** **

**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

##### **FORM 10-Q**

##### ** **

**(MARK ONE)**

 

| **x**      | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES**                                                                                                                                                                                                                                                           |
|------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** ** | ** ** | **EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD  ENDED**                                                                                                                                                                                                                                                                                    |
| ** ** | ** ** | **MARCH 31, 2008.**                                                                                                                                                                                                                                                                                                                    |
|       |       |                                                                                                                                                                                                                                                                                                                                        |
| ** ** | ** ** | **OR**                                                                                                                                                                                                                                                                                                                                      |
|       |       |                                                                                                                                                                                                                                                                                                                                        |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE  TRANSITION PERIOD  FROM                TO                .** |

 

**COMMISSIONFILE NUMBER 1-13627**

 

**APEX SILVER MINES LIMITED**

(EXACT NAME OFREGISTRANT AS SPECIFIED IN ITS CHARTER)

 

| **CAYMAN  ISLANDS, BRITISH WEST INDIES**  | ** ** | **NOT  APPLICABLE**  |
|-------------------------------------------|------------|----------------------|
| (STATE OR OTHER  JURISDICTION OF          |       | (I.R.S. EMPLOYER     |
| INCORPORATION OR  ORGANIZATION)           |       | IDENTIFICATION  NO.) |
|                                      |       |                 |
| **WALKER  HOUSE**                         | ** ** | ** **           |
| **MARY  STREET**                          | ** ** | ** **           |
| **GEORGE  TOWN, GRAND CAYMAN**            | ** ** | ** **           |
| **CAYMAN  ISLANDS, BRITISH WEST INDIES**  | ** ** | **NOT  APPLICABLE**  |
| (ADDRESS OF  PRINCIPAL EXECUTIVE OFFICES) |       | (ZIP CODE)           |

 

| **(345)  949-0050**                                        |
|------------------------------------------------------------|
| (REGISTRANT’S  TELEPHONE NUMBER, INCLUDING AREA CODE) |

 

INDICATE BY CHECK MARKWHETHER THE REGISTRANT (1) HAS FILED ALL REPORTS REQUIRED TO BE FILED BY SECTION 13OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 DURING THE PRECEDING 12MONTHS (OR FOR SUCH SHORTER PERIOD THAT THE REGISTRANT WAS REQUIRED TO FILESUCH REPORTS), AND (2) HAS BEEN SUBJECT TO SUCH FILING REQUIREMENTS FORTHE PAST 90 DAYS:    YES x    NO o

 

INDICATE BY CHECK MARKWHETHER THE REGISTRANT IS A LARGE ACCELERATED FILER, AN ACCELERATED FILER, ANON-ACCELERATED FILER, OR A SMALLER REPORTING COMPANY. SEE DEFINITIONS OF“LARGE ACCELERATED FILER,” “ACCELERATED FILER,” AND “SMALLER REPORTING COMPANY”IN RULE 12B-2 OF THE EXCHANGE ACT. (CHECK ONE):

 

| LARGE ACCELERATED FILER  x |   | ACCELERATED FILER o          |
|----------------------------|--------|-----------------------------------|
|                       |   |                              |
| NON-ACCELERATED FILER o    |   | SMALLER REPORTING  COMPANY o |

 

INDICATE BY CHECK MARKWHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN RULE 12B-2 OF THEEXCHANGE ACT):  YES o    NOx

 

AT MAY 7, 2008,58,931,475 ORDINARY SHARES, $0.01 PAR VALUE PER SHARE, WERE ISSUED ANDOUTSTANDING.

 

 

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APEX SILVER MINESLIMITED

FORM 10-Q

QUARTER ENDED MARCH 31,2008

 

INDEX

 
| ** **                               | ** ** | ** **                                                                                  | ** ** | **PAGE** | ** ** |
|------------------------------------------|------------|---------------------------------------------------------------------------------------------|------------|----------|------------|
|                                     |       |                                                                                        |       |     |       |
| PART I – FINANCIAL INFORMATION |       |                                                                                        |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 1.                                  |       | FINANCIAL  STATEMENTS                                                                       |       | 3        |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 2.                                  |       | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |       | 27       |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 3.                                  |       | QUANTITATIVE  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                 |       | 36       |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 4.                                  |       | CONTROLS AND  PROCEDURES                                                                    |       | 38       |       |
|                                     |       |                                                                                        |       |     |       |
| PART II  – OTHER INFORMATION   |       |                                                                                        |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 1.                                  |       | LEGAL PROCEEDINGS                                                                           |       | 39       |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 1A.                                 |       | RISK FACTORS                                                                                |       | 39       |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 2.                                  |       | UNREGISTERED  SALES OF EQUITY SECURITIES AND USE OF PROCEEDS                                |       | 39       |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 3.                                  |       | DEFAULTS  UPON SENIOR SECURITIES                                                            |       | 39       |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 4.                                  |       | SUBMISSION  OF MATTERS TO A VOTE OF SECURITY HOLDERS                                        |       | 39       |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 5.                                  |       | OTHER INFORMATION                                                                           |       | 39       |       |
|                                     |       |                                                                                        |       |     |       |
| ITEM 6.                                  |       | EXHIBITS                                                                                    |       | 39       |       |
|                                     |       |                                                                                        |       |     |       |
| SIGNATURES                               |       | 40                                                                                          |       |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**Item 1.    Financial Statements**

 

# **APEXSILVER MINES LIMITED**

# **CONSOLIDATEDBALANCE SHEETS**

**(Expressedin United States dollars)**

**(Unaudited)**

** **
| ** **                                                                                                                                    | ** ** | **March 31,**                                        | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                    | ** ** | **2008**                                                  | ** ** | **2007**              | ** ** |
| ** **                                                                                                                                    | ** ** | **(in thousands, except share data)** | ** ** |
| **Assets**                                                                                                                                    |       |                                                      |       |                  |       |
| Current assets                                                                                                                                |       |                                                      |       |                  |       |
| Cash and cash  equivalents                                                                                                                    |       | $                                                         | 32,543     |                  | $          | 40,736 |   |
| Restricted cash                                                                                                                               |       | 77,232                                                    |       | 12,313                |       |
| Investments                                                                                                                                   |       | 7,708                                                     |       | 52,243                |       |
| Trade  receivables                                                                                                                            |       | 19,932                                                    |       | 3,110                 |       |
| Inventories                                                                                                                                   |       | 54,360                                                    |       | 44,211                |       |
| Derivatives at  fair value                                                                                                                    |       | 1,548                                                     |       | —                |       |
| Deferred tax  asset                                                                                                                           |       | 3,433                                                     |       | —                |       |
| Prepaid expenses  and other assets                                                                                                            |       | 24,140                                                    |       | 16,195                |       |
| Total current  assets                                                                                                                         |       | 220,896                                                   |       | 168,808               |       |
|                                                                                                                                          |       |                                                      |       |                  |       |
| Property, plant  and equipment, net                                                                                                           |       | 833,865                                                   |       | 841,981               |       |
| Ore stockpile  inventories                                                                                                                    |       | 87,535                                                    |       | 76,914                |       |
| Deferred financing  costs                                                                                                                     |       | 14,737                                                    |       | 15,990                |       |
| Value added tax  recoverable                                                                                                                  |       | 107,025                                                   |       | 95,327                |       |
| Restricted cash                                                                                                                               |       | 60,677                                                    |       | 91,000                |       |
| Investments                                                                                                                                   |       | 20,767                                                    |       | 24,407                |       |
| Derivatives at  fair value                                                                                                                    |       | 4,558                                                     |       | 8,475                 |       |
| Other                                                                                                                                         |       | 1,439                                                     |       | 2,009                 |       |
| Total assets                                                                                                                                  |       | $                                                         | 1,351,499  |                  | $          | 1,324,911 |   |
|                                                                                                                                          |       |                                                      |       |                  |       |
| **Liabilities and Shareholders’ Deficit**                                                                                                |       |                                                      |       |                  |       |
|                                                                                                                                          |       |                                                      |       |                  |       |
| Current  liabilities                                                                                                                          |       |                                                      |       |                  |       |
| Accounts payable  and other accrued liabilities                                                                                               |       | $                                                         | 63,525     |                  | $          | 55,957 |   |
| Accrued interest  payable                                                                                                                     |       | 3,156                                                     |       | 4,982                 |       |
| Derivatives at  fair value                                                                                                                    |       | 325,269                                                   |       | 266,820               |       |
| Current portion  of long term debt                                                                                                            |       | 41,067                                                    |       | 41,155                |       |
| Total current  liabilities                                                                                                                    |       | 433,017                                                   |       | 368,914               |       |
| Long term debt                                                                                                                                |       | 545,384                                                   |       | 546,981               |       |
| Derivatives at  fair value                                                                                                                    |       | 446,378                                                   |       | 482,683               |       |
| Deferred gain on  sale of asset                                                                                                               |       | 945                                                       |       | 945                   |       |
| Asset retirement  obligation                                                                                                                  |       | 7,906                                                     |       | 6,981                 |       |
| Deferred tax  liability                                                                                                                       |       | 8,370                                                     |       | —                |       |
| Other long term  liabilities                                                                                                                  |       | 2,350                                                     |       | 2,508                 |       |
| Total  liabilities                                                                                                                            |       | 1,444,350                                                 |       | 1,409,012             |       |
| Commitments and  contingencies (Note 18)                                                                                                      |       |                                                      |       |                  |       |
|                                                                                                                                          |       |                                                      |       |                  |       |
| Shareholders’  deficit                                                                                                                   |       |                                                      |       |                  |       |
| Ordinary Shares,  $.01 par value, 175,000,000 shares authorized; 58,931,475 and 58,909,625  shares issued and outstanding at respective dates |       | 590                                                       |       | 589                   |       |
| Additional paid  in capital                                                                                                                   |       | 678,273                                                   |       | 677,203               |       |
| Accumulated  deficit                                                                                                                          |       | (771,036                                                  | )          | (761,783              | )          |
| Accumulated  other comprehensive loss                                                                                                         |       | (678                                                      | )          | (110                  | )          |
| Total  shareholders’ deficit                                                                                                             |       | (92,851                                                   | )          | (84,101               | )          |
| Total  liabilities and shareholders’ deficit                                                                                             |       | $                                                         | 1,351,499  |                  | $          | 1,324,911 |   |

