**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 EndedJune 30, 2008

 

| [  ] | **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.) |
|                                     |   |                |
| **170 Tchaikovsky Street, 4th Floor**    |   |                |
| **Almaty, Kazakhstan**                   |   | **050000**          |
| (Address of principal executive offices) |   | (Zip Code)          |

 

**+7 (7272) 582-386**

(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 such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  

                                                                                                                                                                                 Yes[X]  No[   ]

 

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 the definitions of “*large accelerated filer*,” “*accelerated filer*” and “*smaller reporting            company*” in Rule 12b-2 of the Exchange Act.

 

|   | Large accelerated filer[   ] |              Accelerated filer[   ] |
|--------|---------------------------------------------|----------------------------------------------------------------------------------------------------------------|

|   |  Non-accelerated filer[   ] | Smaller reporting company[X] |
|--------|-------------------------------------------------|------------------------------|

|   | (Do not check if a smaller reporting company) |
|--------|-----------------------------------------------|

 

 

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

 

As of August 11, 2008, 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

June 30, 2008 and December 31, 2007                                                                                                                   |  

3 |
|                                                                                                 |                                                                                                                                                                                                           |   |
|                                                                                                 | Condensed Consolidated Statements of Operations (Unaudited) for the

Three Months and Six Months Ended June 30, 2008 and 2007, and for the Period from March 5, 2004 (Date of Inception) through June 30, 2008 |  

 

4 |
|                                                                                                 |                                                                                                                                                                                                           |   |
|                                                                                                 | Condensed Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2008 and 2007, and for the Period from March 5, 2004 (Date of Inception) through June 30, 2008                   |  

 

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

and Results of Operations |  

16                                                                                                                                                                                                     |
|                                                                                                 |                                                                                                                                                                                                           |
| Item 3. Qualitative and Quantitative Disclosures About Market Risk                                   | 29                                                                                                                                                                                                             |
|                                                                                                 |                                                                                                                                                                                                           |
| Item 4. Controls and Procedures                                                                      | 29                                                                                                                                                                                                             |
|                                                                                                 |                                                                                                                                                                                                           |
| PART II — OTHER INFORMATION                                                                    |                                                                                                                                                                                                           |
|                                                                                                 |                                                                                                                                                                                                           |
| Item 1A. Risk Factors                                                                                | 30                                                                                                                                                                                                             |
|                                                                                                 |                                                                                                                                                                                                           |
| Item 6. Exhibits                                                                                     | 30                                                                                                                                                                                                             |
|                                                                                                 |                                                                                                                                                                                                           |
| Signatures                                                                                           | 31                                                                                                                                                                                                             |

 

 

2

 

 

----

**PART I – FINANCIAL INFORMATION**

**Item 1. Financial Statements**

 

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**(UNAUDITED)**

 

|                                                           |   | **June 30,**       |   | **December 31,**   |
|----------------------------------------------------------------|--------|--------------------|--------|--------------------|
|                                                           |   | **2008**           |   | **2007**           |
|                                                           |   |               |   |               |
| **ASSETS**                                                     |   |               |   |               |
|                                                           |   |               |   |               |
| **Current Assets**                                             |   |               |   |               |
| Cash                                                           |   | $ 3,316,353   |   | $ 756,943     |
| Trade accounts receivable                                      |   | 10,628        |   | 4,048         |
| VAT recoverable                                                |   | 266,854       |   | 269,087       |
| Inventories                                                    |   | 290,092       |   | 287,240       |
| Note receivable from related party                             |   | 14,917,328    |   | -             |
| Prepaid expenses and other current assets                      |   | 102,163       |   | 118,847       |
| Deferred compensation                                          |   | 617,180       |   | 483,766       |
| **Total Current Assets**                                       |   | 19,520,598    |   | 1,919,931     |
|                                                           |   |               |   |               |
| Property, plant and mineral interests (net of accumulated      |   |               |   |               |
| depreciation of $538,377 and $416,773 )                        |   | 14,056,614    |   | 14,226,359    |
| Non-current deferred compensation                              |   | 152,200       |   | 225,351       |
| Other assets                                                   |   | 64,942        |   | 78,996        |
| **Total Assets**                                               |   | $ 33,794,354  |   | $ 16,450,637  |
|                                                           |   |               |   |               |
| **LIABILITIES AND SHAREHOLDERS' EQUITY**                       |   |               |   |               |
|                                                           |   |               |   |               |
| **Current Liabilities**                                        |   |               |   |               |
| Accounts payable                                               |   | $ 503,719     |   | $ 423,776     |
| Accrued expenses                                               |   | 381,341       |   | 237,142       |
| Advances received                                              |   | -             |   | 257,689       |
| Notes payable to related parties                               |   | 19,672,050    |   | -             |
| Due to related party                                           |   | 658           |   | 791           |
| **Total Current Liabilities**                                  |   | 20,557,768    |   | 919,398       |
|                                                           |   |               |   |               |
| Asset retirement obligation                                    |   | 1,078,694     |   | 1,039,048     |
| **Total Liabilities**                                          |   | 21,636,462         |   | 1,958,446     |
|                                                           |   |               |   |               |
| **Commitments and Contingencies**                              |   | -                  |   | -             |
|                                                           |   |               |   |               |
| **Shareholders' Equity**                                       |   |               |   |               |
| Preferred stock; $0.001 par value, 20,000,000 shares           |   |               |   |               |
| authorized, no shares outstanding                              |   | -                  |   | -             |
| Common stock; $0.001 par value, 150,000,000 shares authorized, |   |               |   |               |
| and 125,172,011 and 124,750,239 shares issued and outstanding  |   | 125,172       |   | 124,750       |
| Additional paid-in capital                                     |   | 28,540,235    |   | 28,203,239    |
| Accumulated deficit                                            |   | (17,536,524)       |   | (14,923,899)       |
| Accumulated other comprehensive income                         |   | 1,029,009     |   | 1,088,101     |
| **Total Shareholders' Equity**                                 |   | 12,157,892    |   | 14,492,191    |
|                                                           |   |               |   |               |
| **Total Liabilities and Shareholders' Equity**                 |   | $ 33,794,354  |   | $ 16,450,637  |
|                                                           |   |               |   |               |

 

