Effect of Exchange Rate Changes on Cash**                                                                                                       |   | (3,428) |   | 789  |   | 387,610   |
|                                                                                                                                              |   |   |   |   |   |   |
| **Net (Decrease) / Increase in Cash**                                                                                                             |   | (78,267) |   | 720,505  |   | 37,377   |
| **Cash at Beginning of Period**                                                                                                                   |   | 115,644  |   | 756,943  |   | -   |
| **Cash at End of Period**                                                                                                                         | $  | 37,377  | $ |  1,477,448  | $ |  37,377   |
|                                                                                                                                                   |  |  |  |  |  |  |  |  |

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5

----

 

 

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

| **NOTE 1 – BASIS OF PRESENTATION AND NATURE OF BUSINESS** |
|-----------------------------------------------------------------|

 

***Interim Financial Information***– The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they are condensed and do not                include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments and reclassifications considered necessary for a fair and comparable presentation have been included and are of a normal recurring nature. The accompanying financial statements should be read in conjunction with the most recent audited financial statements of Bekem Metals,                Inc. included in its annual report on Form 10-K filed for the year ended December 31, 2008. Operating results for the nine-month period ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. 

 

**Basis of Presentation**

 

On October 24, 2005, Bekem Metals, Inc. (hereinafter referred to as “us,” “we,” the “Company”, “BMI” or “Bekem”) entered into an Acquisition Agreement with Kazakh Metals, Inc., a British Virgin Islands international business company (“KMI”), under which BMI acquired 100% of the outstanding common shares of KMI in exchange for                the issuance of 61,200,000 common shares. The KMI shareholders received 61.1% of the BMI common stock outstanding after the transaction and therefore KMI was considered the acquirer for financial reporting purposes. Accordingly, the accompanying financial statements include financial statements of KMI for all periods presented. 

 

Brisa Equities Corporation, a British Virgin Islands holding company (“Brisa”), together with other entities its owners control, is the controlling shareholder of KMI and was also the controlling shareholder of BMI. Accordingly, the transaction was considered to be between entities under common control and did not result in a change in control of BMI. Following the transaction,                entities over which the controlling shareholder maintained voting and investment control held 51,600,000 BMI common shares, which represented 51.5% of the 100,088,888 outstanding common shares. The acquisition of the portion of the net liabilities of BMI relating to the common shares owned by the controlling shareholder was recorded at an historical cost of $161,998. The acquisition of the common shares of BMI purchased from the minority shareholders of BMI were recorded at                $345,000, which was the estimated fair value of those shares on the date of acquisition. KMI accounted for the purchase of BMI similar to a pooling. 

 

The consolidated financial statements include the accounts of KMI and its wholly-owned subsidiary, KKM, which it acquired on May 31, 2005 in a purchase business combination.

 

The consolidated financial statements also include the accounts of Condesa and Kaznickel, since the date of its acquisition by Condesa, and the accounts of BMI since its acquisition by Condesa. Condesa was incorporated under the laws of the British Virgin Islands on March 5, 2004. Condesa acquired BMI in a reverse acquisition, on January 28, 2005. On July 24, 2006, Condesa transferred its interest                in Kaznickel to Bekem, making Kaznickel a wholly-owned subsidiary of Bekem. On September 30, 2006, Bekem sold Condesa to a third party for a nominal value. Condesa is included in the consolidated financial statements from the date of acquisition to the date of disposal. 

 

6

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

***Name Change***– On February 9, 2005, the Board of Directors of EMPS Research Corporation approved, and the stockholders holding a majority of the outstanding shares of the Company approved and ratified by written consent, a change in the Company’s name from EMPS Research Corporation to Bekem Metals, Inc. On March 16, 2005, the Company filed an                amendment to its Articles of Incorporation to affect the change.

 

***Foreign Currency Transactions***– The consolidated financial statements are presented in United States Dollars (USD). The functional currency of Bekem Metals, Inc. is USD. 

 

Kaznickel makes its principal investing and financing transactions in USD, which is also its functional currency. Transactions and non-monetary balances denominated in other currencies have been translated or remeasured into USD using historical exchange rates. Monetary balances have been remeasured at the ending exchange rate. Exchange gains and losses from holding foreign currencies and having                liabilities payable in foreign currencies are included in the results of operations.

 

The Kazakh Tenge (KZT) is the functional currency of the operating subsidiary, KKM. The net assets of KKM have been translated into USD at the exchange rates prevailing at each balance sheet date and the equity accounts have been translated at weighted-average historical rates. The respective statements of operations have been translated into USD using the average exchange rates prevailing during                the periods of each statement. The resulting translation adjustments are part of accumulated other comprehensive income and are shown as part of shareholders’ equity.

 

**Nature of Business**

 

The Company is engaged in the exploration of mineral resource properties. 

 

***Business Condition***– The financial crisis impacting the global economy has had a material effect on the Company’s business. Metal prices fell sharply in 2008, making future forecasts problematic and projected financial models unprofitable. Although prices have been recovering since April 2009, turning the projected financial models to positive                expected outcomes, they still remain vulnerable due to the continuing global economic crisis making the Company’s access to equity and/or debt financing temporarily impossible. In light of the uncertain economic environment, the Company has been looking for private investors and/or potential purchasers of some of the Company’s assets.

 

The Gornostai and the Kempirsai deposits have not yet entered the development stage with respect to their mineral interests and have no production while the Company’s mineral licenses contain certain work program requirements to be met which are expected to require significant capital. The Company has realized only limited revenue from the Kempirsai deposit and no revenue from the Gornostai                deposit and has very little ability to generate revenue. The Company does not expect this to change until it builds and begins operating a nickel ore processing plant. The Company will need to raise significant additional capital in order to satisfy its work program requirements, maintain operations and fund construction of a processing plant. The Company expects to be totally dependent upon investment funds to support operations until such time as it begins to generate                sufficient revenue to fund operations. The Company expects these funds will consist primarily of funds raised in equity and/or debt financing activities.

 

7

 

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

In the past the Company has been able to raise capital through the sale of its equity securities and continues to believe that investors will see the merits of its plans to exploit its mineral licenses and will be able to raise capital. The Company currently has no firm commitment from any party to provide additional equity or debt financing and there is no guarantee that it will obtain additional                financing on acceptable terms, or at all. If the Company is unsuccessful in obtaining additional funding during 2009, the Company will have insufficient funds to continue exploring its territories, to meet its mineral license work program requirement or to satisfy its operating needs. Failure to satisfy its work program requirements could result in fines and penalties or even the possible forfeiture of the subsoil use contracts and licenses.

 

In December 2008, a new subsoil use legislation of Kazakhstan was submitted to parliament, superseding legislation on oil production and exploration, mineral resources mineral management, and production sharing agreements (PSAs). The new subsoil use legislation of Kazakhstan, which is expected to be adopted by parliament and signed by the President in first quarter 2010 and become effective six                months after its approval by parliament and the President, allows the government to annul contracts in the extractive sector if they are deemed to be harmful to Kazakhstan's economic security or national interests. The legislation also requires separate contracts for exploration and production operations, puts shorter time limits on exploration contracts, enhances the government’s authority to terminate contracts not in compliance with the law, and requires tax stability                clauses in individual contracts to be approved by the President of Kazakhstan. In addition, under the terms of the legislation, no future contracts would be structured as production sharing agreements (PSAs), companies are required to establish equal terms, conditions, and pay for Kazakhstani and foreign workers, and the government would evaluate subsoil resource bids based on promised social contributions. Also, the latest draft assumes that disputes between subsurface users                and the government will be settled in the courts of Kazakhstan, and does not assume international arbitration. Disputes regarding the existing subsurface use contracts would also be settled in the courts of Kazakhstan. 

 

Under the subsoil use legislation, the Republic of Kazakhstan has a “priority purchase right” over third parties to purchase, on terms not less favorable than those offered by other purchasers, subsoil use rights (or its part) and/or a share in a subsoil user or in a company which can determine/influence (whether directly or indirectly) decisions on subsoil use (provided than such                company’s primary business relates to subsoil use in Kazakhstan). The draft of the new subsoil use legislation details a procedure whereby the state may exercise its priority right and establishes the list of certain state bodies and their respective powers to determine whether the state will exercise its priority right. At the same time, the draft introduces for the first time a procedure to take a decision to exercise the priority right and to acquire such offered asset                either through a state body or a national company, authorized by the Government. Despite delegating the authority to make decisions about the priority right to a number of state bodies and the national company, the role of the Government in resolving this issue remains quite significant. As in the current law, the acquisition shall be carried out on terms not worse than offered to other acquirers. The draft further clarifies this provision by stating that if the disposition is                conducted without compensation or into the charter capital of another legal entity, the state shall acquire such subsoil use right or object connected with it at market price, to be determined on the basis of evaluation. Acquisition should be completed within six months.

 

In January 2009, Kazakhstan adopted a new Tax Code. The new Tax Code invalidates tax stability clauses in existing contracts and eliminated tax stability in future contracts. The government has said that the stability of tax clauses was retained only for existing production sharing agreements that contained stability clauses and had undergone the mandatory tax expert evaluation and subsurface use                contracts approved by the President of Kazakhstan. The new Tax Code increases the taxes paid by extractive industries while lowering the general tax burden on the entire economy. In this respect, the new Tax Code decreases the corporate tax rate from 30% to 20% beginning January 1, 2009. The corporate tax rate decreases to 17.5 % in 2010, and to 15% starting in 2011. Under  the  draft  amendments  planned  to  be  introduced  to                 the  Tax  Code  this  year,  however,  the   planned 

 

8

 

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

reductions in the corporate income tax rate may be postponed, with rate decreases being postponed to 17.5% in 2013 and to 15% starting from 2014. Value-added tax (“VAT”), which has decreased every year from 16% in 2006 to 12% in 2009, is expected to stay at its current level. Under the new Tax Code, the progressive scale of social tax rates imposed on employer’s payroll costs was                replaced with a flat rate of 11%. The personal income tax rate for resident individuals is set at 10%. Depending on the specific type of income, income of non-residents working in Kazakhstan is subject to income taxes (withholding) at varying rates ranging from 5% to 20%. The new Tax Code also increases the tax burden of subsurface users by introducing new minerals extraction tax (“MET”), while canceling royalty payments. In general, MET applies to the value of                produced resources which is calculated based on “world” prices. The current MET rate applicable to nickel is set at 6%. Extractive companies are also liable to pay excess profit tax (“EPT”). EPT liability arises when the ratio of aggregate annual income to deductions allowable for EPT purposes relative to operations under a specific subsurface use contract is more than 1.25 for the reporting tax period which, in most cases, is a calendar year. The Tax                Code provides for an incremental sliding scale of EPT rates ranging from 0% to 60% for various profit levels above the mentioned ratio. The planned amendments to the Tax Code this year may change the current procedure of EPT calculation. The new Tax Code also makes rent tax applicable to exports of coal (previously applicable only to exports of hydrocarbons). The rent tax at the rate of 2.1% applies to value of exported coal calculated on the basis of the sale prices.                