 

The accompanying notesform an integral part of these consolidated financial statements.

 

3

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**APEXSILVER MINES LIMITED**

# **CONSOLIDATED STATEMENTS OF OPERATIONS ANDCOMPREHENSIVE INCOME (LOSS)**

**(Expressedin United States dollars)**

**(Unaudited)**

** **
| ** **                                                               | ** ** | **Three Months Ended**                          | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                               | ** ** | **March 31**                                         | ** ** |
| ** **                                                               | ** ** | **2008**                                                  | ** ** | **2007** | ** ** |
| ** **                                                               | ** ** | **(in thousands, except share data)** | ** ** |
| **Revenues:**                                                            |       |                                                      |       |   |   |
| Sales of  concentrates                                                   |       | $                                                         | 136,853    |   | $ | — |   |
| **Costs  and expenses:**                                                 |       |                                                      |       |   |   |
| Costs applicable  to sales (exclusive of amounts shown separately below) |       | (68,978                                                   | )          | — |   |
| Exploration                                                              |       | (6,192                                                    | )          | (2,731 | ) |
| Administrative                                                           |       | (4,245                                                    | )          | (6,290 | ) |
| Gain (loss) on  commodity derivatives                                    |       | (76,526                                                   | )          | 108,306 |   |
| Gain on foreign  currency derivatives and transactions                   |       | 4,863                                                     |       | 984 |   |
| Asset retirement  accretion expense                                      |       | (169                                                      | )          | (139 | ) |
| Depreciation,  depletion and amortization                                |       | (10,621                                                   | )          | (114 | ) |
| Total operating  expenses, net                                           |       | (161,868                                                  | )          | 100,016 |   |
| Income (loss)  from operations                                           |       | (25,015                                                   | )          | 100,016 |   |
| ** **                                                               |       |                                                      |       |   |   |
| **Other  income and expenses:**                                          |       |                                                      |       |   |   |
| Interest and  other income                                               |       | 2,047                                                     |       | 7,080 |   |
| Interest expense  and other borrowing costs                              |       | (16,188                                                   | )          | — |   |
| Total other  income and expenses                                         |       | (14,141                                                   | )          | 7,080 |   |
| Income (loss)  before minority interest and income taxes                 |       | (39,156                                                   | )          | 107,096 |   |
| Income taxes                                                             |       | (10,919                                                   | )          | (47 | ) |
| Minority  interest in loss of consolidated subsidiaries                  |       | 40,822                                                    |       | 4,930 |   |
| Net income  (loss)                                                       |       | $                                                         | (9,253     | ) | $ | 111,979 |   |
| Other comprehensive  loss: Unrealized loss on securities                 |       | $                                                         | (568       | ) | $ | (232 | ) |
| Comprehensive  income (loss)                                             |       | $                                                         | (9,821     | ) | $ | 111,747 |   |
| **Net  income (loss) per Ordinary Share – basic**                   |       | $                                                         | (0.16      | ) | $ | 1.91 |   |
| **Net  income (loss) per Ordinary Share – diluted**                 |       | $                                                         | (0.16      | ) | $ | 1.62 |   |
| **Weighted  average Ordinary Shares outstanding - basic**                |       | 58,914,066                                                |       | 58,610,698 |   |
| **Weighted  average Ordinary Shares outstanding - diluted**              |       | 58,914,066                                                |       | 69,035,212 |   |

 

The accompanyingnotes form an integral part of these consolidated financial statements.

 

4

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**APEXSILVER MINES LIMITED**

# **CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Expressedin United States dollars)**

**(Unaudited)**

** **
| ** **                                                                                                                   | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                                   | ** ** | **March 31**                | ** ** |
| ** **                                                                                                                   | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ** **                                                                                                                   | ** ** | **(in thousands)**          | ** ** |
| Cash flows from  operating activities:                                                                                       |       |                             |       |   |   |
| Net cash  provided by (used in) operating activities (Note 20)                                                               |       | $                                | 1,442      |   | $ | (16,473 | ) |
| Cash flows from  investing activities:                                                                                       |       |                             |       |   |   |
| Purchase of  available for sale investments                                                                                  |       | (7,130                           | )          | (254,309 | ) |
| Sale of  available for sale investments                                                                                      |       | 52,917                           |       | 351,632 |   |
| Maturities of  held-to-maturity investments                                                                                  |       | 2,000                            |       | 5,000 |   |
| Purchase of  available for sale restricted investments                                                                       |       | —                           |       | (29,800 | ) |
| Sale of  available for sale restricted investments                                                                           |       | —                           |       | 65,600 |   |
| Maturities of  held-to-maturity restricted investments                                                                       |       | —                           |       | 2,800 |   |
| Settlement of  metal derivative instruments                                                                                  |       | (52,012                          | )          | — |   |
| Released from  (transfer to) restricted cash to collateralize credit facility, letters of  credit and interest payments, net |       | (34,596                          | )          | 21,750 |   |
| Capitalized  costs and acquisitions of property, plant and equipment                                                         |       | (1,865                           | )          | (68,851 | ) |
| Net cash  provided by (used in) investing activities                                                                         |       | $                                | (40,686    | ) | $ | 93,822 |   |
| Cash flows from  financing activities:                                                                                       |       |                             |       |   |   |
| Payments of  notes payable and long term debt                                                                                |       | (2,199                           | )          | (4,463 | ) |
| Borrowings under  project finance facility                                                                                   |       | —                           |       | 20,000 |   |
| Minority  interest contributions                                                                                             |       | 33,250                           |       | 4,585 |   |
| Proceeds from  exercise of stock options and warrants                                                                        |       | —                           |       | 481 |   |
| Net cash  provided by financing activities                                                                                   |       | $                                | 31,051     |   | $ | 20,603 |   |
| Net increase  (decrease) in cash and cash equivalents                                                                        |       | (8,193                           | )          | 97,952 |   |
| Cash and cash  equivalents - beginning of period                                                                             |       | 40,736                           |       | 49,840 |   |
| Cash and cash  equivalents - end of period                                                                                   |       | $                                | 32,543     |   | $ | 147,792 |   |

 

See Note 20 forsupplemental cash flow information.

 

The accompanyingnotes form an integral part of these consolidated financial statements.

 

5

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**APEXSILVER MINES LIMITED**

 

**NOTES TOTHE CONSOLIDATED FINANCIAL STATEMENTS**

**(Expressedin United States dollars)**

 

**1.****              Basisof Preparation of Financial Statements and Nature of Operations**

 

These unaudited interimconsolidated financial statements of Apex Silver Mines Limited (the “Company”)and its subsidiaries have been prepared in accordance with the rules andregulations of the Securities and Exchange Commission (“SEC”).  Such rules and regulations allow theomission of certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples in the United States of America (“GAAP”), so long as such omissionsdo not render the financial statements misleading.