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 Period from**                                                                                  |
|---------------------------------------------------|----------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------|
|                                              |                                                                                               |   |                                                                                               |   | **March 5, 2004**                                                                                        |
|                                              | **For the Three Months**                                                                           |   | **For the Six Months**                                                                             |   | **(Date of Inception)**                                                                                  |
|                                              | **Ended June, 30**                                                                                 |   | **Ended June, 30**                                                                                 |   | **Through**                                                                                              |
|                                              | **2008**                                                                                           |   | **2007**                                                                                           |   | **2008**                                                                                                 |   | **2007** |   | **June 30, 2008** |
|                                              |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Revenue**                                       | $               -  |   | $               -  |   | $                -  |   | $                -  |   | $                    -  |
|                                              |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Operating Expenses**                            |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| General and administrative expenses               | 1,320,246                                                                                     |   | 1,387,709                                                                                     |   | 2,345,323                                                                                           |   | 2,643,571  |   | 10,818,826  |
| Research and development costs                    | 184,549                                                                                       |   | -                                                                                             |   | 184,549                                                                                             |   | -  |   | 1,272,787  |
| Exploratory costs                                 | 91,843                                                                                        |   | 982,283                                                                                       |   | 117,382                                                                                             |   | 1,843,145  |   | 6,521,022  |
| Accretion expense on asset retirement obligations | 21,317                                                                                        |   | 20,458                                                                                        |   | 42,641                                                                                              |   | 40,369  |   | 255,426  |
| Stock grant compensation expense                  | 154,295                                                                                       |   | (2,427)                                                                                            |   | 277,155                                                                                             |   | 187,052  |   | 857,673  |
|                                              |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Total Operating Expenses**                      | 1,772,250                                                                                     |   | 2,388,023                                                                                     |   | 2,967,050                                                                                           |   | 4,714,137  |   | 19,725,734  |
|                                              |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Loss From Operations**                          | (1,772,250)                                                                                        |   | (2,388,023)                                                                                        |   | (2,967,050)                                                                                              |   | (4,714,137) |   | (19,725,734) |
|                                              |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Other Income (Expense)**                        |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| Translation adjustment                            | 29,803                                                                                        |   | (55,663)                                                                                           |   | 42,261                                                                                              |   | (139,387) |   | (207,873) |
| Exchange gain (loss)                              | (10,095)                                                                                           |   | 211,847                                                                                       |   | 2,012                                                                                               |   | 691,979  |   | (297,002) |
| Interest income                                   | 62,046                                                                                        |   | 36,996                                                                                        |   | 62,575                                                                                              |   | 226,627  |   | 472,888  |
| Interest expense                                  | -                                                                                             |   | -                                                                                             |   | -                                                                                                   |   | (1,018) |   | (1,677,441) |
| Other income                                      | 248,266                                                                                       |   | 18,585                                                                                        |   | 247,577                                                                                             |   | 22,588  |   | 366,829  |
|                                              |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Net Other Income (Expense)**                    | 330,020                                                                                       |   | 211,765                                                                                       |   | 354,425                                                                                             |   | 800,789  |   | (1,342,599) |
|                                              |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Net Loss Before Minority Interest and Taxes**   | (1,442,230)                                                                                        |   | (2,176,258)                                                                                        |   | (2,612,625)                                                                                              |   | (3,913,348) |   | (21,068,333) |
| Deferred tax benefit                              | -                                                                                             |   | -                                                                                             |   | -                                                                                                   |   | 441,113  |   | 3,390,601  |
| Loss in minority interest                         | -                                                                                             |   | -                                                                                             |   | -                                                                                                   |   | -  |   | 141,208  |
|                                              |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Net Loss**                                      | $ (1,442,230)                                                                                 |   | $  (2,176,258)                                                                           |   | $  (2,612,625)                                                                                 |   | $  (3,472,235) |   | $      (17,536,524) |
|                                              |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Basic Loss per Common Share**                   | $          (0.01)                                |   | $           (0.02)                          |   | $           (0.02)                                |   | $           (0.03) |   |   |
| **Weighted-Average Shares used in**               |                                                                                               |   |                                                                                               |   |                                                                                                     |   |   |   |   |
| **Basic Loss per Common Share**                   | 125,172,011                                                                                   |   | 125,167,376                                                                                   |   | 124,975,030                                                                                         |   | 125,169,681  |   |   |

 

 

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

 

4

 

 

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(UNAUDITED)**

 

|                                                                                                                                                                                |                               |   |                                     |   | **For the Period from**                                       |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------------------------------|--------|------------------------------------------|--------|---------------------------------------------------------------|
|                                                                                                                                                                                |                               |   |                                     |   | **March 5, 2004**                                             |
|                                                                                                                                                                                | **For the Six Months**             |   | **(Date of Inception)**                  |
|                                                                                                                                                                                | **Ended June, 30**                 |   | **through**                              |
|                                                                                                                                                                                | **2008**                           |   | **2007**                                 |   | **June 30, 2008**                                             |
|                                                                                                                                                                                |                               |   |                                     |   |                                                          |
| **Cash Flows from Operating Activities**                                                                                                                                            |                               |   |                                     |   |                                                          |
| Net loss                                                                                                                                                                            | $   (2,612,625)     |   | $   (3,472,235)           |   | $        (17,536,524) |
| Adjustments to reconcile net loss to                                                                                                                                                |                               |   |                                     |   |                                                          |
| net cash provided by operating activities:                                                                                                                                          |                               |   |                                     |   |                                                          |
| Depreciation and amortization                                                                                                                                                       | 145,326                       |   | 66,781                              |   | 631,119                                                  |
| Accretion expense on asset retirement obligations                                                                                                                                   | 42,641                        |   | 40,369                              |   | 255,426                                                  |
| Interest expense from debt discount                                                                                                                                                 | -                             |   | -                                   |   | 963,231                                                  |
| Shares issued on option modification                                                                                                                                                | -                             |   | -                                   |   | 19,426                                                   |
| Deferred tax benefit                                                                                                                                                                | -                             |   | (441,113)                                |   | (3,390,601)                                                   |
| Foreign currency exchange loss (gain) and translation                                              adjustment | (20,892)                           |   | (33,713)                                 |   | 190,387                                                  |
| Purchased exploration costs                                                                                                                                                         | -                             |   | -                                   |   | 251,286                                                  |
| Impairment loss on property, plant and equipment                                                                                                                                    | -                             |   | -                                   |   | 1,043,720                                                |
| Loss (gain) on disposal of property and equipment                                                                                                                                   | (231,497)                          |   | 147,415                             |   | (163,768)                                                     |
| Stock grant compensation expense                                                                                                                                                    | 277,155                       |   | 187,052                             |   | 857,673                                                  |
| Loss recognized on minority shareholders' interest                                                                                                                                  | -                             |   | -                                   |   | (141,208)                                                     |
| Change in operating assets and liabilities:                                                                                                                                         |                               |   |                                     |   |                                                          |
| Trade accounts receivable                                                                                                                                                           | (13,432)                           |   | (3,341)                                  |   | (5,629)                                                       |
| Inventories                                                                                                                                                                         | (3,918)                            |   | (97,076)                                 |   | (15,937)                                                      |
| VAT recoverable                                                                                                                                                                     | 1,483                         |   | 5,410                               |   | (194,080)                                                     |
| Prepaid expenses and other current assets                                                                                                                                           | (16,052)                           |   | (105,495)                                |   | 37,896                                                   |
| Related party receivables / payables                                                                                                                                                | 7,880                         |   | (29,877)                                 |   | (144,300)                                                     |
| Accounts payable                                                                                                                                                                    | 80,748                        |   | 187,034                             |   | 186,655                                                  |
| Accrued expenses                                                                                                                                                                    | 140,111                       |   | (625,373)                                |   | 87,576                                                   |
| **Net Cash From Operating Activities**                                                                                                                                              | (2,203,072)                        |   | (4,174,162)                              |   | (17,067,652)                                                  |
|                                                                                                                                                                                |                               |   |                                     |   |                                                          |
| **Cash Flows from Investing Activities**                                                                                                                                            |                               |   |                                     |   |                                                          |
| Purchase of property and equipment                                                                                                                                                  | (34,660)                           |   | (434,744)                                |   | (3,709,138)                                                   |
| Purchase of intangible assets                                                                                                                                                       | (405)                              |   | (7,016)                                  |   | (65,498)                                                      |
| Proceeds from disposal of property and equipment                                                                                                                                    | -                             |   | -                                   |   | 286,507                                                  |
| Loans provided to related party                                                                                                                                                     | (14,900,000)                       |   | -                                   |   | (14,900,000)                                                  |
| Restricted cash                                                                                                                                                                     | -                             |   | 100,000                             |   | -                                                        |
| Loans provided to third party                                                                                                                                                       | -                             |   | -                                   |   | (56,983)                                                      |
| Cash acquired in acquisitions                                                                                                                                                       | -                             |   | -                                   |   | 50,475                                                   |
| **Net Cash From Investing Activities**                                                                                                                                              | (14,935,065)                       |   | (341,760)                                |   | (18,394,637)                                                  |
|                                                                                                                                                                                |                               |   |                                     |   |                                                          |
| **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**                                                                                                                                         | (603)                              |   | 100,799                             |   | 390,489                                                  |
|                                                                                                                                                                                |                               |   |                                     |   |                                                          |
| **Net Increase (Decrease) in Cash**                                                                                                                                                 | 2,559,410                     |   | (4,415,123)                              |   | 3,316,353                                                |
| **Cash at Beginning of Period**                                                                                                                                                     | 756,943                       |   | 8,583,680                           |   | -                                                        |
| **Cash at End of Period**                                                                                                                                                           | $   3,316,353  |   | $    4,168,557  |   | $       3,316,353     |
|                                                                                                                                                                                |                               |   |                                     |   |                                                          |