 

On February 4, 2009, Kazakhstan’s National Bank dramatically devalued the Tenge, the local currency, from a range of 117-123 Tenge/U.S. dollar to 145-155 Tenge/U.S. dollar, citing the decline in oil price (oil comprises 60% of Kazakh exports), currency devaluations in Kazakhstan’s neighbors, particularly Russia, and the fledgling state of the domestic banking sector. The Company has                limited confidence in the government’s ability to control prices in the near to medium term, and with the value of Tenge wages falling, purchasing power is declining. The future effect of the devaluation is difficult to project given the present uncertainty on the currency markets and on the government’s policies regarding exchange rates and/or foreign currency regulations. Although devaluation of the local currency generally leads to reduced cost of operations, the                foreign exchange rate fluctuations, as well as, the deteriorating overall economic situation in Kazakhstan increase uncertainties peculiar to long-term projects in Kazakhstan. 

 

***Kaznickel***– Kaznickel owns the right to the Gornostayevskoye (“Gornostai”) nickel and cobalt deposit located in the East Kazakhstan Oblast in northeast Kazakhstan. The license is for exploration and production of cobalt and nickel ores and is valid through February 26, 2026 providing commercial discoveries are made before the end of the                exploration period. 

 

Due to the inability of the Company in obtaining equity or debt funding aggravated by the financial crisis impacting the global economy, on February 11, 2009 the Company executed a Memorandum of Understanding for the purchase and sale of 100% of the charter capital of Kaznickel between the Company and Ertis Ferronickel Works LLP (“Ertis”). Subject to the execution of a definitive                agreement, Ertis agreed to acquire 100% of the outstanding charter capital of Kaznickel for 91,900 Kazakh tenge (approximately $630) and for repayment of $5,000,000 worth of loans owed to Bekem Metals by Kaznickel. Subsequently, the purchase price for the sale of 100% of the outstanding charter capital of Kaznickel was increased from 91,900 Kazakh tenge to 280,000 Kazakh tenge (approximately $1,856). The Memorandum of Understanding provides for an initial payment of $500,000,                which was made on March 20, 2009, and payment on the remaining balance is to occur within 20 days after the execution of a definitive agreement. Execution of a definitive agreement was subject to negotiation, due diligence investigation and approval of the transaction by the Ministry of Energy and Mineral Resources (“MEMR”) of the Republic of Kazakhstan. On October 27, 2009 the Company received an official letter from the MEMR approving the transaction and on                November 3,  2009 the Company signed the definitive agreement for sale of 100% of the outstanding charter capital of Kaznickel to Ertis (please refer to Note 8 *“Subsequent events”*).

 

9

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

Despite the execution of the Memorandum of Understanding and receipt of the initial payment of $500,000, as of September 30, 2009 the Company did not reclassify Kaznickel’s long-lived assets as held for sale, as required by generally accepted accounting standards related to long-lived assets, because the sale of the asset was not deemed to be probable at this reporting date. The outcome of the                transaction was uncertain due to lack of confidence in obtaining approval of the MEMR which has been inconsistent in its approvals in similar transactions. 

 

Generally accepted accounting standards require an entity to present assets and liabilities of a disposal group separately in the asset and liability sections, respectively, of the balance sheet; the results of operations of a component of an entity that has been classified as held for sale shall be reported separately in discontinued operations. If the Company classified Kaznickel’s                long-lived assets as held for sale, the disposal group would be presented on the balance sheet as of September 30, 2009 as follows:

 

| **Account**                               | **September 30, 2009**                                   |
|-------------------------------------------|----------------------------------------------------------|
| Assets of the disposal group              | $       107,505  |
| Liabilities of the disposal group         | (7,079,133)                                              |
| Accumulated deficit of the disposal group | $  (6,971,628)                                 |

 

Also, the assets above would have been measured at their carrying amount which is lower than estimated fair value less cost to sell (approximately $5,000,000). The balance of the Kaznickel liabilities mainly consists of the loan provided by the Company in the amount of $5,316,212. Loss from discontinued operations would amount to approximately $162,000. 

 

***KKM -***KKM holds exploration and production licenses from the government of Kazakhstan to a 575,756 acre parcel, located approximately 130 kilometers northwest of Aktobe, Kazakhstan. This deposit is referred to as the Kempirsai deposit. The licenses grant KKM the right to explore for and produce nickel and cobalt from deposits located within the territory through                October 12, 2011, which may be extended upon agreement between KKM and the MEMR. KKM also holds a license to explore for and produce Mamyt brown coal from a deposit located within 40 kilometers of its cobalt and nickel deposit. This license expires on December 11, 2018 with further possible extensions. 

 

On December 10, 2007, the MEMR unilaterally terminated KKM’s contracts and licenses to explore for nickel, cobalt, brown coal, and other minerals within the Kempirsai and the Mamyt deposits on the basis that KKM had material failures in execution of the work programs associated with the contacts and licenses and did not detail those failures. In January 2008, KKM filed an action in the Court                of Astana city against the MEMR challenging the legality of the unilateral termination of the KKM contracts and licenses by the MEMR for several reasons, including that the contracts and licenses had been terminated on grounds not provided for in the subsoil use contracts and legislation and there were no material failures in the execution of the work programs associated with the contracts and licenses. In February 2008, the Court of Astana city acknowledged that the unilateral                termination of the contracts and licenses by the MEMR was illegitimate. The Court cancelled the order of the MEMR relating to the unilateral termination of the licenses and reinstated the KKM contracts and licenses. In March 2008, the MEMR appealed the decision of the Court of Astana city to the Republic of Kazakhstan Supreme Court. On April 22, 2008 the Supreme Court cancelled the MEMR’s unilateral termination and reinstated 

 

10

 

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

the Company’s contracts and licenses to the Kempirsai deposit. On February 18, 2009 the General Prosecutor of the Republic of Kazakhstan lodged a protest to the Supervisory board under the Supreme Court against the judgment of the Court of Astana city and the Supreme Court cancellation of the unilateral termination of the KKM contracts and licenses. Pursuant to the Code of Civil                Procedure of the Republic of Kazakhstan, the General Prosecutor can protest the decision of the Supreme Court within one year of its determination. The General Prosecutor asserted that the Court of Astana city and the Supreme Court wrongly applied the substantive law and requested an order cancelling the decisions of the Court of Astana city and the Supreme Court and reinstating the order unilaterally cancelling the KKM contracts and licenses. The Company filed a formal                objection to the protest of the General Prosecutor. On March 18, 2009, the Supervisory board under the Supreme Court rejected the protest of the General Prosecutor. Experts have regarded this action as an attempt to return most of exploration and production companies’ shares to state ownership, clearly reflecting the recent Russian approach. First, the Ministry of Finance suggested imposing taxation on mineral extraction, already applied for years in Russia. Then the                Ministry of Energy and Mineral Resources lobbied for tax amendments introducing oil export customs duties by January 1, 2009, another analogy to the Russian legislation.

 

The current subsoil use legislation of Kazakhstan requires mining and oil companies to use local goods and services. According to these “local content” regulations, subsurface users in Kazakhstan are obligated to purchase goods and services from Kazakhstan entities, provided that the local goods meet minimum project standards, and to give preference to the employment of local                personnel. Because of the global economy crisis and to support the local producers, the Government requested the MEMR to specify the “local content” requirements in every subsoil use contract. Therefore, on April 9, 2009 KKM and the MEMR signed an addendum # 3 to its nickel subsoil use contract whereby KKM is obliged to the following commitments:

 

|   | **•** | Until 2013, at least 30% of KKM’s total procurements of equipment, materials and other products, must be of goods produced in Kazakhstan, during 2013 and 2014, this percentage shall increase to 40%, after 2014, at least 50% of KKM’s total procurements must have been of equipment, materials and other products produced in Kazakhstan; |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | Of the total percentage of nickel mining related services retained by KKM until 2013, at least 70% shall be provided by Kazakhstani companies, between 2013 and 2014 that percentage shall increase to 80%, after 2014 the percentage shall increase to 90%; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | Kazakhstan citizens shall be given priority in personnel hiring, and depending upon the type of position within KKM, Kazakhstani citizens should account for 80-100% of total KKM personnel until 2013, between 2013 and 2014 the percentages increase to between 90 and 100%, and after 2015, 100% of KKM employees shall be Kazakhstani                                citizens. |
|--------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

In December 2008 KKM received a notice from the MEMR extending the term of KKM’s subsoil use contract for nickel and cobalt ore exploration and production until the year 2020. The MEMR has further agreed to suspend ore mining requirements until the end of 2012 to allow KKM to focus on the construction of an ore processing facility. The notice indicates that under the Work Program, KKM                will be required to invest $135 million to be applied to its mining and ore processing technology during the period 2006-2020 (or around $125 million for the remaining period). Currently, the addendum to the KKM subsoil use contract is under negotiations and expected to be signed in fourth quarter 2009. KKM has received authorizations from various governmental authorities on the draft addendum, however, the addendum has not been signed due to currently occurring changes of key                officials in the regulatory authorities, adoption of a new tax code and changes in the subsoil use legislation of Kazakhstan. Also, the Company received a letter from the MEMR requiring changes/addendums  to the  taxation  provisions  of  the  Company’s existing  subsurface  use contracts to make 

 

11

 

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

them consistent with the new tax regime. Despite the fact that the Company’s existing subsurface use contracts include statements of stabilization of the tax regime in regard of subsurface user taxes (such as royalty, excess profit tax), the MEMR letter requires the new tax regime to be applied to existing contracts starting from January 1, 2009. 

 

Because the Company does not have a reserve estimate for its deposits that conforms to the standards of Industry Guide 7 issued by the U.S. Securities and Exchange Commission, its operations were considered to be at the exploratory stage for the third quarter 2009 and 2008.

 

***Kempirsai Exploration Stage***– The Kempirsai, or KKM, operations are considered to be in the exploration stage until the Company establishes commercially producible reserves within the Kempirsai deposit. Accordingly, no revenues from production have been recorded.

 

***Gornostai Exploration Stage***– The Gornostai, or Kaznickel, operations are considered to be in the exploration stage. Since its inception on March 5, 2004, the Company has devoted a substantial amount of effort in raising capital, acquiring Kaznickel, and exploring the Gornostai deposit under its exploration contract. This mineral property has not yet                reached development or production stage and accordingly, no revenues from production have been recorded. 

 

**NOTE 2 - CASH AND CASH EQUIVALENTS**

 

The Company considers all demand deposits, money market accounts and marketable securities purchased with an original maturity of three months or less to be cash and cash equivalents. The fair value of cash and cash equivalents approximates their carrying amounts due to their short-term maturity.