 

In the opinion ofmanagement, these financial statements reflect all adjustments that arenecessary for a fair statement of the results for the periods presented.  All adjustments were of a normal recurringnature.  Certain reclassifications havebeen made to the prior period financial statements to conform to the currentperiod presentation.  These interimfinancial statements should be read in conjunction with the annual financialstatements of the Company included in its 2007 Annual Report on Form 10-K.

 

The Company is a mining, exploration and developmentcompany that owns 65% of and operates the San Cristobal silver, zinc and leadmine in Bolivia. The Company has focused its resources primarily on thedevelopment of the San Cristobal mine, which began producing silver bearinglead and zinc concentrates during the third quarter 2007 and reached sustainedoperation levels in the fourth quarter 2007. Prior to the third quarter 2007the Company had no mining operations from which product was being produced andsold; consequently, the Company had not previously reported operating income.Although the Company’s senior corporate and operating management havesignificant experience in operating very large mining complexes in manycountries, the Company had never operated a mine prior to commencement ofoperations at San Cristobal, and there are certain risks associated with theCompany’s ability to successfully achieve anticipated production volumes,manage cost increases and operate the San Cristobal mine in accordance with theterms and covenants of the related project finance facility (the “Facility”) asdescribed in Note 10.

 

The Company also conductsexploration activities primarily in South America and Central America andcurrently holds interests in non-producing mineral properties in Argentina,Mexico, Peru, Bolivia, Ecuador and Australia.

 

**2.****              Liquidityand Capital Resources**

 

At March 31, 2008,the Company’s aggregate cash, restricted cash, short and long-term investmentstotaled $198.9 million compared to an aggregate of $220.7 million in cash,restricted cash, short and long-term investments and restricted investments at December 31,2007.  The amounts held at March 31,2008 include $32.5 million of unrestricted cash and cash equivalents, $7.7million of unrestricted short-term investments, $20.8 million of currentlyilliquid auction rate securities (“ARS’) classified as long term (see Note 4),$91.0 million of cash that is restricted to collateralize the metal derivativeopen positions required by the Facility, of which $30.3 million is expected tobecome unrestricted on January 2, 2009 and is therefore classified asshort term, and $46.9 million of cash that is restricted to the operatingrequirements at the San Cristobal mine and interest and principal payments onthe $225 million Facility (see Note 10). At March 31, 2008, the Company’s aggregate unrestricted cash andinvestments (excluding ARS) totaled $40.2 million.

 

Over the next twelvemonths, the Company expects to spend approximately $25 million on generalcorporate costs and interest related to the convertible debt (see Note 10) and$20 million on exploration.  The Companyplans to fund these expenditures primarily from interest and other income andfrom Sumitomo’s deferred payment obligation on silver and zinc production atthe San Cristobal mine.  For the firstquarter 2008, the Company received $2.0 million in interest and other income,some of which was earned on restricted accounts and remained subject torestrictions, and $1.9 million in payments from Sumitomo.  Cash from the deferred payment obligation isnot subject to any restrictions.  In theevent general corporate costs, interest and exploration costs exceed currentprojections any additional cash funding would come from existing unrestrictedcash and investments.  In addition, theCompany expects that $30.3 million of cash that is restricted to collateralizethe metal derivative open positions 

 

6

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required by the Facility will become unrestricted at the beginning of2009 and will be available for general corporate purposes.  If “completion” has not been achieved or theCompany otherwise is not in compliance with the terms of the Facility, thatamount will not be released until such noncompliance has been cured.

 

During the first quarter2008, the Company and Sumitomo contributed $82.1 million to San Cristobal tofund operating costs, income and other taxes, capital costs, financing costs,and settlement of metal derivative positions required in connection with theFacility. The Company funded $48.8 million of this amount and the remaining$33.3 million was funded by Sumitomo (the amounts are different than the65%/35% ownership ratio due to funding by Apex prior to year-end 2007, inadvance of Sumitomo’s corresponding funding which occurred at the beginning of2008).   Although operations at SanCristobal continue in the ramp-up phase, management does not believe that theCompany and Sumitomo will need to contribute any additional amounts to SanCristobal to fund operations through the end of 2008 and that cash flows fromconcentrate sales will cover remaining 2008 San Cristobal operating costs,taxes, capital expenditures, debt service and metal derivative settlementcosts. As noted below, however, the Company currently anticipates that it andSumitomo will be required to contribute additional amounts to the mine inJanuary 2009 in connection with the payment of Bolivian income taxes.

 

The Facility containscovenants that require the Company, among other things, to achieve “completion”of the mine as defined in the Facility by year-end 2008.  Failure to achieve “completion” by year-end2008 would constitute a default under the Facility.  One of the requirements for completion is thefunding of operating and debt service reserve accounts, which are estimated torequire $72 million in aggregate.   TheCompany projects that operating cash flows from the San Cristobal mine will besufficient to fund these reserve accounts by the end of 2008.  If operating cash flows are not sufficient tofund the reserve accounts, the Company and Sumitomo would be required to fundany shortfall, or request that the Facility lenders extend the period toachieve completion, to remain in compliance with the Facility.   There can be no assurance that the lenderswould agree to such an extension.

 

In addition, following“completion” of the San Cristobal mine as defined in the Facility, cash flowsfrom the mine must meet certain minimum forward looking loan coverage ratioswhich must be computed using metals prices set forth in the Facility, which arelower than current market prices. Specifically, for production during 2009, the forward looking debtservice coverage ratio will be computed using metals prices of $7.32 per ouncefor silver, $0.61 per pound for zinc, and $0.32 per pound for lead. AtMarch 31, 2008 the current market prices were $17.99 per ounce for silver,$1.04 per pound for zinc, and $1.27 per pound for lead.  The Company must submit annually an updatedoperating plan to the lenders by November 1 using the metals prices setforth in the Facility and projections of actual production and operating costsfor the following year and life of the mine. Material increases in projected costs or decreases in projectedproduction could cause the Company to fail to comply with the forward lookingfinancial ratios included in the operating plan.  In this situation, the Company would have torequest that the Facility lenders allow increased metals prices in theoperating plan, or otherwise modify the Facility, to remain in compliance.  There can be no assurance that the lenderswould agree to such an increase or other such modifications.

 

Failure to meet one ormore of the conditions or covenants required by the Facility, or to curerelated violations within specified periods, could cause the lenders to declarethe Company in default.   If such adefault were declared and remained uncured, amounts borrowed under the Facilitycould become due and payable immediately and the Company could be required toimmediately settle its share of all outstanding hedge positions associated withthe Facility (see Note 12).  The Companycurrently does not have sufficient cash and investments to settle fully its 65%share of the obligation related to the Facility and hedge liability, and therecan be no assurance that the Company would be able to obtain the additionalfunds necessary to settle such amounts. If the Company were unable to repay the borrowed amounts or otherwiseperform its obligations under the Facility, the lenders would be entitled, incertain circumstances, to enforce their lien and take possession of the securedassets, including the assets that comprise the San Cristobal mine.  In addition, failure to pay amountsaccelerated under the Facility could also result in a default under the termsof the Company’s 2.875% and 4.0% Convertible Senior Subordinated Notes due2024, which could require the repayment of those amounts as well.

 

Further, San Cristobalwill be required to make a significant income tax payment, which will varydepending on the income generated by the mine, in January 2009 upon thefiling of its annual Bolivian income tax return, representing the majority ofits tax liability due for the Bolivian fiscal year ended September 30, 2008.  The Company estimates that the tax paymentcould be as much as $90 million with the Company’s 65% share being as much as$59 million. Based on those projections, the Company anticipates that the cashbalances held by San Cristobal at that time will not be sufficient to both fundthe operating and debt service reserve accounts required by the Facility (seediscussion above) and make the tax payment as required.   This would require the Company and Sumitomoto contribute additional amounts to San Cristobal.   TheCompany is currently projecting that it will be able to fund its share of SanCristobal’s anticipated cash shortfall in January 2009 with availableunrestricted cash and investments and expects that Sumitomo would fund itsshare.

 

Whether San Cristobalwill require future funding from the Company and Sumitomo in excess of currentprojections will depend on, among other things, the amount and timing ofconcentrate production, revenues and related cash receipts, and expenditures,including the settlement of metal derivative positions and payment oftaxes.  Because the mine has not yetreached full production capacity, the amount and timing of production, revenuesand related cash receipts and expenditures are difficult to predict.  If the San Cristobal ramp-up and productionare delayed, or if projected metals recovery rates or mine and mill costestimates are not substantially achieved, additional funding may berequired.   If San Cristobal requiresadditional cash funding, the Company could require additional debt or equityfinancing.  There can be no assurancethat the Company could obtain such debt or equity financing on acceptable termsand conditions or at all.  If Sumitomofunds its pro rata share of additional San Cristobal funding but the Company isunable to fund its share, the Company’s ownership interest in the mine could bereduced.