 

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

 

5

 

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008 (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, 2007. Operating results for the six-month period ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.

 

**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 then outstanding 100,088,888 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.

 

***Bekem Metals, Inc.***– The consolidated financial statements 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**

**June 30, 2008 (UNAUDITED)**

 

 

***Kazakh Metals, Inc.***– The consolidated financial statements also include the accounts of KMI and its wholly-owned subsidiary, Kyzyl Kain Mamyt LLP (“KKM”), which it acquired on May 31, 2005 in a purchase business combination.

 

***Currency Translation***– The consolidated financial statements are presented in U.S. dollars. The functional currency of the Company’s subsidiaries operating in Kazakhstan is U.S. dollars for Kaznickel and Kazakh tenge for KKM. Results of operations are translated into U.S. dollars at the average exchange rates during the reporting period. Non-monetary                assets and liabilities of Kaznickel 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. Translation differences are included in results of operations. All balance sheet accounts of KKM are translated at exchange rates on the date of the financial statements and translation differences are included in stockholders’ equity as                cumulative translation adjustments.

 

***Reclassification***– Certain prior period amounts have been reclassified to conform to the 2008 presentation. These reclassifications had no effect on the previously reported net income.

 

**Nature of Business**

 

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

 

In January 2008, Kaznickel agreed with the Expert Committee of the Ministry of Energy and Minerals Resources (“MEMR”) of the Republic of Kazakhstan to an extension of the exploration period to February 2010. The respective addendum to the subsoil use contract was signed between Kaznickel and the MEMR on May 16, 2008. Upon discovery of commercially producible nickel and/or cobalt                reserves, the Company may notify the MEMR and convert from exploration stage to commercial production stage. If the Company makes no commercial discoveries before the end of the exploration period, as extended, the rights to the territory will revert back to the Republic of Kazakhstan. Upon completion of exploration, the Company will return to the Republic of Kazakhstan the rights to all areas within the licensed territory wherein no commercial discoveries of nickel and/or                cobalt were made. When the Company completes exploration of the Gornostai deposit, assuming that commercial discoveries are made, the Company will apply to the MEMR to move to commercial production.

 

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.

 

7

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008 (UNAUDITED)**

 

 

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 period from March 5, 2004 (Date of Inception) through June 30, 2008.

 

***Business Condition***– 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 maintain its current activities and to fund construction of a processing plant. The Company expects to be totally dependent upon investment funds to support its activities                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.

 

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. Certain shareholders of the Company have indicated a willingness to provide the Company a line of credit to meet current needs, however, the Company has no formal agreement with said shareholders to provide this line of credit and the shareholders are under no obligation to enter into any agreement or make available any funds to the Company. If the Company is unsuccessful in obtaining additional funding during 2008, the Company will have                insufficient funds to continue exploring its territories or to meet its mineral license work program requirement. 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 March 2008, KKM entered into a preliminary consortium agreement (the “Consortium”) with two other Kazakhstani companies, GRK Koitas LLP (“GRK”) and Asia-Invest Corporation LLP (“AI”). GRK and AI are related parties of the Company through a common stockholder. These companies have exploration and production licenses near the Company’s Kempirsai deposits                in northwestern Kazakhstan. The preliminary consortium agreement is for the 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 Asia-Invest – 10%. The final ownership interests of the parties will be                determined upon completion of the feasibility study, design of the processing plant and a definitive consortium agreement, but not later than March 1, 2009. The parties have the right to withdraw from the Consortium subject to three months written notice. 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, which is subject to revision not later than March 1, 2009.

 

8

 

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008 (UNAUDITED)**

 

 

***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.

 

***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 to 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:

 

|                                        | **June 30,**    |   | **December 31,** |
|---------------------------------------------|-----------------|--------|------------------|
|                                        | **2008**        |   | **2007**         |
| Current accounts (USD)                      | $ 2,616,849     |   | $ 253,892        |
| Current accounts (Tenge, translated to USD) | 161,201         |   | 503,051          |
| Bank deposit (Tenge, translated to USD)     | 538,303         |   | –          |
| **Total**                                   | **$ 3,316,353** |   | **$ 756,943**    |

 

Bank deposit account is located in a Kazakhstani Bank (Kazkommertsbank). The bank deposit earns interest of 4.5% annually. The bank deposit was placed for a maturity of one month and is renewable each month.

 

**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. Latimer owns substantial interests in GRK and AI.

 

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 is charged on a monthly basis and is payable as a lump-sum payment at the date of the note repayment. Repayment of                the note is due on March 1, 2009. The balance of the note receivable from related party at June 30, 2008 was $14,917,328, which includes $17,328 of interest.

 

9

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008 (UNAUDITED)**

 

 

Pursuant to a Pledge Agreement dated May 22, 2008 between the Company, its subsidiary, KKM, GRK and AI, the note 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.