 

Cash consists of the following:

 

|                     |   | **September 30,**                                |   | **December 31,**                                     |
|--------------------------|--------|--------------------------------------------------|--------|------------------------------------------------------|
|                     |   | **2009**                                         |   | **2008**                                             |
| Current accounts (USD)   |   | $       6,514 |   | $       102,019   |
| Current accounts (Tenge) |   | 30,863                                           |   | 13,625                                               |
| **Total**                |   | **$**     **37,377**    |   | **$**      **115,644** |

 

**NOTE 3 - NOTE RECEIVABLE FROM RELATED PARTY**

 

On May 22, 2008 the Company signed a Note Agreement with Latimer Assets Inc. Pursuant to the terms of the Note Agreement, the Company loaned $7,400,000 to Latimer Assets Inc. (“Latimer”). The note was originally interest free. 

 

On June 19, 2008 the Company and Latimer entered into Addendum # 1 to the Note Agreement whereby the Company agreed to loan an additional $7,500,000 to Latimer, increasing the total note amount to $14,900,000. The total note was provided at an interest rate of 2% per annum. Interest was agreed to be charged on a monthly basis and was payable as a lump-sum payment at the date of the note repayment.                Repayment of the note was due on March 1, 2009. The Company has not accrued interest on this loan since March 31, 2009, subject to completion of negotiations between the parties of revised repayment terms whereby the parties planned to agree on an extension of the repayment period or on offsetting the note receivable from Latimer against KKM’s notes payable to GRK. Latimer owns substantial interests in GRK Koitas LLP (“GRK”) and Asia-Invest Corporation LLP                (“AI”). On November 11, 2009 the Company, KKM,  Latimer and GRK signed an offset agreement and the Addendum #2 to the preliminary consortium agreement, respectively, to offset the note receivable from Latimer against KKM’s notes payable to GRK (see Notes 5 and 8).

 

12

 

 

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

Pursuant to a Pledge Agreement dated May 22, 2008 between the Company, its subsidiary, KKM, GRK and AI, the Latimer note receivable was secured by a pledge of a cumulative 39% interest in the Consortium (see Note 5). Since the Latimer note receivable was fully secured by the pledge agreement, no allowance against this receivable was created.

 

The balance of the note receivable from a related party at September 30, 2009 was $15,140,828, which includes $240,828 of interest.

 

**NOTE 4 - PROPERTY, PLANT AND MINERAL INTERESTS**

 

Property, plant and mineral interests consist of the following:

 

|                               | **September 30,**                  | **December 31,**                   |
|------------------------------------|------------------------------------|------------------------------------|
|                               | **2009**                           | **2008**                           |
| Buildings                          | $   1,524,115  | $   1,908,113  |
| Machinery and equipment            | 2,311,569                     | 2,904,378                     |
| Other fixed assets                 | 132,906                       | 153,831                       |
| Unproved mineral interests         | -                             | -                             |
|                               | 3,968,590                     | 4,966,322                     |
| Accumulated depreciation           | (570,968)                          | (545,151)                          |
| Property, plant and equipment, net | $   3,397,622  | $   4,421,171  |

 

Unproved mineral interests represent the acquisition costs of the mineral interests upon the purchase business combinations with Kaznickel and with KKM. The government of Kazakhstan retains the title to the property upon which the Company’s mineral rights pertain; however, the Company’s mineral interests are considered to be tangible assets. 

 

In 2008 the Company recognized full impairment of unproved mineral interests of $8,916,265. According to management’s estimates, the Company can generate positive cash flows if nickel prices are not lower than $12,000-$12,500 per ton. However, nickel prices in the fourth quarter of 2008 fell below this level making the Company recognize impairment of the mineral interests. 

 

***Gornostai Deposit***

 

Kaznickel acquired its interest in the Contract on Exploration and Development of Gornostai Cobalt and Nickel Deposit (“the Contract”) issued by the MEMR dated February 26, 2004. As discussed above, Kaznickel acquired the right to exploit the mineral property including the right to explore, develop and produce the cobalt and nickel mineral resources within the deposit through February                26, 2026 providing commercial discoveries are made before the end of the exploration period. The Company has the right to renegotiate the contract at that time for an additional 30 years. The Company capitalized the acquisition costs of its mineral interest upon the purchase business combination with Kaznickel. The allocated purchase price included a capitalized amount of an acquired asset retirement obligation. While the property is not in production, the asset retirement cost                is depleted over the life of the contract from the date of acquisition.

 

13

 

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

The Contract for Gornostai provides Kaznickel certain rights and also imposes certain obligations and commitments. The rights include exploration through February 2010 (extended from 2008, as discussed below), and development and production of minerals through February 26, 2026. The Company may transfer its right to third parties in accordance with Kazakh laws and regulations and has a right to                renegotiate an extension of the Contract. On May 16, 2008 Kaznickel and the Ministry of Energy and Minerals Resources (“MEMR”) of the Republic of Kazakhstan signed an addendum to the subsoil use contract extending the exploration period to February 2010. The obligations and commitments under the amended contract are approximately $2,000,000. This amount includes $543,000 ($275,000 in 2008 and $268,000 in 2009) for exploration drilling (2,000 meters), sampling and                assaying (1,000 core samples), metallurgical tests and preparation of the report to the State Resource Committee. The amount also includes financing the region’s social programs in the amount of $5,000 during the exploration extension period. Also, the estimates include $750,000 for repayment to the Republic of Kazakhstan of historical costs incurred by it in undertaking geological and geophysical studies and infrastructure improvements related to the Gornostai deposit.                The repayment terms of this obligation will not be determined until Kaznickel applies to the Republic of Kazakhstan for and is granted a contract to engage in commercial production, which must occur prior to the expiration of the exploration stage of our contract in February 2010. However, there is no guarantee when or if Kaznickel will discover commercially producible reserves within the Gornostai deposit. Also, the estimates include the subsoil use contract requirement to                donate $300,000 for the ongoing development of Astana and Kurchatov, which are cities in Kazakhstan.

 

***Kempirsai Deposit***

 

Bekem acquired two contracts to explore for and extract minerals in connection with the purchase of KKM. One contract is for the exploration and extraction of nickel and cobalt ore through October 12, 2011 from deposits located in an approximately 575,756 acre site in the northwest area of the Republic of Kazakhstan approximately 130 kilometers northeast of the city of Aktobe, Kazakhstan, near the                town of Badamsha, referred to as the “Kempirsai” deposit. The other contract is for the exploration and extraction of Mamyt brown coal through December 11, 2018 at a site located within 40 kilometers of the Kempirsai deposit. The contracts may be extended upon agreement between KKM and the Geology and Minerals Resources Committee of the MEMR. The obligations and commitments under the contracts are approximately $130,000,000. This amount includes a commitment to                invest $100,000,000 for construction of a processing plant during the contract period. Also, the estimates include $950,000 for removal of all equipment and to remediate the property. The KKM work program for 2009 and subsequent years is currently under discussion and negotiation with the MEMR.

 

The Kempirsai contract requires the Company to pay royalty payments equal to 2.21% of gross ore sales. The Mamyt brown coal contract requires a royalty payment equal to nine tenths of one percent (0.9%) of gross coal sales. Both contracts require the Company to pay an excess profits tax ranging from 4 to 30 percent based upon an internal rate of return (as defined in the contracts) ranging from 22                to 30 percent. The new subsoil use and tax legislation of Kazakhstan, which defines the framework and procedures connected with the regulation of activities of subsoil users, introduces significant changes in terms of the regulation of the activities of subsoil users, including the abolition of the existing stabilization regime for all subsoil users. Currently, the addendum to the KKM subsoil use contract is under negotiations and expected to be signed in fourth quarter 2009.                The new Tax Code regime is discussed in Note 1.

 

14

 

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

The allocated purchase price of the mineral interest included a capitalized amount of an acquired asset retirement obligation. The obligations also include the establishment and funding of a reclamation fund that includes the cost of removing buildings and equipment used. The Company is also required to comply with Kazakh environmental laws and regulations. As discussed in Note 1 above, due to the                changes in the subsoil use legislation of Kazakhstan, on April 9, 2009 KKM and the MEMR signed an addendum # 3 to its nickel subsoil use contract whereby KKM is obliged to acquire 30-50% of its total procurements of equipment, materials and other products from Kazakhstan producers; 70-90% of nickel mining related services shall be provided by Kazakhstani companies; and Kazakhstani citizens should account for 80-100% of total KKM personnel.

 

**NOTE 5 - NOTES PAYABLE TO RELATED PARTIES**

 

In March 2008, KKM entered into a preliminary consortium agreement, subject to negotiation of the terms of a definitive agreement, with two Kazakhstani companies, GRK and AI. GRK and AI are related parties of the Company through a common stockholder. These companies also have exploration and production licenses near the Company’s Kempirsai deposits in northwestern                Kazakhstan. This agreement provides for the joint development and construction of a nickel processing plant in the area for joint use by the parties. Under the preliminary consortium agreement, KKM is considered to be the operator of the Consortium. The preliminary shares of the parties in the Consortium are the following: KKM - 50%; GRK Koitas - 40%; and AI - 10%.

 

Under the preliminary consortium agreement, the parties are obliged to jointly contribute approximately $40 million for financing the construction of the processing plant. Of this amount, KKM is obligated to contribute approximately $20 million. In the first half of 2008 KKM received advances from GRK and AI of KZT 2,375.4 million (approximately $19,698,000 U.S. dollars), including KZT 2,278                million from GRK and KZT 97.4 million from AI (approximately $18,890,000 U.S. dollars and $808,000 U.S. dollars, respectively), which are to be used for construction of a processing plant. The parties have the right to withdraw from the Consortium without penalty subject to three months written notice. Consequently, these advances have been classified as current notes payable to related parties and bear no interest since they represent contributions to the Consortium.

 

When the Company received the advance payments from GRK and AI, the parties had not yet selected the technology to be implemented for processing the Kempirsai ore and therefore, they had not yet developed a detailed plan for capital expenditures. The technology (Vanyukov process) for the processing plant was selected in September 2008 only after completion of the initial pilot testing of various                technologies capable of processing nickel ore. The technology was selected based on the results of the testing and the preliminary feasibility study report. In addition, KKM was in dispute with the MEMR in relation to unilateral termination of the subsoil use contract as disclosed in Note 1. Therefore, in May 2008 Latimer, one of the major shareholders in GRK and AI, applied to the Company with a request for a loan (see Note 3). 

 

Pursuant to a Pledge Agreement dated May 22, 2008 between the Company, its subsidiary, KKM, GRK and AI, the Latimer note receivable is secured by a pledge of a cumulative 39% interest in the Consortium. The 39% interest consists of 31% of GRK’s 40% interest in the Consortium and 8% of AI’s 10% interest in the Consortium. 