 

7

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The Company is exploringalternatives for increasing its liquidity in the event that its current balanceof unrestricted cash and investments falls below acceptable levels.  Alternatives for increasing availableunrestricted cash and investments could include, among other things, debt orequity financing or selling an additional interest in San Cristobal or one ormore exploration properties.  Inaddition, the Company could seek certain waivers from the lenders of theFacility to extend the period for meeting completion under the Facility or toassure compliance with financial ratios. There can be no assurance that any of these strategies, if undertaken,would be successful or that the Company would find the terms and conditions ofany of the alternatives acceptable.

 

**3.****              SignificantAccounting Policies**

 

*Recently Adopted Standards*

 

Effective January 1,2008 the Company adopted the provisions of Financial Accounting Standards No. 157,“Fair Value Measurements” (“FAS No. 157”) for the financial assets andliabilities and nonfinancial assets and liabilities which were measured at fairvalue on a recurring (annual) basis.  FASNo. 157 defines fair value, establishes a framework for measuring fairvalue in generally accepted accounting principles, and expands disclosuresabout fair value measurements. This Standard addresses how companies shouldmeasure fair value when they are required to use a fair value measure forrecognition or disclosure purposes under GAAP. Accordingly, this Standard doesnot require any new fair value measurements. During February 2008 the Financial Accounting Standards Board (“FASB”)issued Staff Position No 157-2 “Effective Date of FASB Statement No. 157”(“FSP FAS 157-2”). FSP FAS 157-2 delayed the effective date of FAS No. 157by one year (until fiscal years beginning after November 15, 2008) fornon-financial assets and non-financial liabilities that are recognized ordisclosed at fair value in the financial statements on a nonrecurringbasis.  The adoption of FAS No. 157did not have a material impact on the Company’s financial position or resultsof operations at March 31, 2008 and is not expected to have a materialimpact in the future. See Note 13 for detail regarding the Company’s fair valuemeasurement disclosures in accordance with FAS No. 157.

 

Effective January 1,2008 the Company adopted Financial Accounting Standards No. 159, “The FairValue Option for Financial Assets and Financial Liabilities-Including anamendment of FASB Statement No. 115” (“FAS No. 159”).  FAS No. 159 permits entities to chooseto measure many financial instruments and certain other items at fair value.Most of the provisions of FAS No. 159 apply only to entities that electthe fair value option.  However, theamendment to FASB Statement No. 115, “Accounting for Certain Investmentsin Debt and Equity Securities,” (“FAS No. 115”) applies to all entitieswith available-for-sale and trading securities. The Company did not elect the fair value option for any of its financialassets or liabilities, and as a result, the adoption of FAS No. 159 didnot have a material impact on the Company’s financial position or results ofoperations at March 31, 2008 and is not expected to have a material impactin the future.

 

8

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*New Accounting Standards*

 

During March 2008the FASB issued Financial Accounting Standards No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133”(“FAS No. 161”).  FAS No. 161enhances the disclosure requirements under FAS No. 133 pertaining to howand why an entity uses derivative instruments, how derivative instruments andrelated hedge items are accounted for under FAS No. 133, and howderivative instruments and related hedge items affect an entity’s financialposition, financial performance, and cash flows.  FAS No. 161 is effective for fiscalyears, and interim periods within those fiscal years, beginning after November 15,2008 (fiscal year 2009 for the Company). The Company is currently evaluatingthe potential impact of adopting this statement on the Company’s derivativeinstrument disclosures.

 

During December 2007the FASB issued Financial Accounting Standards No. 160, “Non-controllingInterests in Consolidated Financial Statements—an Amendment of AccountingResearch Bulletin No. 51, ‘Consolidated Financial Statements’” (“FAS No. 160”).A non-controlling interest, sometimes called a minority interest, is theportion of equity in a subsidiary not attributable, directly or indirectly, toa parent. The objective of this Standard is to improve the relevance,comparability, and transparency of the financial information that a reportingentity provides in its consolidated financial statements by establishingaccounting and reporting standards related to non-controlling interests. FAS No. 160is effective for fiscal years, and interim periods within those fiscal years,beginning on or after December 15, 2008 (fiscal year 2009 for theCompany).  Upon adoption of FAS No. 160,the Company will no longer report minority interest in the “mezzanine”, butwill reflect such interests as part of shareholder’s equity.  Furthermore, FAS No. 160 changes the waytransactions among shareholders are accounted for and allows the fullallocation of losses to the non-controlling interest, even when non-controllinginterest’s equity balance is in a deficit position. Historically the Companyhas absorbed losses in excess of its interest in certain subsidiaries asdescribed in Note 16.

 

During December 2007the FASB issued Financial Accounting Standards No. 141 (Revised 2007), “BusinessCombinations” (“FAS No. 141R”).  FASNo. 141R provides revised guidance on how an acquirer in a businesscombination recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, non-controllinginterests, and goodwill acquired. FAS No. 141R also expands requireddisclosures around the nature and financial effects of business combinations.FAS No. 141R generally applies prospectively to business combinations forwhich the acquisition date is on or after the beginning of the first annualreporting period beginning on or after December 15, 2008 (fiscal year 2009for the Company).  The Company iscurrently evaluating the impact FAS No. 141R would have on its financialposition and results of operations should it enter into a business combinationin the future.

 

During September 2007the FASB issued Proposed FASB Staff Position No. APB 14-a, “Accounting forConvertible Debt Instruments That May Be Settled in Cash Upon Conversion(Including Partial Cash Settlement)” (“FSP No. 14-a”).  FSP No. 14-a applies to convertible debtinstruments that, by their stated terms, may be settled in cash (or otherassets) upon conversion, including partial cash settlement, unless the embeddedconversion option is required to be separately accounted for as a derivativeunder Financial Accounting Standards No. 133, “Accounting for DerivativesInstruments and Hedging Activities” (“FAS No. 133”) .  FSP No. 14-a will require the liabilityand equity components of convertible debt instruments to be separatelyaccounted for in a manner that will reflect the entity’s nonconvertible debtborrowing rate when interest cost is recognized in subsequent periods.  If a convertible debt instrument within thescope of FSP No. 14-a is settled through the issuance of cash, stock, orany combination thereof, or if a modification or exchange of an instrument isaccounted for as an extinguishment, an issuer will recognize separately theextinguishment of the liability component and the reacquisition of the equitycomponent.  Any difference between thesettlement consideration attributed to the liability component and its carryingamount is recognized in the income statement as a gain or loss on debtextinguishment.  Any difference betweenthe consideration attributed to the equity component and its carrying amount isrecognized in stockholders’ equity. The Company is currently evaluating whatimpact if any FSP No. 14-a would have on the Company’s financial positionor results of operations if the FASB were to require its adoption.

 

9

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**4.****              Investments**

 

The Company considers all highly liquid investments with a maturity ofthree months or less when purchased to be cash equivalents.  Short-term investments include investmentswith maturities greater than three months, but not exceeding twelve months.Long-term investments include investments with maturities greater than twelvemonths.

 

The Company determines the appropriate classification of itsinvestments in debt and equity securities at the time of purchase andre-evaluates those classifications at each balance sheet date. Debt securitiesare classified as held to maturity when the Company has the intent and abilityto hold the securities to maturity.  Heldto maturity debt securities are stated at amortized cost.  Available for sale investments are marked tomarket at each reporting period with changes in value recorded as a componentof other comprehensive loss. If declines in value are deemed other thantemporary, a charge is made to net income (loss) for the period.

 

At March 31, 2008the Company held investments in ARS with an adjusted cost basis of $21.4million.  The adjusted cost basisreflects $30.6 million of other than temporary impairment charges recordedthrough December 31, 2007. For the first quarter 2008 the Company recordeda net temporary impairment on its ARS’s held as of March 31, 2008 of $0.6million which has been recorded in other comprehensive loss.  During the quarter ended March 31, 2008the Company liquidated at par value approximately $0.3 million of its ARS. Thefair value for each of the remaining ARS was determined by the Company, withthe assistance of a third party valuation firm. (See Note 13 for fair valuemeasurements disclosure).