 

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

 

Property, plant and mineral interests consist of the following:

 

|                           | **June 30,**           |   | **December 31,**       |
|--------------------------------|------------------------|--------|------------------------|
|                           | **2008**               |   | **2007**               |
| Buildings                      | $ 2,001,699       |   | $ 1,995,927       |
| Machinery and equipment        | 3,746,824         |   | 3,771,957         |
| Other fixed assets             | 150,030           |   | 149,721           |
| Unproved mineral interests     | 8,696,438         |   | 8,725,527         |
|                           | 14,594,991        |   | 14,643,132        |
| Accumulated depreciation       | (538,377)              |   | (416,773)              |
| **Net Property and Equipment** | **$ 14,056,614**  |   | **$ 14,226,359**  |

 

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.

 

***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 re-negotiate 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.

 

The Contract provides the Company certain rights and also imposes certain obligations and commitments. The rights include exploration through February 2010 (extended from 2008, as discussed in Note 1), and development and production of minerals through February 26, 2026. 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

 

10

 

 

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008 (UNAUDITED)**

 

 

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 is anticipated within the next one to two years. 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 2008 work program for KKM 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 allocated purchase price of the mineral interest included a capitalized amount of an acquired asset retirement obligation. 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.

 

**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) who 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. 

 

11

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008 (UNAUDITED)**

 

 

In March and April 2008, KKM received advances of KZT 2,278 million ($18,865,424 as of June 30, 2008) from GRK, and KZT 97 million ($806,625 as of June 30, 2008) from AI, which are to be used for construction of a processing plant. As discussed in Note 1, the parties have the right to withdraw from the Consortium subject to three months written notice. Consequently, these advances have been                classified as current notes payable to related parties.

 

**NOTE 6 – SHAREHOLDERS’ EQUITY**

 

***Stock grants and shares resigned**–*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 to certain executives and key employees of the Company restricted stock grants totaling 1,083,123                shares. 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 deadlines for operations as dictated by the board of directors, timely performing of the drilling work program requirements as dictated by the MEMR, and start of commercial operations. If these goals are not met, the Company will not recognize compensation expense 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.

 

As a result of the resignation of Marat Cherdabayev, the former CEO and President of the Company,

during 2007, the Company reversed $822,455 (421,772 shares) of previously realized deferred compensation. On March 25, 2008 the board agreed to award to certain executives and key employees of the Company restricted stock grants totaling 421,772 shares. The fair value of the restricted stock grants was valued at $0.80 per share, which represented the closing market price of the Company’s                stock on March 25, 2008, or $337,418.

 

As of June 30, 2008, there was $769,380 of total unexpensed compensation cost. The cost is expected to be recognized over a period of fifteen months. As of June 30, 2008, shares vested amounted to 280,367. The Company recognized $277,155 and $187,052 of compensation expense for the six months ended June 30, 2008 and 2007, respectively.

 

**NOTE 7 - COMMITMENTS AND CONTINGENCIES**

 

***Need for Additional Capital –***The Company has no proven mineral reserves that conform to U.S. standards. The Gornostai and Kempirsai deposits have not yet entered the development stage with respect to the mineral interests and the Company has no production. 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 a nickel ore processing plant is built and the Company has commenced commercial operations.

 

12

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008 (UNAUDITED)**

 

 

Management expects the Company will need $50 million to $300 million to fund construction of a processing plant, depending on which technology and the size of plant the Company determines to be appropriate. If funding can be secured, management hopes to begin construction in 2008 and anticipates a processing plant could be operational in 2011. As the Company generates no revenue, it will need                to raise additional capital through the sale of its equity and/or debt securities to fund plant construction.

 

***Failure to Satisfy the Terms of the Subsoil Use Contracts***– Under its subsoil use contracts, the Company is required to satisfy its annual minimum work program requirements. There is no guarantee that the Company will be able to continue to meet these commitments in the future. If the Company fails to satisfy these commitments, it may be subject to                penalties and fines and/or the loss of one or more of its subsoil use contracts. The cancellation of contracts would have a material adverse effect on the business, results of operations and financial condition of the Company. The Company would seek waivers of any breaches or seek to renegotiate the terms of its commitments in the event the Company cannot meet such commitments.

 

For many years it was the practice of the MEMR that if a subsurface user for any reason could not fulfill certain conditions for a specific year, such actions were extended to the next year. During the latter part of 2007, however, this practice was terminated by order of the president of Kazakhstan. This change in practice has created great uncertainty as to how the government will proceed in the                future. This problem is enhanced by the fact that no legislatively fixed mechanism exists for independent determination, at a detail level, of compliance by subsurface users with the parameters of their annual work program. Currently, this determination is made at the discretion of officials employed by the MEMR. These officials are authorized to suspend the activities of the subsurface user even for a minor breach of the detailed annual program. This fact, coupled with the                right of the MEMR to unilaterally terminate a subsoil user’s contract if the contractor materially breaches the subsoil use contract obligations, indicates the Company has a risk of penalties and fines and/or even the loss of one or more of its subsoil use contracts.

 

***Foreign Operations –***In recent years, the Republic of Kazakhstan has undergone substantial political and economic change. As an emerging market, Kazakhstan does not possess the well-developed business infrastructure that generally exists in more mature free market economies. As a result, operations carried out in Kazakhstan can involve significant risks                that are not typically associated with developed markets. Instability in the market reform process could subject the Company to unpredictable changes in the basic business infrastructure in which it currently operates. Therefore, the Company faces risks inherent in conducting business internationally, such as:

 

13

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008 (UNAUDITED)**

 

 

|   | **•** | Foreign currency exchange fluctuations or imposition of currency exchange controls; |
|--------|------------|-------------------------------------------------------------------------------------|

 

|   | **•** | Legal and governmental regulatory requirements; |
|--------|------------|-------------------------------------------------|

 

|   | **•** | Disruption of tenders resulting from disputes with governmental authorities; |
|--------|------------|------------------------------------------------------------------------------|

 

|   | **•** | Potential seizure or nationalization of assets; |
|--------|------------|-------------------------------------------------|

 

|   | **•** | Import-export quotas or other trade barriers; |
|--------|------------|-----------------------------------------------|

 

|   | **•** | Difficulties in collecting accounts receivable and longer collection periods; |
|--------|------------|-------------------------------------------------------------------------------|

 

|   | **•** | Political and economic instability; |
|--------|------------|-------------------------------------|

 

|   | **•** | Difficulties and costs of staffing and managing international operations; and |
|--------|------------|-------------------------------------------------------------------------------|

 

|   | **•** | Language and cultural differences. |
|--------|------------|------------------------------------|

 

Any of these factors could materially adversely affect the Company’s business and financial condition. At this time, management is unable to estimate what, if any, changes may occur or the resulting effect of any such changes.

 

The Company also faces a significant potential risk of unfavorable tax treatment and currency law violations. Legislation and regulations regarding taxation, foreign currency transactions and licensing of foreign currency loans in the Republic of Kazakhstan continue to evolve as the central government manages the transformation from a command to a market-oriented economy. The legislation and                regulations are not always clearly written and their interpretation is subject to the opinions of local tax inspectors. Instances of inconsistent opinions between local, regional and national tax authorities are not unusual.