 

15

 

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

On May 6, 2009 KKM, GRK and AI entered into Addendum #1 to the preliminary consortium agreement whereby the parties agreed to convert the advance payments of the total amount of KZT 2,375,400,000 (equivalent to $19,668,792 at the rate of KZT 120.77 per $1 effective as of January 1, 2009) received by KKM from GRK and AI in 2008 into U.S. dollars. The addendum was made to memorialize the original                intent of the consortium parties at the time they entered into the preliminary consortium agreement in the context of the subsequent Tenge devaluation made by the Kazakhstan government in February, 2009. Of the approximately $19,700,000 advances made by GRK and AI to the consortium, approximately $14,900,000 was loaned to Latimer Assets, Inc., pursuant to a U.S. dollar denominated Note Agreement, as discussed in more detail in *Note 3 – Note                Receivable From a Related Party*, and therefore not effected by the Tenge devaluation. The balance, approximately $4,800,000, was used by Bekem in its own operations prior to the devaluation.As a result of the addendum execution, as of September 30, 2009 the advance payments received by KKM from GRK and AI equals $19,668,792 at the rate of KZT 150.95 per $1 and KKM recognized foreign exchange loss of KZT 593,604,140 (approximately $3,932,455).                

 

GRK was successful in negotiations with the MEMR on transfer of its own investment obligations to later periods while AI has also been negotiating postponing its investment obligations to later periods. As a result, on November 11, 2009 the Company, KKM, Latimer and GRK signed an offset agreement and Addendum #2 to the preliminary consortium agreement. Please refer to Note 8 “Subsequent                Events”.

 

**NOTE 6 – SHAREHOLDERS’ EQUITY**

 

***Stock grants and shares cancelled**–*On October 20, 2006, under the Company’s 2003 Stock Option Plan and pursuant to the Board of Directors desire to attract and retain experienced and educated executives, the Board agreed to award restricted stock grants (1,083,123 shares) to certain executives and key employees of the Company.                The vesting of the shares is contingent upon meeting various company-wide performance goals, including timely filing of reports with the Securities and Exchange Commission, meeting the yearly deadlines for the pilot plant construction, operations as dictated by the Board of Directors, timely performing of the drilling work program requirements as dictated by the Republic of Kazakhstan’s Ministry of Energy and Mineral Resources, and start of commercial operations. The                shares under the restricted stock grant scheme are held and released by the Company to awarded employees based on the approval of the Board and analysis of employee’s performance. If these performance conditions are not met, the Company will reverse compensation expense, unless approved by the Board of Directors, and will reverse any previously recognized compensation expenses. The fair value of the restricted stock grants was valued at $1.95 per share, which represented                the closing market price of the Company’s stock on October 20, 2006, or $2,112,090. These restricted shares are being expensed over the expected term of the performance condition, which is three years.

 

During 2007, the Company reversed the amount of deferred compensation of $822,455 (421,772 shares) due to the resignation of Mr. Cherdabayev, the previous CEO and President of the Company. 

 

On March 25, 2008, the board agreed to award to certain executives and key employees of the Company additional restricted stock grants (421,772 shares) with an estimated fair value of $337,418 at the closing market price of common stock on the date of grant ($0.80 per share).

 

As of September 30, 2009, there was $150,746 of total unexpensed compensation cost. The cost is expected to be fully recognized by January 2011. As of September 30, 2009, 656,591 shares were vested. The Company recognized $310,044 and $431,450 of compensation expense for the nine months ended September 30, 2009 and 2008, respectively.

 

16

 

 

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

**NOTE 7 - COMMITMENTS AND CONTINGENCIES**

 

***Concentration of Risk Relating to Foreign Mining Operations***– All of the Company’s properties are located within the Republic of Kazakhstan in Central Asia. In addition to general industry risks of nickel and cobalt price fluctuations, and potential lack of economic viability of the claims, the Company has a concentration of risk related to its                foreign properties and interests which are subject to political uncertainty, changes in government, unilateral renegotiation of licenses, claims or contracts, nationalization, or other uncertainties. In addition, the validity of mining claims which constitute the Company’s property holdings in Kazakhstan, may, in certain cases, be uncertain and are subject to being contested. 

 

***Failure to Satisfy the Terms of the Subsoil Use Contracts***– Under the subsoil use contracts, the Company is required to satisfy the annual minimum work program requirements. If the Company fails to satisfy these commitments, it may be subject to penalties and fines and, potentially, to the loss of one or more of its subsoil use contracts. The cancellation                of contracts would have a material adverse effect on the Company’s business, results of operations and financial condition. 

 

***Annual Work Program***– Historically, it has been the practice of the MEMR that if a subsurface user could not fulfill certain conditions for a specific year, for any reason, then the work program requirements of that year would be extended to the next year. This was done because the obligations of subsoil users were typically set forth on the basis of the                full duration of the subsoil use contract, rather than on an annual basis. During the latter part of 2007, this practice was terminated by order of the president of the country. This change in practice has created great uncertainty as to how the government will proceed in the future. Currently, there is no legislatively fixed mechanism governing the development of annual work programs or for the independent determination of compliance by the subsurface user with the parameters                of the annual work program. The determination is currently being made at the discretion of officials employed by the authorized governmental body. Based solely on their own discretion, these officials have the authority to suspend the activities of the subsurface user even for a minor breach of the detailed annual work program. These facts, coupled with the right of the competent body to unilaterally terminate a subsoil user’s contract if the contractor materially breaches                the subsoil use contract obligations, indicates there is a risk that penalties and fines could be assessed and/or one or more of the subsoil use contracts could be cancelled. 

 

***Kazakhstan Business Environment***– Kazakhstan, as an emerging market, has a legal and regulatory infrastructure that is not as mature and stable as those usually existing in more developed free market economies. As a result, operations carried out in Kazakhstan can involve risks and uncertainties that are not typically associated with those in developed                markets. The instability associated with the ongoing transformation process to a market economy can lead to changes in the business conditions in which the Company currently operates. Changes in the political, legal, tax or regulatory environment could adversely impact the Company’s operations.

 

***Environmental Matters***– Extensive national, regional and local environmental laws and regulations in Kazakhstan affect the Company’s operations. These laws and regulations set various standards regulating certain aspects of health and environmental quality and impose user fees, penalties and other liabilities for the violation of                these  standards and  establish, in some  circumstances, obligations  to remediate current  and former 

 

17

 

 

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

facilities and off-site locations. The Company believes it is currently in compliance with all existing Republic of Kazakhstan environmental laws and regulations. However, as new environmental laws and legislation are enacted and the old laws are repealed, interpretation, application and enforcement of the laws may become inconsistent. Compliance in the future could require significant                expenditures, which may adversely affect the Company’s operations.

 

***Due to the Government of the Republic of Kazakhstan***– In connection with the Company’s acquisition of the exploration contract covering the Gornostai deposit, it is required to repay the Republic of Kazakhstan for historical costs incurred in undertaking geological and geophysical studies and infrastructure improvements. The repayment terms of this                obligation will not be determined until the Company applies for and is granted a contract by the Republic of Kazakhstan to engage in commercial production. That amount is expected to be around $731,000 and has not been recorded as a liability. Under the current contract, once the Company determines the property contains commercially producible reserves, and desires to commence commercial production, it must apply for such right prior to the expiration of its exploration                contract, which is currently February 2010. The Company anticipates it will apply for a commercial production contract within the next 1-3 years. There is no guarantee when or if the Company will discover commercially producible reserves within the Gornostai deposit. Should the Company decide not to pursue a commercial production contract, then it can relinquish the Gornostai deposit to the Republic of Kazakhstan in satisfaction of this obligation.

 

The Company is required, under its licenses, to submit a proposed annual work program to the MEMR for approval. Failure to meet the minimum work program requirements could cause the Company to lose its licenses. 

 

***Liquidity of Common Shares***– The Company’s common stock has limited trading volume on the Over-the-Counter Bulletin Board and is not listed on a national exchange. Moreover, a significant percentage of the outstanding common stock is “restricted” and therefore subject to the resale restrictions set forth in Rule 144 of the rules and                regulations promulgated by the U.S. Securities and Exchange Commission under the Securities Act of 1933. These factors could adversely affect the liquidity, trading volume, price and transferability of the Company’s common shares.

 

***Nickel and Cobalt Prices can be Volatile –***Commodity prices for nickel and cobalt fluctuate according to the influence of diverse market conditions that can affect the supply or demand for a commodity such as political and economic conditions and uncertainties, advances in exploration and development technology, introduction of competing products, and                governmental restrictions on exploration, production and export of natural resources.

 

***Competition***– The Company’s principal competitors are large established companies with substantial financial resources and market share. If the Company establishes commercially producible reserves and moves to production stage, it will have to compete for customers with these companies.

 

***Operating Leases***– Bekem leases approximately 400 square feet of office space located at 324 South 400 West, Suite 225, Salt Lake City, Utah 84101 for its administrative and registered office in the United States. The Company pays annual rents of approximately $7,800 for this space pursuant to a lease agreement that expired in October 2009. The Company is                currently renting this space on a month-to-month basis at its current rate while it negotiates the terms of a new one-year lease. The Company anticipates it will be successful in negotiating a new lease on terms comparable to its previous lease, but if negotiations are unsuccessful, the Company anticipates it will be able to find a replacement space under similar terms. 

 

18

 

 

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**SEPTEMBER 30, 2009 (UNAUDITED)**

 

 

The Company also maintains a representative office in Almaty, Kazakhstan, where it leases approximately 645 square feet of office space. The lease agreement expires on August 31, 2010. The monthly lease payment is $905. Upon consent of both parties, the agreement may be prolonged further. 

 

Kaznickel LLP rents an office (approximately 2,200 square feet) in Semei, Kazakhstan, for approximately $4,000 per month. Semei is the closest city to the Gornostai deposit. Kaznickel also rents approximately 5,300 square feet of warehouse space in Semei for $3,900 per month. Kaznickel uses this space to store test ore. These lease agreements expire in March 31, 2010. If at any time the owner of                this space decides they need or want the space for other purposes, Kaznickel has no right to continue to occupy the space and could be forced to move. 

 

KKM rents approximately 1,101 square feet of office space in Aktobe, Kazakhstan. KKM pays approximately $725 per month for this space.The lease agreement expires on July 20, 2010. Upon consent of both parties, the agreement may be prolonged further.

 

**NOTE 8 –SUBSEQUENT EVENTS**

 

On October 27, 2009 the MEMR issued a letter whereby it allowed the Company to sell 100% interest in the authorized capital of Kaznickel to Ertis for 280,000 Kazakh tenge provided that Ertis will repay the loan of $5,000,000 payable by Kaznickel to the Company. The Company and Ertis signed a definitive sale-purchase agreement on November 3, 2009, which is scheduled to close within 20 business days of                November 3, 2009. As of the date of this report, the Company has received $2,001,856 from Ertis, including $500,000 which was received as an advance payment in the first quarter 2009. 