 

The following tablessummarize the Company’s investments at March 31, 2008 and December 31,2007:

 
| **March 31, 2008** | ** ** | **Cost**                | ** ** | **Estimated  Fair Value** | ** ** | **Carrying  Value** | ** ** |
|------------------------------|------------|-------------------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                   | ** ** | **(in thousands)** | ** ** |
|                         |       |                    |       |                           |       |                |       |
| Investments:                 |       |                    |       |                           |       |                |       |
| Short-term:                  |       |                    |       |                           |       |                |       |
| Available for  sale          |       |                    |       |                           |       |                |       |
| Common stock                 |       | $                       | 761        |                           | $          | 591                 |       | $ | 591 |   |
| Corporate notes              |       | 2,980                   |       | 2,977                          |       | 2,977               |       |
| Government bonds             |       | 4,134                   |       | 4,140                          |       | 4,140               |       |
| Total available  for sale    |       | 7,875                   |       | 7,708                          |       | 7,708               |       |
| Total short term             |       | $                       | 7,875      |                           | $          | 7,708               |       | $ | 7,708 |   |
| Long-term:                   |       |                    |       |                           |       |                |       |
| Available for  sale          |       |                    |       |                           |       |                |       |
| Auction rate  securities     |       | $                       | 21,364     |                           | $          | 20,767              |       | $ | 20,767 |   |
| Total available  for sale    |       | 21,364                  |       | 20,767                         |       | 20,767              |       |
| Total long term              |       | $                       | 21,364     |                           | $          | 20,767              |       | $ | 20,767 |   |

 

10

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| **December 31, 2007**    | ** ** | **Cost**   | ** ** | **Estimated  Fair Value** | ** ** | **Carrying  Value** | ** ** |
|------------------------------------|------------|------------|------------|--------------------------------|------------|---------------------|------------|
| ** **                         | ** ** | ** ** | ** ** | **(in thousands)**        | ** ** |
| Investments:                       |       |       |       |                           |       |                |       |
| Short-term:                        |       |       |       |                           |       |                |       |
| Available for  sale                |       |       |       |                           |       |                |       |
| Common stock                       |       | $          | 761        |                           | $          | 654                 |       | $ | 654 |   |
| Corporate notes                    |       | 36,040     |       | 35,946                         |       | 35,946              |       |
| Government bonds                   |       | 13,635     |       | 13,643                         |       | 13,643              |       |
| Total available  for sale          |       | 50,436     |       | 50,243                         |       | 50,243              |       |
| Held to maturity  Government bonds |       | 2,000      |       | 2,001                          |       | 2,000               |       |
| Total held to  maturity            |       | 2,000      |       | 2,001                          |       | 2,000               |       |
| Total short term                   |       | $          | 52,436     |                           | $          | 52,244              |       | $ | 52,243 |   |
| Long-term:                         |       |       |       |                           |       |                |       |
| Available for  sale                |       |       |       |                           |       |                |       |
| Corporate notes                    |       | $          | 2,900      |                           | $          | 2,897               |       | $ | 2,897 |   |
| Auction rate  securities           |       | 21,510     |       | 21,510                         |       | 21,510              |       |
| Total available  for sale          |       | 24,410     |       | 24,407                         |       | 24,407              |       |
| Total long term                    |       | $          | 24,410     |                           | $          | 24,407              |       | $ | 24,407 |   |

 

Quoted market prices at March 31,2008 and December 31, 2007 were used to determine the fair values of theabove investments, except with respect to the auction rate securities. See Note13 for further discussion on the fair value measurement techniques used by theCompany to value the above investments.

 

*Credit Risk*

 

Credit risk is the riskthat a third party might fail to fulfill its performance obligations under theterms of a financial instrument. For cash and equivalents and investments,credit risk represents the carrying amount on the balance sheet. We attempt tomitigate credit risk for cash and equivalents and investments by placing our fundsand investments with high credit-quality financial institutions, limiting theamount of exposure to each of the financial institutions, monitoring thefinancial condition of the financial institutions and investing only ingovernment and corporate securities rated “investment grade” or better. TheCompany invests with financial institutions that maintain a net worth of notless than $1 billion and are members in good standing of the SecuritiesInvestor Protection Corporation. (See the discussion above regarding theCompany’s ARS investments.)

 

**5. Prepaid expenses and otherassets**

 

Prepaid expenses andother assets consist of the following:

 
| ** **                                   | ** ** | **March 31,  2008** | ** ** | **December 31,  2007** | ** ** |
|----------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                   | ** ** | **(in thousands)**  | ** ** |
| Current portion  of note receivable          |       | $                        | 2,702      |                        | $          | 2,728 |   |
| Prepaid  insurance                           |       | 3,558                    |       | 3,651                       |       |
| Accrued interest  on investments             |       | 274                      |       | 768                         |       |
| Prepaid  contractor fees and vendor advances |       | 10,681                   |       | 5,615                       |       |
| Deferred  payments receivable                |       | 5,451                    |       | 1,928                       |       |
| Other                                        |       | 1,474                    |       | 1,505                       |       |
|                                         |       | $                        | 24,140     |                        | $          | 16,195 |   |

 

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The currentportion of notes receivable is related to funds previously advanced by theCompany to the contractor that constructed the load out facilities at the Portof Mejillones (see Note 9). Prepaid contractor fees and vendor advances at March 31,2008 consist primarily of advance payments made to contractors and suppliersfor mining and processing supplies and services at the San Cristobal mine.

 

Under the terms of the sale to Sumitomo of a 35% interest in thesubsidiary holding our San Cristobal mine, the Company retained certaininterests in future silver and zinc production from Sumitomo’s interest in SanCristobal mine production. Deferred payments receivable are related to amountsreceivable from Sumitomo related to those retained interests in San Cristobalmine silver and zinc production (see Note 16). The Company received the $5.5million of deferred payments from Sumitomo during April 2008.

 

**6.****              Inventories**

 

Inventories at our SanCristobal mine at March 31, 2008 and December 31, 2007 consist of thefollowing:

 
| **Current Inventories**                       | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|----------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| Concentrate  inventories                           |       | $                            | 23,927     |                            | $          | 23,377 |   |
| Sulfide ore  stockpiles                            |       | 797                          |       | 834                             |       |
| Material and  supplies                             |       | 29,636                       |       | 20,000                          |       |
|                                               |       | $                            | 54,360     |                            | $          | 44,211 |   |
|                                               |       |                         |       |                            |       |
| **Long Term Stockpile Inventories** | ** ** | ** **                   | ** ** | ** **                      | ** ** |
| Sulfide ore  stockpiles                            |       | $                            | 19,524     |                            | $          | 15,092 |   |
| Oxide ore  stockpiles                              |       | 68,011                       |       | 61,822                          |       |
|                                               |       | $                            | 87,535     |                            | $          | 76,914 |   |

 

Concentrate inventoriesconsist of approximately 26,191 tonnes and 19,863 tonnes of concentrates at March 31,2008 and December 31, 2007, respectively, and are carried at cost, whichis lower than net realizable value. Concentrate inventories includeconcentrates at the mine and in transit for which title has not yet passed tothe smelter.  Material and suppliesinventory consist primarily of fuel, reagents and operating supplies and arecarried at the lower of cost or market. The long term stockpile inventoriesconsist of stockpiled ore that will be processed later in the mine life and arecarried at cost.

 

**7.****              Value Added TaxRecoverable**

 

The Company has recorded value added tax (“VAT”) paid in Bolivia andrelated to the San Cristobal mine as a recoverable asset.  Bolivian law states that VAT paid prior toproduction is recoverable as a credit against Bolivian taxes arising fromproduction, including income taxes. The VAT is expected to be recovered throughfuture production and sales from the San Cristobal mine.  Future changes to Bolivian tax law could havean adverse effect on the Company’s ability to recover the VAT paid in Bolivia(see Note 18).  At March 31, 2008and December 31, 2007, the VAT recoverable was $107.0 million and $95.3million, respectively.  The VATrecoverable amounts include $9.5 million and $8.6 million of recoverableBolivian import duties for the periods ended March 31, 2008 and December 31,2007, respectively.

 

The Company has also paid VAT in Bolivia as well as other countries,primarily related to exploration projects, which has been charged to expense asincurred because of the uncertainty of recoverability.