 

The current regime of penalties and interest related to reported and discovered violations of Kazakhstan’s laws, decrees and related regulations can be severe. Penalties include confiscation of the amounts at issue for currency law violations, as well as fines of generally 100% of the taxes unpaid. Interest is assessable at rates of generally 0.3% per day. As a result, penalties and interest                can result in amounts that are multiples of any unreported taxes.

 

The Company may be adversely affected by Kazakh political developments, including the application of existing and future legislation and tax regulations.

 

***Environmental Regulations***– The Company is subject to stringent state and local laws and regulations relating to the release or disposal of materials into the environment or otherwise relating to environmental protection. These laws and regulations may require the acquisition of permits before extraction activities commence, restrict the types, quantities                and concentration of substances that can be released into the environment in connection with extraction and production activities and impose substantial liabilities for pollution resulting from the Company  operations.  Failure  to  comply  with  these  laws  and  regulations  may  result  in  the  assessment  of

 

14

 

 

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**June 30, 2008 (UNAUDITED)**

 

 

administrative, civil and criminal penalties, incurrence of investigatory or remedial obligations or the imposition of injunctive relief. Changes in environmental laws and regulations occur frequently, and any changes that result in more stringent or costly waste handling, storage, transport, disposal or cleanup requirements could require the Company to make significant expenditures to maintain                compliance, and may otherwise have a material adverse effect on it as well as the industry in general. Under these environmental laws and regulations, the Company could be held strictly liable for the removal or remediation of previously released materials or property contamination regardless of whether the Company was responsible.

 

***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 in Salt Lake City, Utah for its administrative and registered office in the United States. The Company pays annual rent of approximately $7,800 for this space pursuant to a lease agreement that expires December 31, 2008 with an option to extend the lease for an additional                year.

 

The Company also maintains a representative office in Almaty, Kazakhstan, where it leases approximately 3,220 square feet of office space (before March 1, 2008 - 1,880 square feet). The lease agreement expires on November 30, 2008. On March 1, 2008, the monthly lease payment increased from $7,000 to $12,000 due to increased office space.

 

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 $4,250 per month. Kaznickel uses this space to store test ore. These lease agreements expire in March 31, 2009.

 

KKM rents approximately 1,120 square feet of office space in Aktobe, Kazakhstan. KKM pays approximately $5,500 per month for this space under a one-year lease agreement, which expires December 31, 2008.

 

15

 

 

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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 should be read in conjunction with the*Financial Statements*and*Notes to the 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, 2007.

 

**Forward Looking Information and Cautionary Statement**

 

Certain statements contained herein including, but not limited to those relating to our plan of operations, future potential revenue, future expenses, future development of our mineral properties, the development and commercial viability of our processing technology, our ability to obtain future governmental approvals, expansion of our operations, our ability to generate cash                flow, future demand for nickel, cobalt and brown coal, future commodity prices, integration of new technologies into operations, credit facilities, future capital expenditures and working capital, sufficiency of future working capital, borrowings and capital resources and liquidity, expectations of timing, satisfaction of contingencies, the impact of any change in accounting policies on our financial statements, future acquisitions, management’s assessment of internal                control over financial reporting, financial results, opportunities, growth, business plans and strategy and other statements that are not historical facts contained in this report are forward-looking statements. When used in this document, words like “*believe*,” “*expect*,” “*project*,”                “*intend*,” “*estimate*,” “*budget*,” “*plan*,” “*forecast*,” “*predict*,”                “*may*,” “*will*,” “*could*,” “*should*,” or “*anticipate*” and similar expressions or the negative thereof, or other variations thereon, or comparable terminology, or                discussions of strategy that involve risk and uncertainties are also intended to identify forward-looking statements. Such statements involve known and unknown risks, uncertainties, and other factors that may cause the actual results, performance or achievements of the Company or industry to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Such factors include, but are not limited to, market                factors, market prices (including regional basis differentials) of nickel, cobalt and brown coal, results of future exploration and extraction activities, future production and costs, unsettled political conditions, civil unrest and governmental actions, foreign currency fluctuations, and environmental and labor laws and other factors detailed herein. Given these uncertainties, prospective investors are cautioned not to place undue reliance on such forward-looking statements.                These forward-looking statements are based on current expectations. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.

 

|   | **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 (“Kaznickel”).

 

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-

 

16

 

 

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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.

 

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 nickel and cobalt ore through February 2026.

 

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

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

and

Production | 1349                         | Exploration period expires February 26, 2010(1). Production period expires February 26, 2026 unless extended. |

 

| (1) | In January 2008, Kaznickel agreed with the Expert Committee of the MEMR to the extension of the exploration period up to February 2010. The respective addendum to the subsoil use contract was signed between Kaznickel and the MEMR on May 16, 2008. |
|-----|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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 are currently at the exploration stage on the Gornostai deposit. To retain our subsoil use contract during the exploration stage we are required to satisfy a minimum work program that is approved by the Geology Committee of the MEMR. The annual work program for 2008 requires Kaznickel to drill test holes totaling at least 1,000 meters (the same for 2009).

 

The objective of our drilling program is to complete a detailed study of the structural characteristics of what we believe to be the two largest ore bodies in the Gornostai deposit, as well as certain other ore bodies where high grade nickel deposits have been located. The drilling was conducted on a 50 x 50-100 meter grid, which will make it possible to convert                indicated and inferred resources to proved and probable reserves as development of the property progresses.

 

17

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When we complete exploration of the Gornostai deposit, assuming we make commercial discoveries, we will apply to the MEMR to move to commercial production.

 

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.

 

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. Historically, pyrometallurgy has been the most common processing procedure utilized to process nickel and cobalt ores. Hydrometallurgical technology has improved to the point that it is now an acceptable                alternative to pyrometallurgy for processing nickel and cobalt ores. Both technologies require large plants, costly construction and expensive equipment often requiring capital infusions of hundreds of millions of dollars.

 

We have retained the services of an independent engineering firm to conduct a pre-feasibility study reviewing different technologies to determine the best processing technology, optimal processing capacity, construction costs and timelines, etc. to allow us to determine the type of processing facility we will construct at the Kempirsai deposit. We expect the pre-feasibility study                to be completed by the second half of 2008.

 

**Results of Operations**

 

Since inception we have generated limited revenue. We have spent millions of dollars to date and anticipate that we will spend significant additional capital before we begin to realize significant revenue from operations.

 

In July 2006, we realized net proceeds of approximately $26,400,000 through a private placement of our equity securities. As of June 30, 2008, we had fully spent those funds. Currently, we are in the process of seeking additional funding to continue our efforts to develop and exploit our mineral resources. There is no assurance that we will be able to obtain additional funding in                the future on favorable terms, or at all. At this time, we have no commitments from any parties to provide us additional funding.

 

***Three months ended June 30, 2008 compared to the three months ended June 30, 2007***

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

 

Because our deposits are without known reserves, we are considered to be in the exploration stage. Any revenues earned during this stage from sale of ore or brown coal is recorded against exploratory costs. During the three months ended June 30, 2008, such incidental sales amounted to $78,270. By comparison, during the second quarter 2007, we realized $36,655 from                such incidental sales.