 

On November 11, 2009 the Company, KKM, Latimer and GRK signed an offset agreement and Addendum #2 to the preliminary consortium agreement to offset the note receivable from Latimer (see Note 3) against KKM’s notes payable to GRK because of the current inability of GRK, AI and their shareholders to finance the Consortium due to the effects of the volatility in the world financial and nickel                markets. Under the Addendum #2, the parties are obliged to jointly contribute approximately $9.2 million to be used in connection with financing the construction of the processing plant. Of this amount, KKM is obligated to contribute approximately $4.6 million. Also, since the Consortium Agreement is of a preliminary nature, on October 26, 2009 GRK has made a demand for the return of $2.5 million it initially contributed to the Consortium. As of the date of these financial                statements, the $2.5 million has not been returned to GRK. It is anticipated these funds will be returned during the upcoming fiscal quarter. KKM, GRK and AI are currently in the process of negotiating a definitive consortium agreement. In connection with the Addendum #2, the parties agreed to extend the period of final determination of the ownership interests of the parties to March 1, 2010.

 

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**Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations**

 

For a complete understanding, this management’s discussion and analysis of financial condition and results of operations should be read in conjunction with the Condensed Consolidated Financial Statements and Notes to the Condensed Consolidated Financial Statements contained in this quarterly report on Form 10-Q and our annual report on Form 10-K for the year ended December                31, 2008. 

 

**Forward Looking Information and Cautionary Statement**

 

This quarterly report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Act of 1934, as amended, that are based on our management’s beliefs and assumptions and on information currently available to our management. For this purpose any statement contained in this                annual report that is not a statement of historical fact may be deemed to be forward-looking, including statements about our revenue, spending, cash flow, products, actions, intentions, plans, strategies and objectives. Without limiting the foregoing, words such as “*may*,” “*hope*,” “*will*,”                “*expect*,” “*believe*,” “*anticipate*,” “*estimate*” “*projected”*or “*continue*” or comparable terminology are                intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainty, and actual results may differ materially depending on a variety of factors, many of which are not within our control. These factors include but are not limited to those relating to our plan of operations including our ability to construct a processing plant and put our property into commercial production, economic conditions generally and in the industry                in which we and our customers participate, future commodity prices; competition within our industry, including competition from much larger competitors, future exploration, legislative requirements and changes and the effect of such on our business, results of operations, sufficiency of future working capital, borrowings and capital resources and liquidity and our ability to generate future cash flow and to continue to meet the requirements of and maintain our rights to our                properties.

 

Forward-looking statements are predictions and not guarantees of future performance or events. Forward-looking statements are based on current industry, financial and economic information, which we have assessed but which by its nature is dynamic and subject to rapid and possibly abrupt changes. Our actual results could differ materially from those stated or implied by such                forward-looking statements due to risks and uncertainties associated with our business. We hereby qualify all our forward-looking statements by these cautionary statements. We undertake no obligation to amend this report or revise publicly these forward looking statements (other than pursuant to reporting obligations imposed on registrants pursuant to the Securities Exchange Act of 1934) to reflect subsequent events or circumstances.

 

Throughout this report, unless otherwise indicated by the context, references herein to the “Company”, “BMI”, “we”, our” or “us” and similar language means Bekem Metals, Inc., a Utah corporation, and its corporate subsidiaries and predecessors**.**

 

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|   | **Overview** |
|--------|--------------|

 

We are engaged in the development and exploration of nickel, cobalt and brown coal deposits in the Republic of Kazakhstan. We carry out our exploration activities through our two wholly-owned subsidiaries, Kyzyl Kain Mamyt LLP (“KKM”) and Kaznickel LLP. 

 

The following table provides additional information regarding our subsoil use contracts: 

 

| **Territory****Name** | **Size of****Territory** |  

**Primary Minerals** | **License**

**Type**         | **License or****Contract #** | **License and**

**Subsoil Use Contract Term**                                                     |
|-----------------------|--------------------------|------------------------------|-------------------------------|------------------------------|----------------------------------------------------------------------------------------------------|
|                  |                     |                         |                          |                         |                                                                                               |
| Kempirsai             | 575,756 acres            | Nickel and cobalt ore        | Production                    | MG #420

MG #426             | Expires Oct. 12, 2011 unless extended.                                                             |
|                  |                     |                         |                          |                         |                                                                                               |
| Mamyt                 | 116 acres                | Brown coal                   | Production                    | MG #9-D                      | Expires Dec. 11, 2018 unless 

extended.

                                                    |
| Gornostai             | 12,232 acres             | Nickel and cobalt ore        | Exploration

and 

Production | 1349                         | Exploration period expires Feb. 26, 2010. Production period expires Feb. 26, 2026 unless extended. |

 

The primary assets of KKM are exclusive subsoil use licenses and contracts to a 575,756 acre territory in northwestern Kazakhstan referred to herein as the Kempirsai deposit. The contract grants KKM the right to explore, extract and process nickel and cobalt ore from the Kempirsai deposit, which is comprised of the Kara-Obinskoe and Stepninskoye sections (collectively referred to                as the “Kara-Obinskoye section”) and the Novo-Shandashinskoe section. KKM also holds a subsoil use contract to explore and produce brown coal from the Mamyt coal deposit, which is located within 40 kilometers of the Kempirsai deposit. Unless otherwise indicated by the context of the disclosure, the Kara-Obinskoye section, the Novo-Shandashinskoye section and the Mamyt deposit are collectively referred to herein as the Kempirsai deposit. 

 

In December 2008 KKM received a notice from the MEMR extending the term of KKM’s subsoil use contract for nickel and cobalt ore exploration and production until the year 2020. The MEMR has further agreed to suspend ore mining requirements until the end of 2012 to allow KKM to focus on the construction of an ore processing facility. The notice indicates that under the                Work Program, KKM will be required to invest $135 million to be applied to its mining and ore processing technology during the period 2006-2020 (or around $125 

million for the remaining period). Currently, the addendum to the KKM subsoil use contract is under negotiations and expected to be signed in fourth quarter 2009. KKM has received authorizations from various governmental authorities on the draft addendum; however, the addendum has not been signed due to currently occurring changes of key officials in the regulatory authorities, adoption of a new tax                code and changes in the subsoil use legislation of Kazakhstan. The new addendum will also replace the existing tax regime indicated in the subsoil use contact to be in compliance with the new Tax Code regime in exchange for changes proposed by KKM. Should we fail to complete the minimum work program imposed by any of our subsoil use contracts in a given year, the MEMR could review the work program, request an update and amendment to the work program, impose fines and penalties                upon us or even revoke our subsoil use contracts and licenses.

 

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Also, as noted above, our subsoil use contract for the Kempirsai nickel and cobalt deposit and Mamyt brown coal deposit grant us commercial production rights. The Kempirsai deposit was discovered in 1938 and at its peak in the late 1980’s produced almost five million tons of ore annually. Since the mid-1990’s, however, mining activity at the deposit has been                insignificant.

 

We currently have no processing facilities at either the Kempirsai or Gornostai deposits. We plan to construct processing facilities to process our ores at our Kempirsai deposit. On September 8, 2008 the Company announced that it has completed initial pilot testing of various technologies for processing nickel ore from its Kempirsai deposit. Based on the results of the                pre-feasibility study, the Company intends to focus on the Vanyukov Process for further development of the Kempirsai deposits and construction of a nickel processing plant in Aktobe region, Kazakhstan (Kempirsai deposit). The Vanyukov Process, first developed in the 1940's in Russia, is capable of treating oxide nickel ores to form either a nickel matte (by addition of a sulphur containing compound such as pyrite) or directly to form a ferronickel alloy containing up to 20%                nickel. Management expects the Company will need around $160 million to fund construction of a processing plant with the planned annual capacity of 20,000 tons of ferronickel (5,000 tons of nickel). If funding can be secured, management hopes to begin construction in 2010 and anticipates a processing plant could be operational in 2013. As we generate no revenue, we will need to raise additional capital through the sale of our equity and/or debt securities to fund plant                construction.

 

The primary asset of Kaznickel is an exclusive subsoil use license and contract that grants Kaznickel the exclusive right, through February 2010, to explore for nickel, cobalt and other minerals in a 12,232 acre area in northeastern Kazakhstan known as the Gornostai deposit. The concession further provides that if we make a commercial discovery of nickel, cobalt or other minerals                within the concession territory, we can apply for and receive the exclusive rights to commercially produce and sell such ore through February 2026. The annual work program for 2009 requires Kaznickel to drill test holes totaling at least 1,000 meters. 

 

As noted above, on November 3, 2009 we entered into an agreement to sale our interest in Kaznickel, which would include our rights to the Gornostai deposit to Ertis Ferronickel, an unrelated third party. The agreement is scheduled to close within 20 business days of November 3, 2009.

 

**Liquidity and Capital Resources**

 

At September 30, 2009 we had cash on hand of $37,377. Since inception we have generated limited revenue and we anticipate we will need to spend at least $160 million to fund construction of a processing plant before we begin to realize significant revenue from operations. Since inception we have an accumulated deficit of $35,017,455. At September 30, 2009, current liabilities                exceeded current assets by $5,630,447. For some time we have been seeking sources of additional funding, but to date we have been unsuccessful in our efforts. Given the current global financial and economic condition, coupled with the significant decline in world nickel prices, we anticipate it will be difficult to secure additional funding.

 

As we have, to date, been unable to obtain equity or debt funding, we have been investigating the possibility of liquidating certain Company assets to allow us to continue operations while we continue to seek equity or debt funding. Due to inability of the Company to obtain equity or debt funding, partially as a result of 

 

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the financial crisis impacting the global economy, on February 11, 2009 the Company executed a Memorandum of Understanding for the purchase and sale of 100% of the charter capital of Kaznickel between the Company and Ertis Ferronickel Works LLP (“Ertis”). Subject to the execution of a definitive agreement, Ertis agreed to acquire 100% of the outstanding charter capital of            Kaznickel for 91,900 Kazakh tenge (approximately $630) and for repayment of $5,000,000 worth of loans owed to Bekem Metals by Kaznickel. Subsequently, the purchase price for the sale of 100% of the outstanding charter capital of Kaznickel was increased from 91,900 Kazakh tenge to 280,000 Kazakh tenge (approximately $1,867). The Memorandum of Understanding provided for an initial payment of $500,000, which was made on March 20, 2009, and payment of the remaining balance is to occur            within 20 business days after the execution of a definitive agreement. Execution of a definitive agreement was subject to negotiation, due diligence investigation and approval of the transaction by the MEMR. On October 27, 2009 the Company received MEMR approval of the sale of Kaznickel to Ertis and on November 3, 2009 the Company and Ertis executed a definitive agreement for sale of 100% of the outstanding charter capital of Kaznickel to Ertis. Closing of the agreement is scheduled            to occur within 20 business days of November 3, 2009.