 

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**8.****              Property, Plant andEquipment**

 

The components of property, plant and equipment wereas follows:

 
| ** **                      | ** ** | **March 31,**      | ** ** | **December 31,** | ** ** |
|---------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                      | ** ** | **2008**                | ** ** | **2007**              | ** ** |
| ** **                      | ** ** | **(in thousands)** | ** ** |
| Mineral  properties             |       | $                       | 247,849    |                  | $          | 248,120 |   |
| Construction in  progress       |       | 6,302                   |       | 3,863                 |       |
| Buildings                       |       | 14,576                  |       | 14,576                |       |
| Mining equipment  and machinery |       | 521,311                 |       | 521,070               |       |
| Other furniture  and equipment  |       | 4,792                   |       | 4,669                 |       |
|                            |       | 794,830                 |       | 792,298               |       |
| Less:  Accumulated depreciation |       | (27,920                 | )          | (19,652               | )          |
|                            |       | 766,910                 |       | 772,646               |       |
| Equipment under  capital lease  |       | 69,107                  |       | 69,107                |       |
| Less:  Accumulated depreciation |       | (14,180                 | )          | (11,918               | )          |
|                            |       | 54,927                  |       | 57,189                |       |
| Port facilities  under lease    |       | 12,283                  |       | 12,283                |       |
| Less:  Accumulated depreciation |       | (255                    | )          | (137                  | )          |
|                            |       | 12,028                  |       | 12,146                |       |
|                            |       | $                       | 833,865    |                  | $          | 841,981 |   |

 

Mineral propertiesinclude engineering, financing and other costs not attributable to specificfixed assets at the San Cristobal mine.

 

For the three monthsended March 31, 2008 and 2007 the Company recorded depreciation expense of$10.6 million and $0.1 million, respectively. For the three months ended March 31, 2007 the Company capitalizeddepreciation associated with the construction of the San Cristobal mine in theamount of $2.0 million.  No depreciationwas capitalized for the comparable period of 2008.

 

At March 31, 2008the Company had recorded a lease obligation of $50.9 million related to SanCristobal mining equipment under capital lease (see Note 10).

 

**9.****              Other Long TermAssets**

 

At March 31, 2008other long term assets consists primarily of $1.4 million long-term portion ofa $4.1 million note receivable, plus accrued interest, from the contractor thatconstructed the load out facilities at the Port of Mejillones for fundspreviously advanced by the Company (see Note 5). The note and accrued interestare being repaid by applying a portion of the amounts owed for port charges bythe San Cristobal mine to the outstanding note and accrued interestbalances.  For the three month periodended March 31, 2008 approximately $0.7 million of port fees have beenapplied to reduce the principal amount of the note and accrued interest.  The note plus accrued interest is expected tobe fully recovered by December 2009.

 

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**10.  Debt**

 

The Company’s debtconsists of the following:

 
| ** **                                             | ** ** | **March 31, 2008** | ** ** | **December 31, 2007** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **Current**                  | ** ** | **Long-term**                   | ** ** | **Current** | ** ** | **Long-term** | ** ** |
| ** **                                             | ** ** | **(in thousands)**      | ** ** |
|                                                   |       |                         |       |                            |       |   |   |   |   |
| 2.875%  Convertible Senior Subordinated Notes due 2024 |       | $                            | —     |                            | $          | 180,000 |   | $ | — |   | $ | 180,000 |   |
|                                                   |       |                         |       |                            |       |   |   |   |   |
| 4.0% Convertible  Senior Subordinated Notes due 2024   |       | —                       |       | 109,987                         |       | — |   | 109,987 |   |
|                                                   |       |                         |       |                            |       |   |   |   |   |
| Project finance  facility                              |       | 32,625                       |       | 192,375                         |       | 32,625 |   | 192,375 |   |
|                                                   |       |                         |       |                            |       |   |   |   |   |
| Note assigned to  Sumitomo                             |       | —                       |       | 8,615                           |       | — |   | 8,013 |   |
|                                                   |       |                         |       |                            |       |   |   |   |   |
| Capital leases                                         |       | 8,038                        |       | 42,850                          |       | 8,242 |   | 44,845 |   |
|                                                   |       |                         |       |                            |       |   |   |   |   |
| Port lease  liability                                  |       | 404                          |       | 11,557                          |       | 288 |   | 11,761 |   |
|                                                   |       |                         |       |                            |       |   |   |   |   |
|                                                   |       | $                            | 41,067     |                            | $          | 545,384 |   | $ | 41,155 |   | $ | 546,981 |   |

* *

*2.875% Notes and 4.0% Notes*

 

Both the 2.875% Notes andthe 4.0% Notes (collectively the “Notes”) are convertible into the Company’sOrdinary Shares at a conversion rate of 34.9406 shares per $1,000 principalamount of the Notes (equal to an initial conversion price of approximately$28.62 per share), subject to adjustment in certain circumstances. Holders mayconvert their Notes only if: (i) the price of Apex Silver Ordinary Sharesreaches a specified threshold; (ii) the trading price for the Notes fallsbelow certain thresholds; (iii) the Notes have been called for redemption;or (iv) specified corporate transactions occur.  Full conversion of the Notes would result inthe issuance of approximately 10.1 million of the Company’s OrdinaryShares.  Accumulated interest on theNotes is paid twice a year in March and September.

 

Costs incurred inconnection with the issuance of the Notes were deferred and are being amortizedto interest expense over ten years which corresponds to the related callprovisions on the Notes.  At March 31,2008 the unamortized balance of deferred financing costs related to the Noteswas approximately $6.3 million.

 

*San Cristobal Project FinanceFacility*

 

In December 2005 theCompany closed on the $225 million Facility, arranged by BNP Paribas andBarclays Capital, and funded by a group of international financial institutionsincluding banks, export credit agencies and the Andean Development Corporation,a multilateral financial agency that promotes sustainable development in SouthAmerica.  During 2006 and 2007 theCompany borrowed the full $225 million available under the Facility and theproceeds were used to complete construction of the Company’s San Cristobalmine.  Interest on the outstandingamounts drawn under the Facility is based on LIBOR plus a credit spread.  The first principal payment under theFacility is due in December 2008, and the Facility must be fully repaid byDecember 2012.

 

In connection with the September 2006sale to Sumitomo Corporation (“Sumitomo”) of a 35% interest in the subsidiariesthat own and operate the San Cristobal mine, Sumitomo guaranteed the repaymentof 35% of the Facility debt through project completion. (For this purposecompletion is defined as the satisfaction of certain financial and operationalrequirements including the creation of operating and debt service reserves andmeeting certain operational performance levels over specified periods of timeand can occur no later than December 2008.)

 

The Facility containscovenants that require the Company to, among other things, maintain certainsecurity interests, collateral accounts related to operating and debt servicereserves, financial ratios after project completion, insurance coverage,minimum sales contracts and metals price protection contracts as 

 

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well as otherrequirements.  Failure to comply withthese covenants or to cure related violations within specified periods couldresult in an event of default, pursuant to which the project lenders couldrequire immediate repayment of all amounts outstanding under the Facility andimmediate cash settlement of the outstanding metal derivative positionsassociated with the San Cristobal mine (see Note 2 related to the Company’sliquidity and ability to meet its obligations under the Facility).

 

In connection with theFacility the Company funded a $91 million margin account and at March 31,2008, the Company had recorded $60.7 million as non-current restrictedcash and $30.3 million as current restricted cash.  In addition, Sumitomo has provided a $49million post-completion guarantee, for the benefit of the two banks holding themetal derivative positions. Unused funds remaining in the margin account willbe released and the guarantee will be reduced one-third per year on the firstbusiness day following December 31st of each of 2008, 2009 and 2010.

 

In May 2006, theConstitutional Court of Bolivia issued a ruling declaring certain articles ofthe 1997 Mining Code unconstitutional.  The Court’s ruling is noteffective until May 2008 and the Court urged the Bolivian Congress toenact legislation during that time which may supersede the ruling. In April 2008,the Lower House of the Bolivian Congress enacted legislation, which replacedcertain articles of the Mining Code.  The proposed legislation willrequire approval by the Senate to become a law. The proposed legislation wouldlimit the rights associated with mining concessions including the right totransfer, inherit, or mortgage the concession. Although the Company understands that the Court’s ruling and subsequentlegislation will not be applied retroactively, the ruling could limit thetransferability of the Company’s mining concessions and may call into questionthe enforceability of the pledges of our concessions to the lenders under theFacility.

 

Direct costs incurred inobtaining the Facility were deferred and are being amortized to interestexpense, using the effective interest method, over the term of the Facility. AtMarch 31, 2008 the unamortized balance of deferred financing costs relatedto the Facility was approximately $8.5 million.