 

18

 

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

 

Our general and administrative expenses during the three months ended June 30, 2008 decreased to $1,320,246 from $1,387,709 during the second quarter 2007. This $67,463 decrease in general and administrative expenses during the three months ended June 30, 2008 was primarily the result of lower non-recurring tax expenses. During the second quarter of 2007, we incurred approximately                $80,000 of withholding taxes on equipment acquired for pilot testing hydrochlorination equipment. We plan to allocate approximately $2,700,000 for general and administrative expenses during the remainder of the 2008 fiscal year.

 

Research and Development Costs

 

During the three months ended June 30, 2008, we incurred research and development costs of $184,549. This amount was related to preparation of the pre-feasibility study on construction of nickel processing plant at the Kempirsai deposits. We engaged in no research and development cost during the second quarter of 2007. During the 2008 fiscal year, we have budgeted approximately                $800,000 for processing technology testing and pre-feasibility studies. 

 

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

 

During the three months ended June 30, 2008, we have done no exploratory drilling at the Gornostai deposit. The exploratory drilling specified in our annual work program for 2008 is planned to be completed in the second half of the year. Approximately $107,200 was spent during this period on chemical and other laboratory analyses of drilled samples. By comparison, we incurred                $561,608 in exploratory costs during the three months ended June 30, 2007 in drilling 250 test holes (246 test holes in the South section of the Gornostai deposit and 4 test holes in the North section of the Gornostai deposit). We budgeted $400,000 for drilling and core sampling expenses during 2008.

 

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 three month period ended June 30, 2008, we realized revenue of $78,270. By comparison during the three month period ended June 30, 2007, we realized $36,655 of revenue.

 

The remaining exploratory costs of $62,913 incurred during the second quarter of 2008 mainly represent geologists’ and other specialists’ salaries and other costs in preparation for future exploratory activities.

 

We plan to spend $1,500,000 for extraction of 350,000 tons of ore in order to meet KKM’s contract obligations. This cost will be included in exploratory costs for as long as we are an exploration stage company.

 

19

 

 

 

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

 

Accretion expense increased by $859 to $21,317 during the three months ended June 30, 2008 compared to the same period of 2007. Until we engage in mining and production, we believe accretion expense will continue at rates consistent with those realized during the quarter ended June 30, 2008.

 

Grant Compensation Expense

 

During the three months ended June 30, 2008, we recognized $154,295 in grant compensation expense for restricted stock grants issued to certain officers and key employees during the fourth quarter of 2006 and the first quarter 2008 compared to $(2,427) for the three months ended June 30, 2007, which resulted from a reversal of the deferred compensation amount of $822,455 during                the first quarter 2007 due to the resignation of Marat 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. As a result of the award of these restricted stock grants, the quarterly grant compensation expense amount has increase by approximately $31,440.

 

Total Operating Expense and Loss from Operations

 

Our total operating expense and loss from operations decreased from $2,388,023 during the three months ended June 30, 2007 to $1,772,250 during three months ended June 30, 2008. The principal reason for the change is a decrease in exploratory costs of $890,440 mainly due to significantly reduced volume of the required drilling and other exploratory works at the Gornostai                deposit.

 

Interest Income

 

During the three months ended June 30, 2008, we realized interest on deposits and on the note receivable from related party of $62,046. The amount includes $44,718 of interest earned on short-term bank deposits and $17,328 accrued on the note receivable from Latimer. By comparison, during the three months ended June 30, 2007, we realized interest on deposits of $36,996.

 

Translation Adjustment

 

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 and translation differences are included in stockholders’ equity as cumulative translation adjustments. However, non-monetary assets and liabilities of Kaznickel, 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 Kaznickel translation                differences are included in the results of operations.

 

20

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Therefore, the translation adjustment in the consolidated financial statements represents the translation differences from translation of Kaznickel’s financial statements. As a result, the translation adjustment is commonly, but not always, positive if the average exchange rates are lower than exchange rates on the date of the financial statements and negative if the                average exchange rates are higher than exchange rates on the date of the financial statements.

 

Exchange Gain/Loss

 

During the quarter ended June 30, 2008, we realized an exchange loss of $10,095 compared to an exchange gain of $211,847 during the quarter ended June 30, 2007. As with the translation adjustment, we recognize an 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.

 

Other Income (Expense)

 

During the three months ended June 30, 2008, we realized $248,266 of other income mainly representing income from the sale of two locomotives. Advance payments for the locomotives were received in 2007 in the amount of $252,958.

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

 

For the foregoing reasons, during the three months ended June 30, 2008, we experienced a net loss of $1,442,230 compared to a net loss of $2,176,258 during the three months ended June 30, 2007. We anticipate we will continue to experience net losses until we are able to engage in significant nickel and cobalt ore extraction, processing and sales.

 

***Six months ended June 30, 2008 compared to the six months ended June 30, 2007***

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

 

As explained above, because our deposits are without known reserves, we are considered to be in the exploration stage. Any revenues earned from sale of ore or brown coal while we are in exploration stage is recorded against exploratory costs. During the six months ended June 30, 2008, sales amounted to $93,070. By comparison, during the six month period ended June 30, 2007, we                realized $36,655 of sales.

 

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

 

Our general and administrative expenses during the six months ended June 30, 2008 decreased to $2,345,323 from $2,643,571 during the six months ended 2007. This $298,248 decrease in general and administrative expenses for the six months ended June 30, 2008 was primarily the result of lower professional

 

21

 

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fees. During the first quarter 2007, we incurred certain costs for professional fees primarily attributable to costs associated with a resource estimation prepared by a third party consulting firm. We did not incur similar fees during the first quarter 2008. In addition, in the second quarter of 2007 we incurred approximately $80,000 of non-recurring withholding taxes on equipment acquired for pilot                testing hydrochlorination equipment.

 

Research and Development Costs

 

During the six months ended June 30, 2008, we incurred research and development cost of $184,549. This amount was related to preparation of the pre-feasibility study on construction of nickel processing plant at the Kempirsai deposits. We engaged in no research and development cost during the six months ended June 30, 2007. During the 2008 fiscal year, we have budgeted                approximately $800,000 for processing technology testing and pre-feasibility studies.

 

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

 

During the six months ended June 30, 2008, we have done no exploratory drilling at the Gornostai deposit. The exploratory drilling specified in our annual work program for 2008 is planned to be completed in the second half of the year. Approximately $107,200 was spent during this period on chemical and other laboratory analyses of the drilled samples. By comparison, during the                first six months of 2007 we incurred $1,395,804 in exploratory drilling costs on completion of drilling of 603 test holes (599 test holes in the South section and 4 test holes in the North section of the Gornostai deposit) to an aggregate depth of 15,020 meters (14,720 meters in the South section and 300 in the North section). We budgeted $400,000 for drilling and core sampling expenses during 2008.

 

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 six month period ended June 30, 2008, we realized revenue of $93,070. By comparison during the six month period ended June 30, 2007, we realized $36,655 of revenue.