 

The remaining proceeds from that sale, approximately $4,500,000 ($500,000 was received in the first fiscal quarter 2009 as an advance payment), will not provide us adequate funding to meet our minimal operational needs through the end of the current fiscal year. 

 

After execution of the addendum to our Kempersai license, we anticipate the minimum annual work program associated with the Kempirsai deposit will be at least $6,000,000 during 2009. To address our minimal operating needs and the annual work program requirements associated with the Kempirsai deposit, we anticipate we will require approximately $7,000,000 during the remaining                period of 2009. We anticipate the failure to satisfy our annual work program requirements will result in the forfeiture of our Kempirsai subsoil use contracts and licenses. We plan to continue negotiations with the MEMR to transfer the part of the 2009 investment obligations to 2010 due to significant delay in signing the new addendum. We do not know if we will be successful in shifting any portion of our 2009 obligations into 2010. 

 

In order to meet our anticipated short fall and avoid the forfeiture of our rights to the Kempirsai deposit, we continue to seek sources of funding. We are also investigating the potential sale of other Company assets. Given the significant capital requirements associated with the construction of a processing plant and the difficulties we have faced in the current economic and                financial climate in sourcing additional capital, coupled with the collapse of world nickel prices, we may even investigate the possibility of selling our interest in our wholly-owned subsidiary KKM, including its rights to the Kempirsai deposit.

 

The *Report of Independent Registered Public Accounting Firm*included in our annual report for the year ended December 31, 2008, included a going concern note. We believe nothing has occurred during the quarter that would change that guidance, nor do we anticipate that the underlying conditions will improve until we are able to                obtain significant additional funding.

 

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During the nine months ended September 30, 2009 and September 30, 2008, cash was used to fund operations as follows:

 

 

| *For the Nine Months Ended September 30,*           | **2009**       | **2008**            |
|-----------------------------------------------------|----------------|---------------------|
|                                                |           |                |
| Net cash used in operating activities               | $ (698,707)    | $(3,944,023)        |
| Net cash provided by (used in) investing activities | 623,868   | (15,034,411)        |
| Net cash provided by financing activities           | –   | 19,698,150     |
| Effect of exchange rate changes on cash             | (3,428)        | 789            |
| **NET (DECREASE) / INCREASE IN CASH**               | **$ (78,267)** | **$ 720,505**  |

 

During the nine months ended September 30, 2009 net cash used in operating activities was $698,707 compared to net cash used in operating activities of $3,944,023 during the nine months ended September 30, 2008. This decrease in net cash used in operating activities primarily occurred due to reduced general and administrative costs and exploratory activities as a result of our                financial difficulties.

 

During the nine months ended September 30, 2009 net cash received from investing activities was $623,868. By comparison, during the nine months ended September 30, 2008 we used net cash in investing activities of $15,034,411. Cash received from investing activities mainly represents an advance payment received in connection with the potential sale of Kaznickel and an advance                received from Asia Invest for sale of special equipment.

 

During the nine months ended September 30, 2009 we did not receive any cash from financing activities. During the nine months ended September 30, 2008 net cash provided by financing activities was $19,698,150 which occurred due to loans provided to KKM under the consortium agreement. 

 

**Results of Operations**

 

***Three months ended September 30, 2009 compared to the three months ended September 30, 2008***

|   | Revenue |
|--------|---------|

 

Because our deposits are without known reserves, we are considered to be in the exploration stage. Any revenue earned during this stage from sale of ore or brown coal is recorded against exploratory costs. We did not have any of such incidental sales during the three months ended September 30, 2009 and September 30, 2008.

 

|   | General and Administrative Expenses |
|--------|-------------------------------------|

 

Our general and administrative expenses during the three months ended September 30, 2009 decreased to $716,250 from $966,815during the third quarter 2008. This $250,565 decrease in general and administrative expenses in the third quarter 2009 was primarily the result of lower payroll expenses. During the three months ended September 30, 2009 payroll expenses                decreased by approximately $168,000. We currently employ approximately 200 employees, including part- and full-time working employees and 115 employees have been sent on unpaid vacation due to our current financial difficulties. General and administrative expenses also decreased as a result of the Tenge devaluation which occurred in the beginning of February, 2009. The total estimated effect of the Tenge devaluation on our general and administrative expenses is approximately                $94,000, including devaluation effect on payroll expenses of $48,000. The balance of the decrease (approximately $37,000) resulted from the reduced scope of the Company’s operations due to our current financial difficulties. 

 

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Research and Development Costs

 

We engaged in no research and development activities during the third quarter 2009, while during the three months ended September 30, 2008, we incurred research and development costs of $44,749 related to preparation of the pre-feasibility study on construction of a nickel processing plant at the Kempirsai deposits. 

 

|   | Exploratory Costs |
|--------|-------------------|

 

During the three months ended September 30, 2009, due to a lack of working capital, we did no exploratory drilling at the Gornostai deposit. During the three months ended September 30, 2008 we incurred $134,251 in exploratory costs in drilling 8 test holes (all 8 test holes were in the North section of the Gornostai deposit) and chemical and other laboratory analyses of drilled                samples.

 

During the three months ended September 30, 2009 we did not extract any ore or coal. During the three months ended September 30, 2008 we extracted 85,901 tons of ore. The ore extraction costs of $199,687 incurred during the third quarter of 2008 were included into exploratory costs since the Company is in the exploration stage.

 

Exploratory costs of $25,705 and $61,407 during the quarter ended September 30, 2009 and 2008, respectively, mainly represent geologists’ and other specialists’ salaries, other costs in preparation for future exploratory activities and some Kempirsai mining asset maintenance expenses. 

|   | Accretion Expense |
|--------|-------------------|

 

Accretion expense increased by $8,406 to $29,743 during the three months ended September 30, 2009 compared to the same period of 2008 due to the revision of asset retirement obligations made at the end of 2008. Until we engage in mining and production, we believe accretion expense will continue at rates consistent with those realized during the quarter ended September 30, 2009.                

 

Grant Compensation Expense

 

During the three months ended September 30, 2009 we recognized $72,416 in grant compensation expense for restricted stock grants issued to certain officers and key employees during the fourth quarter 2006 and the second quarter 2008 compared to $154,295 for the three months ended September 30, 2008. The reduction in grant compensation expenses has occurred due to vesting of the                major part of shares granted. As a result of the vesting, we anticipate the grant compensation expense amount to decrease by approximately $36,130 next quarter. 

 

Total Operating Expenses and Loss from Operations

 

Our total operating expenses and loss from operations decreased from $1,582,541 during the three months ended September 30, 2008 to $844,114 during three months ended September 30, 2009. The principal reasons for the decrease are a decrease in general and administrative expense of $250,565 due to lower payroll expenses and the effect of the Tenge devaluation during the first                quarter 2009. In addition, less exploratory costs (decreased by $369,640) and no research and development costs were incurred in the third quarter of 2009 due to our current shortage of financial resources. Grant compensation expense was also lower due to vesting of a significant portion of the granted shares. 

 

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Interest Income

 

During the three months ended September 30, 2009, we realized interest of $377 on deposits. By comparison, during the three months ended September 30, 2008, we realized interest of $82,738 on deposits and on the note receivable from a related party.

 

Translation Adjustment and Exchange Gain/Loss From Remeasurement

 

The consolidated financial statements are presented in U.S. dollars. The functional currency of Kaznickel is U.S. dollars. The functional currency of KKM is Kazakh tenge. Results of operations are translated into U.S. dollars at the average exchange rates during the reporting period. All balance sheet accounts of KKM are translated at exchange rates on the date of the financial                statements, except equity which is translated at weighted-average historical rates. The translation differences are included in stockholders’ equity as cumulative translation adjustments. 

 

Non-monetary assets and liabilities of our Kaznickel and Almaty representative offices, as well as the related expense accounts, are translated into U.S. dollars, using historical exchange rates and monetary assets and liabilities are translated into U.S. dollars using exchange rates on the date of the financial statements and the resulting balance sheet item differences are                included in the results of operations as exchange gains/losses from remeasurement. The exchange difference from remeasurement is commonly, but not always, positive (gain) if the average exchange rates are lower than exchange rates on the date of the financial statements and negative (loss) if the average exchange rates are higher than exchange rates on the date of the financial statements.

 

Exchange Gain/Loss

 

During the quarter ended September 30, 2009, we realized an exchange loss of $99,823 compared to an exchange gain of $14,186during the quarter ended September 30, 2008. As with the gain/loss from remeasurement, we recognize exchange gain or loss as a result of having subsidiaries operating in foreign countries whose functional currency may or may not be the                U.S. dollar. This requires us to translate results of operations from a foreign currency, in this case Kazakh tenge, to U.S. dollars at the average exchange rate, where results of operations include exchange gains or losses on the U.S. dollar monetary assets and liabilities. 

|   | Net Loss |
|--------|----------|

 

For the foregoing reasons, during the three months ended September 30, 2009 we experienced a net loss of $812,234 compared to a net loss of $1,410,589 during the three months ended September 30, 2008. We anticipate that we will continue to experience net losses of around $900,000 per quarter until we are able to engage in significant nickel and cobalt ore extraction, processing                and sales.

 

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***Nine months ended September 30, 2009 compared to the nine months ended September 30, 2008***

|   | Revenue |
|--------|---------|

 

Because our deposits are without known reserves, we are considered to be in the exploration stage. Any revenue earned during this stage from sale of ore or brown coal is recorded against exploratory costs. During the nine months ended September 30, 2009, such incidental sales amounted to $311. By comparison, during the third quarter 2008, we realized $93,070from the sale of ore or brown coal.

 

|   | General and Administrative Expenses |
|--------|-------------------------------------|

 

Our general and administrative expenses during the nine months ended September 30, 2009 decreased to $2,127,911 from $3,312,138 during nine months ended September 30, 2008. This $1,184,227 decrease in general and administrative expenses for the nine months ended September 30, 2009 was primarily the result of lower payroll expenses. During the nine months ended September 30, 2009                payroll expenses decreased by approximately $730,000. We currently employ approximately 200 employees, including part- and full-time working employees and 115 employees have been sent on unpaid vacation due to our current financial difficulties. General and administrative expenses also decreased as a result of the Tenge devaluation which occurred in the beginning of February 2009. The total estimated effect of the Tenge devaluation on our general and administrative expenses is                approximately $268,000, including devaluation effect on payroll expenses of $117,000. The balance of the decrease (approximately $303,000) has occurred as a result of the reduced scope of the Company’s operations due to our current financial difficulties. 

                                                                                            

Research and Development Costs

 

We engaged in no research and development activities during the nine months ended September 30, 2009. During the nine months ended September 30, 2008, we incurred research and development cost of $229,298. This amount was related to preparation of the pre-feasibility study on construction of a nickel processing plant at the Kempirsai deposits. 