 

*Sumitomo Note Assignment*

 

The Company has loanedfunds to SC TESA, the contractor that constructed the power line for the SanCristobal mine, and holds a note receivable from SC TESA in the amount of $21.9million, which is eliminated in consolidation. The Company consolidates SC TESAfor financial reporting purposes per the guidance of FASB Interpretation No.46R“Variable Interest Entities” (“FIN 46R”). The Company is receiving repayment ofthe note from SC TESA in the form of credits against electric transmissioncharges to the San Cristobal mine.  Inconnection with the sale of 35% of the San Cristobal mine to Sumitomo, theCompany sold 35% of the $21.9 million note to Sumitomo. As the Company receivespayments from SC TESA it incurs an obligation to pay Sumitomo its 35% share ofsuch payments. As a result, at March 31, 2008 the Company has recorded anote payable to Sumitomo in the amount of $8.6 million, which includes accruedinterest.

 

*Capital Leases*

 

Certain mining equipmentat the San Cristobal mine used by the contractor that provides mining servicesto the Company has been recorded as capital leases because the equipment isused exclusively at the San Cristobal mine. At March 31, 2008 the Company had recorded on its balance sheet$54.9 million, of equipment, net of accumulated depreciation and a capitallease obligation of $50.9 million related to the leased equipment.  During the three months ended March 31,2008 the Company made payments of approximately $2.2 million related to itscapital lease obligations.

 

*Port Lease Liability*

 

Certain assetsconstructed at the Port of Mejillones are for the exclusive use of the Company,including concentrate reception, unloading and storage facilities. The Companydetermined that a leasing arrangement exists with respect to those assets (seeNote 8).  As of March 31, 2008 theCompany has recorded on its balance sheet $12.0 million, of plant andequipment, net of accumulated depreciation and a financing obligation of $12.0million related to the port facility.  Inaddition, the Company holds a 

 

15

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$4.1 million notereceivable from the port contractor for funds previously advanced to thecontractor including interest (see Note 9).

 

**11.  Asset Retirement Obligations**

 

The Company has developedan asset retirement plan for its San Cristobal mine which includes estimatedreclamation, remediation and closure requirements based on Bolivian governmentrequirements, World Bank financing requirements and the Company’spolicies.  The Company accrues estimatedreclamation liabilities based on the asset retirement plan as activitiesrequiring future reclamation and remediation occur.

 

The Company preparesestimates of the timing and amount of expected cash flows when an assetretirement obligation (“ARO”) is incurred. The fair value of the ARO ismeasured by discounting the expected cash flows using a discount factor thatreflects the credit-adjusted risk-free rate of interest. The Company recordsthe fair value of an ARO when it is incurred along with an offsetting increasein the mineral property asset. Changes in the fair value of the ARO arerecorded as an adjustment to the corresponding mineral property asset carryingamount. The ARO is adjusted to reflect the passage of time (accretion cost)calculated by applying the discount factor implicit in the initial fair-valuemeasurement to the beginning-of-period carrying amount of the ARO. The Companyrecords accretion costs to expense as incurred.

 

The following tablereconciles the beginning and ending balance for the Company’s asset retirementobligations:

 
| ** **                       | ** ** | **Three Months  Ended March 31,  2008** | ** ** | **Year Ended  December 31,  2007** | ** ** |
|----------------------------------|------------|--------------------------------------------------------|------------|----------------------------------------------|------------|
| ** **                       | ** ** | **(in thousands)**                                | ** ** |
| Beginning  balance               |       | $                                                      | 6,981      |                                         | $          | 5,761 |   |
|                             |       |                                                   |       |                                         |       |
| ARO arising in  the period       |       | 756                                                    |       | 620                                          |       |
| Changes in estimates,  and other |       | —                                                 |       | —                                       |       |
| Liabilities  settled             |       | —                                                 |       | —                                       |       |
| Accretion  expense               |       | 169                                                    |       | 600                                          |       |
|                             |       |                                                   |       |                                         |       |
| Ending balance                   |       | $                                                      | 7,906      |                                         | $          | 6,981 |   |

 

**12.   Derivative Instruments**

 

Certain covenants relatedto the Facility required the Company to provide price protection for a portionof its planned production of metals from San Cristobal.  The Company has entered into certain metalderivative positions utilizing primarily forward sales but also puts and callsto comply with the Facility covenants. In order to maintain leverage to silver market prices, the Companyentered into proportionally more zinc and lead positions than silver positions.

 

The Company began tosettle the metal derivative positions required by the Facility during the thirdquarter 2007.  At the time of finalsettlement, the gain or loss recorded excludes previously recognized non-cashmark-to-market gains or losses.

 

16

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The following table setsforth forward contracts settled and options that expired during the threemonths ended March 31, 2008:

 
| ** **                      | ** ** | **Quantity**            | ** ** | **Average  Market  Price**       | ** ** | **Average  Contract  Price** | ** ** | **Average  Cash  Settlement** | ** ** | **Total Cash  Settlement** | ** ** |
|---------------------------------|------------|-------------------------|------------|----------------------------------|------------|------------------------------|------------|-------------------------------|------------|---------------------------------|------------|
| ** **                      | ** ** | **(in thousands)** | ** ** | **(per unit settled)** | ** ** | **(in thousands)**      | ** ** |
| **Forward  Contracts**          |       |                    |       |                             |       |                         |       |                          |       |                            |       |
| Silver (000  ounces)            |       | 40                      |       | $                                | 13.45      |                         | $          | 7.15                          |       | $                               | 6.30       |   | $ | 252 |   |
| Zinc (000  pounds)              |       | 34,950                  |       | $                                | 1.08       |                         | $          | 0.48                          |       | $                               | 0.60       |   | $ | 20,880 |   |
| Lead (000  pounds)              |       | 28,325                  |       | $                                | 1.26       |                         | $          | 0.30                          |       | $                               | 0.96       |   | $ | 27,177 |   |
| **Call  Contracts Written**     |       |                    |       |                             |       |                         |       |                          |       |                            |       |
| Zinc (000  pounds)              |       | 1,653                   |       | $                                | 1.08       |                         | $          | 0.57                          |       | $                               | 0.51       |   | $ | 841 |   |
| Lead (000  pounds)              |       | 3,307                   |       | $                                | 1.25       |                         | $          | 0.39                          |       | $                               | 0.86       |   | $ | 2,862 |   |
| **Put  Option Contracts Owned** |       |                    |       |                             |       |                         |       |                          |       |                            |       |
| Silver (000  ounces)            |       | 100                     |       | $                                | 15.98      |                         | $          | 5.25                          |       | $                               | —     |   | $ | — |   |
|                            |       |                    |       |                             |       |                         |       |                          |       |                            |       |
| Total                           |       |                    |       |                             |       |                         |       |                          |       | $                               | 52,012     |   |

 

The actual financialimpact of the remaining metal derivative positions will not be known until thepositions are closed on their future settlement dates.

 

The following table setsforth the Company’s open metal derivative positions at March 31, 2008:

 
| ** **                            | ** ** | **Current Maturity Date**             | ** ** |
|---------------------------------------|------------|-------------------------------------------------|------------|
| ** **                            | ** ** | **Less Than**                              | ** ** | **2 to 3** | ** ** | **4 to 5** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                            | ** ** | **1 Year**                                 | ** ** | **Years** | ** ** | **Years** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| ** **                            | ** ** | **(in thousands except prices)** | ** ** |
| **Forward  Contracts**                |       |                                            |       |   |   |   |   |   |   |   |   |
| Silver (ounces)                       |       | 80                                              |       | 160 |   | 200 |   | 40 |   | 480 |   |
| Average price                         |       | $                                               | 7.15       |   | $ | 7.15 |   | $ | 7.13 |   | $ | 7.15 |   | $ | 7.14 |   |
|                                  |       |                                            |       |   |   |   |   |   |   |   |   |
| Zinc (pounds)                         |       | 234,878                                         |       | 413,287 |   | 61,734 |   | — |   | 709,899 |   |
| Average price                         |       | $                                               | 0.48       |   | $ | 0.48 |   | $ | 0.48 |   | $ | — |   | $ | 0.48 |   |
|                                  |       |                                            |       |   |   |   |   |   |   |   |   |
| Lead (pounds)                         |       | 127,515                                         |       | 127,859 |   | — |   | — |   | 255,374 |   |
| Average price                         |       | $                                               | 0.30       |   | $ | 0.29 |   | $ | — |   | $ | — |   | $ | 0.30 |   |
|                                  |       |                                            |       |   |   |   |   |   |   |   |   |
| **Put  Option Contracts Owned (Net)** |       |                                            |       |   |   |   |   |   |   |   |   |
| Silver (ounces)                       |       | 625                                             |       | 2,575 |   | 5,400 |   | 200 |   | 8,800 |   |
| Average price                         |       | $                                               | 5.48       |   | $ | 5.69 |   | $ | 5.89 |   | $ | 5.60 |   | $ | 5.79 |   |
|                                  |       |                                            |       |   |   |   |   |   |   |   |   |
| Lead (pounds)                         |       | 9,590                                           |       | 21,821 |   | 1,429 |   | — |   | 32,840 |   |
| Average price                         |       | $                                               | 1.19       |   | $ | 1.15 |   | $ | 1.07 |   | $ | — |   | $ | 1.15 |   |
|                                  |       |                                            |       |   |   |   |   |   |   |   |   |
| **Call  Option Contracts Written**    |       |                                            |       |   |   |   |   |   |   |   |   |
| Silver (ounces)                       |       | 3,450                                           |       | 5,675 |   | 675 |   | — |   | 9,800 |   |
| Average price                         |       | $                                               | 8.44       |   | $ | 8.14 |   | $ | 9.24 |   | $ | — |   | $ | 8.32 |   |
|                                  |       |                                            |       |   |   |   |   |   |   |   |   |
| Zinc (pounds)                         |       | 6,614                                           |       | 4,960 |   | — |   | — |   | 11,574 |   |
| Average price                         |       | $                                               | 0.57       |   | $ | 0.57 |   | $ | — |   | $ | — |   | $ | 0.57 |   |
|                                  |       |                                            |       |   |   |   |   |   |   |   |   |
| Lead (pounds)                         |       | 13,228                                          |       | 9,921 |   | — |   | — |   | 23,149 |   |
| Average price                         |       | $                                               | 0.39       |   | $ | 0.39 |   | $ | — |   | $ | — |   | $ | 0.39 |   |