 

The remaining exploratory costs, $103,252, incurred during the six months ended June 30, 2008 mainly represent geologists’ and other specialists’ salaries and other costs in preparation for future exploratory activities.

 

We also plan to spend $1,500,000 for extraction of 350,000 tons of ore in order to meet KKM’s contract obligations. This cost will be included in exploratory costs for as long as the Company is an exploration stage company.

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

 

Accretion expense increased by $2,272 to $42,641 during the six months ended June 30, 2008 compared to the same period of 2007. Until we engage in mining and production, we believe accretion expense will continue at rates consistent with those realized during the six months ended June 30, 2008.

 

22

 

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Grant Compensation Expense

 

During the six months ended June 30, 2008, we recognized $277,155 in grant compensation expense for restricted stock grants issued to certain officers and key employees during the fourth quarter 2006 and the first quarter 2008 compared to $187,052 of the expenses for the similar period of 2007. The decrease in 2007 occurred mainly because of the reversal of deferred compensation                of $822,455 due to the resignation of Marat Cherdabayev, our former CEO and President.

 

Total Operating Expense and Loss from Operations

 

Our total operating expense and loss from operations decreased from $4,714,137 during the six months ended June 30, 2007 to $2,967,050 during six months ended June 30, 2008. The principal reasons for the decrease are the following:

 

|   | **•** | a decrease in general and administrative expense of $298,248 due to lower professional fees and non-recurring tax expenses during the six months ended June 30, 2008; and |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | a decrease in exploratory costs of $1,725,763 mainly due to significantly reduced volume of the required drilling and other exploratory works at the Gornostai deposit. |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

Interest Income

 

During the six months ended June 30, 2008, we realized interest on deposits and on the note receivable related party of $62,575. The amount includes $45,247 of interest earned on short-term bank deposits and $17,328 accrued on the note receivable from Latimer. By comparison, during the six months ended June 30, 2007, we realized interest on deposits of $226,627.

 

Translation Adjustment

 

As indicated above, the translation adjustment in the consolidated financial statements represents the translation differences from translation of the Kaznickel’s financial statements. The average exchange rate during the six months ended June 30, 2008 was lower than the closing exchange rate, thus resulting in a positive translation adjustment during the six months ended                June 30, 2008.

 

Exchange Gain/Loss

 

During the six months ended June 30, 2008, we realized an exchange gain of $2,012 compared to an exchange gain of $691,979 during the six months ended June 30, 2007. As with the translation adjustment, 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.

 

23

 

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Other Income (Expense)

 

During the six months ended June 30, 2008, we realized $247,577 of other income mainly representing income from the sale of two locomotives. Advance payments for the locomotives were received in 2007 in the amount of $252,958.

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

 

For the foregoing reasons, during the six months ended June 30, 2008, we experienced a net loss of $2,612,625 compared to a net loss of $3,472,235 during the six months ended June 30, 2007. We anticipate we will continue to experience net losses until we are able to engage in significant nickel and cobalt ore extraction, processing and sales.

 

**Liquidity and Capital Resources**

 

Our capital resources have consisted primarily of funds we have borrowed from related and non-related parties and funds we raised through a private placement of our equity securities in July 2006. As of June 30, 2008, we had fully spent funds previously realized from the private placement of our equity securities. We have used the money raised in the private offering to reduce                debt, acquire equipment, explore our deposits and fund our activities.

 

We have incurred a net loss of $17,536,524 for the period from March 5, 2004 (date of inception) through June 30, 2008. Current liabilities exceeded current assets by $1,037,170 at June 30, 2008.

 

We anticipate the need for substantial additional capital resources during the 2008 fiscal year to meet the annual work program obligations associated with our Kempirsai and Gornostai deposits. Certain shareholders of the Company have indicated a willingness to provide us a line of credit to satisfy at least part of our 2008 annual work program requirement. We do not, however,                have any formal agreement with said shareholders to provide this line of credit and our shareholders are under no obligation to enter into any agreement or make available to us any funds. As discussed above, if we are unsuccessful in obtaining additional funding during 2008, we will likely have insufficient funds to continue operations or to meet our annual work program requirements. If we cannot fulfill our annual work program requirement, we could be subjected to fines and                penalties and to the possible forfeiture of our subsoil use contracts and licenses.

 

During the six months ended June 30, 2008 and June 30, 2007, cash was used to fund operations as follows:

 

| *For the Six Months Ended June 30,*       | **2008**              | **2007**          |
|-------------------------------------------|-----------------------|-------------------|
|                                      |                  |              |
| Net cash used in operating activities     | $( 2,203,072)         | $ (4,174,162)     |
| Net cash used in investing activities     | (14,935,065)          | (341,760)         |
| Net cash provided by financing activities | 19,698,150       | -            |
| Effect of exchange rate changes on cash   | (603)                 | 100,799      |
| **NET (DECREASE) INCREASE IN CASH**       | **$ 2,559,410**  | **$ (4,415,123)** |

 

24

 

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During the six months ended June 30, 2008, net cash used in operating activities was $2,203,072 compared to net cash used in operating activities of $4,174,162 during the six months ended June 30, 2007. This decrease in net cash used in operating activities primarily occurred due to reduced exploratory activities as a result of the uncertainty regarding the KKM lawsuit with the                MEMR (which was resolved during the second quarter of 2008) and the delay in signing the amendment to the subsoil agreement between Kaznickel and the MEMR (signed on May 16, 2008).

 

During the six months ended June 30, 2008, net cash used in investing activities was $14,935,065. By comparison, during the six months ended June 30, 2007, we used net cash in investing activities of $341,760. The increased cash outflows in investing activity during the six month ended June 30, 2008 mainly occurred due to the loan provided to Latimer.

 

During the six months ended June 30, 2007, no cash was generated in financing activities. By comparison, net cash provided by financing activities was $19,698,150 during the six months ended June 30, 2008. This increase in net cash provided by financing activities occurred due to proceeds received by KKM under the preliminary Consortium agreement.

 

**Plan of Operations**

 

As of June 30, 2008, we had cash on hand of $3,316,353. This amount will mainly be spent on works under the preliminary consortium agreement signed by KKM, GRK Koitas and Asia-Invest. We will still need to raise an additional $19,000,000 to meet our annual work program requirements and planned activities. We plan to seek these funds through a combination of private equity and debt                financing. The following is a brief description of how we plan to allocate such funds during the final six months of the 2008 fiscal year if they are obtained.

 

***Drilling and Core Analysis***

 

We will allocate approximately $400,000 to drilling and exploration. This includes drilling of approximately 1,000 meters of the North section of the Gornostai deposit, sample assaying, sample selection and handling and preparation of the geological report on the South section for the State Reserves Committee. These services will be performed by a local drilling company and                certain research institutes.

 

***Processing Technology Testing***

 

During the next six months, we expect to spend approximately $200,000 for testing at our pilot plant of the mineral concentrating capability of our proprietary hydrochlorination processing technology and to formulate required procedures, protocols and operational guidelines.

 

***Extraction costs*** 

 

We plan to spend $1,500,000 for extraction of 350,000 tons of ore in order to meet KKM’s contract obligations.