 

|   | Exploratory Costs |
|--------|-------------------|

 

During the nine months ended September 30, 2009, due to a lack of working capital as a result of our current inability to raise funds, we did no exploratory drilling. During the nine months of 2008 we completed drilling of 8 test holes (all 8 test holes were in the North section of the Gornostai deposit) to an aggregate depth of 725 meters. Approximately $241,451 was spent during                this period on exploratory drilling and on chemical and other laboratory analyses of the drilled samples. 

 

During the nine months ended September 30, 2009 we did not extract any ore or coal. During the nine months ended September 30, 2008 we extracted 85,901 tons of ore. The ore extraction costs of $199,687 were included into exploratory costs since the Company is in the exploration stage.

 

27

 

 

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Also, as discussed above, because our activities are considered as exploratory, exploratory costs are reflected net of revenues earned from sale of ore or brown coal. During the nine month period ended September 30, 2009 and September 30, 2008, we realized revenue of $311 and $93,070, respectively. 

 

The balance of exploratory costs of $62,798 and $164,659 mainly represent geologists’ and other specialists’ salaries, other costs in preparation for future exploratory activities and some Kempirsai mining asset maintenance expenses incurred during the nine months ended September 30, 2009 and 2008, respectively. 

|   | Accretion Expense |
|--------|-------------------|

 

Accretion expense increased by $27,823 to $91,801 during the nine months ended September 30, 2009 compared to the same period of 2008 due to the revision of asset retirement obligations made in the end of 2008. Until we engage in mining and production, we believe accretion expense will continue at rates consistent with those realized during the nine months ended September 30,                2009. 

 

Grant Compensation Expense

 

During the nine months ended September 30, 2009 we recognized $310,044 in grant compensation expense for restricted stock grants issued to certain officers and key employees during the fourth quarter 2006 and the second quarter 2008 compared to $431,450 for the nine months ended September 30, 2008. The reduction in grant compensation expenses occurred due to the vesting of a                significant portion of shares granted. As a result, we anticipate the next nine months grant compensation expense amount to decrease by approximately $219,254. 

 

Total Operating Expenses and Loss from Operations

 

Our total operating expenses and loss from operations decreased from $4,549,591during the nine months ended September 30, 2008 to $2,592,243 during the nine months ended September 30, 2009. The principal reasons for the decrease are a decrease in general and administrative expense of $1,184,227 due to lower payroll expenses and the effect of the Tenge                devaluation during the first quarter 2009. In addition, we incurred less exploratory costs (decreased by $450,240) and no research and development costs during the nine months ended September 30, 2009 due to our current shortage of financial resources. Also, grant compensation expenses were lower due to the vesting of a significant portion of the granted shares. 

 

Interest Income

 

During the nine months ended September 30, 2009, we realized interest of $577 on deposits and interest of $74,500 on the note receivable from a related party (Latimer). By comparison, during the nine months ended September 30, 2008, we realized interest of $145,313 on deposits and on the note receivable related party. 

 

As discussed above in the Notes to the Condensed Consolidated Financial Statements, the Company and Latimer are in the process of negotiating an addendum to the Note Agreement. Pending completion of negotiations of such addendum, accrual of interest previously accrued at a rate of 2% per annum was suspended as of March 31, 2009.

 

28

 

 

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Translation Adjustment and Exchange Gain/Loss From Remeasurement

 

The consolidated financial statements are presented in U.S. dollars. The functional currency of Kaznickel is U.S. dollars. The functional currency of KKM is Kazakh tenge. Results of operations are translated into U.S. dollars at the average exchange rates during the reporting period. All balance sheet accounts of KKM are translated at exchange rates on the date of the financial                statements, except equity which is translated at weighted-average historical rates. The translation differences are included in stockholders’ equity as cumulative translation adjustments. 

 

Non-monetary assets and liabilities of our Kaznickel and Almaty representative offices, as well as the related expense accounts, are translated into U.S. dollars, using historical exchange rates and monetary assets and liabilities are translated into U.S. dollars using exchange rates on the date of the financial statements and the resulting balance sheet item differences are                included in the results of operations as exchange gains/losses from remeasurement. The exchange difference from remeasurement is commonly, but not always, positive (gain) if the average exchange rates are lower than exchange rates on the date of the financial statements and negative (loss) if the average exchange rates are higher than exchange rates on the date of the financial statements.

 

On February 4, 2009, Kazakhstan’s National Bank dramatically devalued the Tenge, the local currency, from a range of 117-123 Tenge/U.S. dollar to 145-155 Tenge/U.S. dollar, citing the decline in oil price (oil comprises 60% of Kazakh exports), currency devaluations in Kazakhstan’s neighbors, particularly Russia, and the fledgling state of the domestic banking sector.                This currency devaluation was the main cause of the exchange gain from remeasurement recognized by us during the nine months ended September 30, 2009.

 

Exchange Gain/Loss

 

During the nine months ended September 30, 2009, we realized an exchange loss of $3,967,595 compared to an exchange gain of $16,198 during the same period of 2008. As with the gain/loss from remeasurement, we recognize exchange gain or loss as a result of having subsidiaries operating in foreign countries whose functional currency may or may not be the U.S. dollar. This requires                us to translate results of operations from a foreign currency, in this case Kazakh tenge, to U.S. dollars at the average exchange rate, where results of operations include exchange gains or losses on the U.S. dollar monetary assets and liabilities. The currency devaluation discussed above was the main cause of the foreign exchange loss incurred by the Company during the nine months ended September 30, 2009 and comprised mainly of the loss incurred from revaluation of advances                received by KKM under the preliminary consortium agreement (approximately $3,932,455).

 

29

 

 

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|   | Net Loss |
|--------|----------|

 

For the foregoing reasons, during the nine months ended September 30, 2009 we experienced a net loss of $4,744,581 compared to a net loss of $4,023,214during the nine months ended September 30, 2008. We anticipate we will continue to experience net losses until we are able to engage in nickel and cobalt ore extraction, processing and sales. 

 

**Summary of Material Contractual Commitments**

 

|   | The following table lists our significant commitments as of September 30, 2009: |
|--------|---------------------------------------------------------------------------------|

 

 

|                                |   | **Payments due by Fiscal Year**      |
|-------------------------------------|--------|--------------------------------------|
|  

**Contractual Commitments** |   |  

**Total**                    |   | **Less than****1 year** |   |  

**1-3 years** |   |  

**3-5 years** |   | **More than 5 years** |
|                                |   |                                 |   |   |   |   |   |   |   |   |
| Kaznickel’s work programs(1)  |   |  

$   3,409,580 |   |  

$     378,000 |   |  

$    1,900,000 |   |  

$1,131,580 |   |  

-0- |
| KKM’s work programs (2) (3)   |   | 121,018,000                          |   | 12,700,000 |   | 108,318,000 |   | -0- |   | -0- |
| Operating leases                    |   | 279,228                              |   | 279,228 |   | -0- |   | -0- |   | -0- |
| **Total**                           |   | $124,706,808                         |   | $13,357,228 |   | $110,218,000 |   | $1,131,580 |   | -0- |
|                                     |        |                                      |  |  |  |  |  |  |  |  |  |

                

| (1) | The work program for Kaznickel substantially represents estimates for 2009 based on the subsoil use contract and includes $378,000 for exploration drilling (1,000 meters), sampling and assaying (650 core samples), metallurgical tests and preparation of the report to the State Resource Committee. Also, the estimate includes $831,580 for repayment to                                the Republic of Kazakhstan of historical costs incurred by it in undertaking geological and geophysical studies and infrastructure improvements related to the Gornostai deposit. The repayment terms of this obligation will not be determined until such time as we apply for and are granted a contract to engage in commercial production by the Republic of Kazakhstan. We currently anticipate that we will apply for a commercial production contract within the next one to                                two years. The figures above include an estimated amount of a commercial discovery bonus of $1,500,000. However, there is no guarantee when or if we will discover commercially producible reserves within the Gornostai deposit. Should we decide not to pursue a commercial production contract, we can relinquish the Gornostai deposit to the Republic of Kazakhstan in satisfaction of this obligation. Also, the estimates include the subsoil use contract requirement to                                donate $300,000 for the ongoing development of Astana and Kurchatov, which are cities in Kazakhstan. The estimates above do not include the cost of a bankable feasibility study and construction of a nickel processing plant. The amount of preliminary feasibility study included in the table above is $400,000. 

  |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

  

| (2) | KKM’s work program represents estimates based on the subsoil use contract and the financial model which is attached to the working program. The current terms of the contract require us to invest up to $100,000,000 for construction of a processing plant during the contract period. Also, the estimate includes $950,000 for removal of all                                equipment and to remediate the property. This remediation work can be done during the term of the subsoil use contract or upon completion of the terms of the contract. On December 29, 2008 KKM received a notice from the MEMR that it has agreed to extend the term of KKM’s subsoil use contract until the year 2020. The MEMR has further agreed to suspend ore mining requirements until the end of 2012 to allow KKM to focus on the construction of an ore                                processing facility. The notice indicates that under the new work program, KKM will be required to invest $135 million to be applied to its mining and ore processing technology during the period 2006-2020 (or around $123.4 million for the remaining period). Currently, the addendum to the KKM subsoil use contract and new annual work program for 2009 is under negotiation and expected to be signed in fourth quarter 2009. The expected changes are not reflected in the                                above estimates and will be reflected when these changes are legally approved by the MEMR by signing the new addendum to the existing subsoil use contract. |
|-----|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

30

 

 

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| (3) | In March 2008, KKM entered into a preliminary consortium agreement with two Kazakhstani companies, GRK Koitas LLP (“GRK”) and Asia-Invest Corporation LLP (“AI”), who also have exploration and production licenses near the Company's Kempirsai deposits in northwestern Kazakhstan. In connection with the                                preliminary consortium agreement KKM received advances of KZT 2.278 million ($18,889,956 as of December 31, 2008) from GRK, and KZT 97.4 million ($807,963 as of December 31, 2008) from AI, which were to be used for construction of a processing plant. On October 26, 2009, GRK and its shareholders requested for an offset of the amount received under the preliminary consortium agreement against the note receivable from Latimer of $15,140,828 and the return of an                                additional $2.5 million it contributed to the Consortium. Consequently, these advances have been classified as current notes payable to related parties. Contributions made by the parties into the consortium are accounted for in the annual work programs of these parties. Under the preliminary consortium agreement, which was amended in November 2009, the parties are obliged to jointly contribute approximately $9.2 million to be used in connection                                with financing the construction of the processing plant. Of this amount, KKM is obligated to contribute approximately $4.6 million. |
|-----|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

As discussed above, to maintain our rights to the Gornostai, Kempirsai and Mamyt deposits we must satisfy the minimum work program requirements of the MEMR. Should we fail to complete the minimum work program requirements, the MEMR could review the work program, request an update and amendment to the work program, impose fines and penalties upon us or even revoke our subsoil use                contracts and licenses.

 

**Off-Balance Sheet Financing Arrangements**

 

|   | As of September 30, 2009 we had no off-balance sheet financing arrangements. |
|--------|------------------------------------------------------------------------------|

 

**Critical Accounting Policies**

 

We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the                financial statements and the reported amounts of expenses and revenues, to the extent we generated revenue during the periods presented. Actual results could differ from these estimates. Our significant accounting policies require us to make difficult, subjective or complex judgments or estimates. We consider an accounting estimate to be critical if (1) the accounting estimate requires us to make assumption about matters that were highly uncertain at the time the accounting                estimate was made and (2) changes in the estimates that are reasonably likely to occur from period to period, or use different estimates that we reasonably could have used in the current period, would have a material impact on our financial condition or results of operations.

 

There are other items within our financial statements that require estimation, but are not deemed critical as defined above. Changes in estimates used in these and other items could have a material impact on our financial statements. Management has discussed the development of these critical accounting estimates with our board of directors and they have reviewed the foregoing                disclosure.

31

 

 

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***Use of Estimates***– In connection with the preparation of our financial statements, we are required to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. One of the significant areas requiring the use of management estimates and assumptions relates to environmental reclamation                and closure obligations. Under our licenses with the Republic of Kazakhstan, following completion of exploration and mining activities we are required to reclaim our licensed territories. To prepare our financial statements in accordance with accounting principles generally accepted in the United States of America we are required to account for this obligation. The determination of the amount of the mine retirement and environmental reclamation obligation the Republic of                Kazakhstan will impose upon us, however, has not yet been determined. The determination of the mine retirement and environmental reclamation obligation is based, in significant part, on the size of each deposit. Because we are still exploring our Gornostai property and do not yet know the full extent of the Gornostai deposit, the mine retirement and environmental reclamation obligation has not yet been set by the Republic of Kazakhstan. We base our estimate of this obligation on                historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Accordingly, actual results may differ significantly from our estimate. 

 

***Income Taxes***– While we are a Utah corporation, our primary operations are in the Republic of Kazakhstan. The Republic of Kazakhstan was formed in 1991 following the break-up of the former Soviet Union. At the time the Republic of Kazakhstan was formed, it adopted a new tax code. The tax code and the application of tax laws in the Republic                of Kazakhstan are still developing and may not be uniformly applied in all instances.

 

**Item 3. Qualitative and Quantitative Disclosures about Market Risk**

 

Our primary market risks are fluctuations in commodity prices and foreign currency exchange rates. We do not currently use derivative commodity instruments or similar financial instruments to attempt to hedge commodity price risks associated with future nickel production.

 

**Commodity Price Risk**

 

Our revenues, profitability and future growth will depend substantially on prevailing prices for nickel and cobalt. If and when we commence commercial production, commodity prices will affect the amount of cash flow available for capital expenditures and our ability to either borrow or raise additional capital. Price will also affect our ability to produce, transport and market                the nickel and cobalt we produce.

 

Historically, nickel and cobalt prices have been subject to significant volatility in response to changes in supply, market uncertainty and a variety of other factors beyond our control. Nickel and cobalt are likely to continue to be volatile in the future and this volatility makes it difficult to predict future price movements with any certainty. Any declines in nickel and cobalt                prices would reduce the revenues we could earn when we begin commercial production, and could also reduce the amount of nickel and cobalt that we can produce economically. As a result, this could have a material adverse effect on our business, financial condition and results of operations. 

 

32

 

 

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**Foreign Currency Risk**

 

Our functional currency is the U.S. dollar. Our Kazakhstani subsidiary Kaznickel uses the U.S. dollar as its functional currency and KKM uses the Kazakh tenge as its functional currency. To the extent that business transactions in Kazakhstan are denominated in the Kazakh tenge we are exposed to transaction gains and losses that could result from fluctuations in the U.S.                dollar—Kazakh tenge exchange rate. When the U.S. dollar strengthens in relation to the Kazakh tenge, the U.S. dollar-reported expenses will decrease. We do not engage in hedging transactions to protect us from such risk. 

 

On February 4, 2009, Kazakhstan’s National Bank dramatically devalued the Tenge, the local currency, from a range of 117-123 Tenge/U.S. dollar to 145-155 Tenge/U.S. dollar, citing the decline in oil price (oil comprises 60% of Kazakh exports), currency devaluations in Kazakhstan’s neighbors, particularly Russia, and the fledgling state of the domestic banking sector.                We have limited confidence in the government’s ability to control prices in the near to medium term, and with the value of Tenge wages falling, purchasing power is declining. The future effect of the devaluation is difficult to project given present uncertainty on the currency markets and on the government’s policy regarding the exchange rates and/or foreign currency regulations.

 

**Item 4T. Controls and Procedures**

 

*Evaluation of Disclosure Controls and Procedures*

 

We maintain disclosure controls and procedures, as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that are designed to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed,                summarized and reported within the time periods specified in the SEC rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required financial disclosures. Because of inherent limitations, our disclosure controls and procedures, no matter how well designed and operated, can provide only reasonable, and not                absolute, assurance that the objectives of such disclosure controls and procedures are met.

 

As of the end of the period covered by this report we conducted an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b).                Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2009. 

 

*Changes in Internal Control Over Financial Reporting*

 

There were no changes in our internal control over financial reporting during the quarter ended September 30, 2009 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

33

 

 

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**PART II -- OTHER INFORMATION**

 

**Item 1A. Risk Factors**

There have been no material changes to the risk factors as previously disclosed in our annual report on Form 10-K for the year ended December 31, 2008. 

 

**Item 5. Other Information**

 

In connection with the execution of the Money Obligations Offset Agreement, dated November 11, 2009, between KKM and GRK (the “Offset Agreement”), on September 15, 2009 Bekem Metals, KKM, GRK and Latimer Assets Inc. executed an Assignment and Assumption Agreement, dated August 13, 2009 (the “Assignment Agreement”). Pursuant to the Assignment Agreement,                Bekem assigned to KKM its right to demand repayment from Latimer of a loan made by Bekem to Latimer in May 2008. The amount owed by Latimer to Bekem at the time of execution of the Assignment Agreement was 2,282,934,046 KZT, (equivalent to $15,140,828 USD on the date of the Assignment Agreement). Pursuant to the Assignment Agreement, GRK agreed to assume the repayment obligations of Latimer. Latimer is the majority interest holder of GRK.

 

On November 11, 2009 KKM and GRK entered into the Offset Agreement. Pursuant to the terms of the Offset Agreement, GRK and KKM agreed to partially offset 2,282,328,413 KZT (equivalent to $15,349,576 USD at the currency conversion rate of 152.690 KZT per $1 USD on November 11, 2009) owed by GRK to KKM under the Assignment Agreement against the 2,847,472,009 KZT (equivalent to                $19,150,393 USD on November 11, 2009) owed by KKM to GRK in connection with advances made to the Consortium under the Joint activity agreement, dated March 3, 2008, between KKM, GRK and AI (the “Consortium Agreement”). As a result of the partial offset under the Offset Agreement, the residual debt owed by KKM to GRK under the Consortium Agreement as of November 11, 2009 was 565,143,597 KZT (equivalent to $3,800,818 USD on November 11, 2009).

 

On November 11, 2009 KKM, GRK and AI also executed an Addendum #2 to the Joint Activity Agreement (“Addendum #2”) to reflect certain changes in connection with the Offset Agreement. Specifically, Addendum #2 amends Clause 3.3 of the Consortium Agreement to reduce the initial capital contributions of KKM and GRK. The capital contribution of KKM is reduced from                2,333,000,000 KZT (equivalent to $15,690,362 

USD on November 11, 2009) to 686,936,015 KZT (equivalent to $4,619,921 USD on November 11, 2009). The capital contribution of GRK is reduced from 2,235,600,000 (equivalent to $15,707,849 USD on November 11, 2009) to 565,143,597 (equivalent to $3,800,818 USD on November 11, 2009). Addendum #2 increases the capital contribution of AI from 97,400,000 KZT (equivalent to $655,054 USD on November 11, 2009)                to 121,792,418 KZT (equivalent to $819,103 USD on November 11, 2009.) In connection with Addendum #2, the parties also agreed to extend the period for final determination of the ownership interests of the parties in the Consortium to March 1, 2010.

 

The descriptions of the Offset Agreement, the Assignment Agreement and Addendum #2 included in this Quarterly Report are only summaries of those documents and are qualified in their entirety by reference to the terms of the Offset Agreement, the Assignment Agreement and the Addendum #2, respectively, copies of which are attached as exhibits to this Quarterly Report.

 

34

 

 

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**Item 6. Exhibits**

 

Exhibits. The following exhibits are included as part of this report:

                

|           | Exhibit 10.1 |   | Money Obligations Offset Agreement, dated November 11, 2009, between Kyzyl Kain Mamyt LLP and GRK Koitas LLP                                                                                                                  |
|----------------|--------------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           |         |   |                                                                                                                                                                                                                          |
|           | Exhibit 10.2 |   | Assignment and Assumption Agreement, dated August 13, 2009, between Bekem Metals, Inc., Kyzyl Kain Mamyt LLP, GRK Koitas LLP and Latimer Assets Inc.                                                                          |
|           |         |   |                                                                                                                                                                                                                          |
|           | Exhibit 10.3 |   | Addendum #2 to Joint activity agreement <<Consortium>> (simple partnership) No. 210-03-KKM dated 03.3.2008, dated November 11, 2009, between Kyzyl Kain Mamyt LLP, GRK Koitas LLP and Asia-Invest Corporation LLP |
|           |         |   |                                                                                                                                                                                                                          |
|           | Exhibit 31.1 |   | Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                        |
|           |         |   |                                                                                                                                                                                                                          |
|           | Exhibit 31.2 |   | Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                                        |
|           |         |   |                                                                                                                                                                                                                          |
|           | Exhibit 32.1 |   | Certification by the Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                    |
|           |         |   |                                                                                                                                                                                                                          |
|  

  | Exhibit 32.2 |   | Certification by the Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                                                                                                                    |

 

 

**SIGNATURES**

 

In accordance with Section 12 of the Securities Exchange Act of 1934, the registrant caused this registration statement to be signed on its behalf, thereunto duly authorized.

 

**BEKEM METALS, INC.**

 

| Date: November 13, 2009 | /s/ Yermek Kudabayev                              |
|-------------------------|---------------------------------------------------|
|                    | Yermek Kudabayev

Chief Executive Officer

  |

 

| Date: November 13, 2009 | Zhassulan Bitenov                                  |
|-------------------------|----------------------------------------------------|
|                    | Zhassulan Bitenov

Chief Financial Officer

  |

 

35

 

 

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