 

25

 

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***Pre-Feasibility Study***

 

We anticipate spending approximately $400,000 for the preparation of a pre-feasibility study for the construction of pyrometallurgical and hydrometallurgical plants in the Gornostai deposit. This study will be prepared by Wardell Armstrong International.

 

Also, we plan to spend approximately $200,000 for completion of a pre-feasibility study with indication of estimates for capital and operational expenditures, which will allow us to make a final decision on the technology to be used for the processing of the Kempirsai ore and to start the feasibility study and design of the processing plant. This amount includes involvement of the                Russian institute Gipronickel (St. Peterburg) for pilot testing on the Russian technology and Wardell Armstrong International for completion of the pilot testing on the acid leaching technologies. The pre-feasibility study on the Kempirsai deposit is in the process of review and approval.

 

***Feasibility Study and Processing Plant Design*** 

 

We plan to spend approximately $9,100,000 for design of the processing plant in the Kempirsai field during the second half of 2008. This amount includes $2,500,000 for preparation of the bankable feasibility study, if requested by financial institutes.

 

***Field Modernization***

 

We have allocated approximately $4,000,000 for modernization of vehicles and equipment at the Kempirsai deposit to allow us to increase our ore extracting capabilities.

 

***Administrative Expenses***

 

We plan to allocate approximately $2,700,000 for administrative expenses during the next six months, which include expenses of maintaining offices in the United States and Kazakhstan, salaries and taxes.

 

***Professional Fees***

 

We expect to incur approximately $500,000 in expenses for services from our financial auditors and securities attorneys during the next six months.

 

**Additional Activities**

 

As discussed above, we are currently considering alternatives to a hydrochlorination processing plant to allow us to begin to generate cash flow from the Kempirsai deposit. We do not currently have sufficient cash on hand to fund these activities, nor have we budgeted for these items in our 2008 budget. Therefore, to undertake these activities we will need to obtain additional                capital either through equity or debt financing. We plan to seek this funding through private equity investments or debt financing to be obtained from banks or shareholders. We currently have no firm commitment from any party to provide us additional funding.

 

26

 

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On November 7, 2007, we signed an agreement with a Russian processing plant for the sale of 4,500 tons of ore for testing purposes. The whole volume of ore was shipped during the six months ended June 30, 2008. We have agreed with the Russian processing plant to commence negotiations for the sale of up to 500,000 tons of ore annually depending on the test processing results of the                initial 4,500 tons of ore. We plan to start this negotiation during the second half of 2008.

 

**Summary of Material Contractual Commitments**

 

|   | The following table lists our significant commitments as of June 30, 2008: |
|--------|----------------------------------------------------------------------------|

 

|                                      |                                    | Payments Due by Fiscal Year            |
|-------------------------------------------|-----------------------------------------|----------------------------------------|
| Contractual Commitments                   | Total                                   | Less than 1 year                       | 2-3 years | 4-5 years |
|                                      |                                    |                                   |   |   |
| Kaznickel’s work programs (1)  | $    2,000,000           | $     275,000 | $  1,725,000 | -0- |
|                                      |                                    |                                   |   |   |
| KKM’s work programs (2)             | $130,000,000                            | $10,000,000                            | $90,000,000 | $30,000,000 |
|                                      |                                    |                                   |   |   |
| Operating leases                          | $      328,836 | $     328,836 | -0- | -0- |
| Total                                     | $132,328,836                            | $10,603,836                            | $91,725,000 | $30,000,000 |

                

                

| (1) | Each year we must submit an annual work program to the MEMR. The annual work program indicates the scope of mining works for exploration, production and finance costs. The work program for Kaznickel represents estimates based on the subsoil use contract and includes $550,000 for exploration drilling (2,000 meters - in 2008 and 2009), sampling and assaying (1,000 core samples in 2008 and 2009),                                metallurgical tests and preparation of the report to the State Resource Committee. 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 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. 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. |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

  

| (2) | Each year we must submit an annual work program to the MEMR. The annual work program indicates the scope of mining works for exploration, production and finance costs. KKM’s work program represents estimates based on the subsoil use contract and the financial model which is attached to the working program as a justification of the hydroclorination technology. The contract requires us to invest up to $100,000,000                                for construction of a processing plant during the contract period. As discussed above, prior to the end of 2007, it had been the practice in Kazakhstan that if the subsurface user, for any reason, could not fulfill the conditions of its annual work program during a given year, those conditions were extended to the next year because the subsoil user’s obligations under its contract were effective throughout the contract duration. This practice, however, was                                terminated by order of the president of Kazakhstan at the end of 2007. It now appears that the government will impose fines and/or penalties and may even cancel subsurface use contracts if the contract holder fails to satisfy the annual work program on a yearly basis. Also, the estimates include $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. The 2008 work program for KKM is under discussion and negotiations with the MEMR. |
|-----|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

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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 in some 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.

 

**Off-Balance Sheet Financing Arrangements**

 

|   | As of June 30, 2008 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.

 

***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, we are required to reclaim our licensed territories following completion of the exploration and mining activities. 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.

 

28

 

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***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 crude oil 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.

 

**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. We do not engage in hedging transactions to protect us from such risk.

 

**Item 4. 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

 

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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 June 30, 2008.

 

*Changes in Internal Control Over Financial Reporting*

 

There were no changes in our internal control over financial reporting during the quarter ended June 30, 2008 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

**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, 2007.

 

**Item 6. Exhibits**

 

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

 

|           | Exhibit 10.1 |   | Loan Agreement, dated May 22, 2008, between Bekem Metals, Inc., and Latimer Assets Inc.                                                                                          |
|----------------|--------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|           |         |   |                                                                                                                                                                             |
|           | Exhibit 10.2 |   | Addendum No. 1 to the Loan Agreement dated 22 May 2008, dated 19 June 2008, between Bekem Metals, Inc. and Latimer Assets Inc.                                                   |
|           |         |   |                                                                                                                                                                             |
|           | Exhibit 10.3 |   | Pledge Agreement, dated May 22, 2008, between Bekem Metals, Inc., GRK Koitas LLC, Asia-Invest Corporation LLC and Kyzyl Kain Mamyt LLC.                                          |
|           |         |   |                                                                                                                                                                             |
|           | Exhibit 10.4 |   | Addendum No. 1 to the Pledge Agreement dated May 22, 2008, dated 19 June 2008, between Bekem Metals, Inc., GRK Koitas LLC, Asia-Invest Corporation LLC and Kyzyl Kain Mamyt LLC. |
|           |         |   |                                                                                                                                                                             |
|           | 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                                                                       |

 

            

30

 

 

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**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: August 14, 2008 | /s/ Yermek Kudabayev                              |
|-----------------------|---------------------------------------------------|
|                  | Yermek Kudabayev

Chief Executive Officer

  |

 

 

 

| Date: August 14, 2008 | /s/Zhassulan Bitenov                               |
|-----------------------|----------------------------------------------------|
|                  | Zhassulan Bitenov

Chief Financial Officer

  |

 

 

31

 

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