 

The Company adjusts itsopen metal derivative positions to estimated fair value at the end of each accountingperiod with the related change in fair value recorded to earnings.  For the three months ended March 31,2008 the Company recorded a metal derivative loss of $76.5 million as a resultof adjusting the open positions and positions settled during the period toestimated fair value.  For the threemonths ended 

 

17

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March 31, 2007 theCompany recorded a mark-to-market derivative gain of $108.3 million. Non-cashmark-to-market gains and losses from the remaining outstanding derivativepositions may fluctuate substantially from period to period based on spot andforward prices and option volatilities. The Company does not intend to settlethe remaining open derivatives position contracts prior to their settlementdates.

 

The following table setsforth the fair value of the Company’s net open metal derivative positions at March 31,2008 and December 31, 2007 and the change for the three months ended March 31,2008:

 
| ** **                                             | ** ** | **Liability Amount To Be Realized In** | ** ** |
|--------------------------------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                                             | ** ** | **Less Than**                                              | ** ** | **2 to 3** | ** ** | **4 to 5** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Period Ended**                                  | ** ** | **1 Year**                                                 | ** ** | **Years** | ** ** | **Years** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **(in thousands)**                                         | ** ** |
| December 31,  2007                                |       | $                                                               | 266,820    |   | $ | 425,569 |   | $ | 47,958 |   | $ | 681 |   | $ | 741,028 |   |
| March 31,  2008                                   |       | $                                                               | 322,329    |   | $ | 404,718 |   | $ | 38,337 |   | $ | 157 |   | $ | 765,541 |   |
| Change for the  three months ended March 31, 2008 |       | $                                                               | 55,509     |   | $ | (20,851 | ) | $ | (9,621 | ) | $ | (524 | ) | $ | 24,513 |   |

 

The metal derivativepositions in the tables above are primarily held in a separate Cayman Islandsubsidiary which is owned 65% by the Company and 35% by Sumitomo, and Sumitomohas guaranteed the payment of 35% of the metal derivative positions throughcompletion (which, according to the terms of the Facility, may be no later thanDecember 2008) (see Note 10).  Thelead puts owned by Minera San Cristobal which have a positive carrying value atMarch 31, 2008 of approximately $6.1 million are netted against theliabilities in the table above, which are reflected as $1.5 million and $4.6million in current and non-current assets, respectively, in the accompanyingconsolidated balance sheet.  (See Note 13for fair value measurements disclosure).

 

**13.   Fair Value Measurements**

 

Effective January 1,2008 the Company adopted the provisions of Financial Accounting Standards No. 157,“Fair Value Measurements” (“FAS No. 157”) for the financial assets andliabilities and nonfinancial assets and liabilities which were measured at fairvalue on a recurring (annual) basis.  FASNo. 157 establishes a framework for measuring fair value in the form of afair value hierarchy which prioritizes the inputs into valuation techniquesused to measure fair value into three broad levels.  This hierarchy gives the highest priority toquoted prices (unadjusted) in active markets and the lowest priority tounobservable inputs.  Further, financialassets and liabilities should be classified by level in their entirety basedupon the lowest level of input that was significant to the fair valuemeasurement.  The three levels of thefair value hierarchy per FAS No. 157 are as follows:

 

**Level1:  **Unadjusted quotedmarket prices in active markets for identical assets or liabilities that areaccessible at the measurement date.

 

**Level2: **Quoted prices ininactive markets for identical assets or liabilities, quoted prices for similarassets or liabilities in active markets, or other observable inputs eitherdirectly related to the asset or liability or derived principally fromcorroborated observable market data.

 

**Level3: **Unobservable inputsdue to the fact that there is little or no market activity. This entails usingassumptions in models which estimate what market participants would use inpricing the asset or liability.

 

The following tablesummarizes the Company’s financial assets and liabilities at fair value at March 31,2008, by respective level of the fair value hierarchy:

 

18

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| ** **                                | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| Assets:                                   |       |             |       |             |       |             |       |      |       |
| Cash equivalents                          |       | $                | 11,892     |             | $          | —           |       | $         | —     |   | $ | 11,892 |   |
| Short-term  available for sale securities |       | 7,708            |       | —           |       | —           |       | 7,708     |       |
| Trade  receivables                        |       | 19,932           |       | —           |       | —           |       | 19,932    |       |
| Auction rate  securities                  |       | —           |       | —           |       | 20,767           |       | 20,767    |       |
| Derivatives                               |       | —           |       | 6,106            |       | —           |       | 6,106     |       |
|                                      |       | $                | 39,532     |             | $          | 6,106            |       | $         | 20,767     |   | $ | 66,405 |   |
|                                      |       |             |       |             |       |             |       |      |       |
| Liabilities:                              |       |             |       |             |       |             |       |      |       |
| Trade payables                            |       | $                | 1,488      |             | $          | —           |       | $         | —     |   | $ | 1,488 |   |
| Derivatives                               |       | —           |       | 771,648          |       | —           |       | 771,648   |       |
|                                      |       | $                | 1,488      |             | $          | 771,648          |       | $         | —     |   | $ | 773,136 |   |
|                                           |            |                  |            |                  |            |                  |            |           |            |  |  |  |  |  |  |

 

The Company’s cashequivalents are classified within Level 1 of the fair value hierarchy.  These securities are comprised principally ofcommercial paper and government bonds which have been valued using quotedprices in active markets.

 

The Company’s short-terminvestments are classified within Level 1 of the fair value hierarchy.  These securities are comprised principally ofcommon stock, commercial paper and government bonds which have been valuedusing quoted prices in active markets.

 

The Company’s tradereceivables and trade payables (to smelters) are classified within Level 1 ofthe fair value hierarchy.  These amountsrepresent embedded derivatives as part of the Company’s concentrate sales andare marked-to-market based upon quoted market prices in the respectivecommodity futures market based upon the period of estimated settlement.  Trade payables arise when the overall mark-tomarket valuation of a respective sale falls below the amount the Company hasreceived to date from applicable provisional payments.

 

All of the Company’smetal derivative positions are classified within Level 2 of the fair valuehierarchy.  These metal derivative positionsare valued from quoted market information reflected in the applicablecommodities price indices for the periods the indices are available.  For periods beyond the available indicesthese metal derivative positions are valued using quoted prices and extrapolationof the commodities price indices from the counterparties holding the metalderivative positions.

 

The Company’s ARS areclassified within Level 3 of the fair value hierarchy.   These securities are valued by the Company,with the assistance of a third party valuation firm.  The ARS are classified into two categories,collateralized debt obligations (“CDO’s”) and corporate debt.  The CDO’s are valued by estimating the valueof the underlying collateral using significant assumptions regarding default,recovery and prepayment rates, and factoring these estimated collateral valuesin conjunction with the tranche for pay-out of the underlying collateral thatthe Company’s holds in each respective security.  The corporate debt ARS are valued based uponthe estimated present value of expected cash flows using a Monte Carlosimulation model taking into account significant assumptions regarding couponpayments, recovery, and redemption, values. The Company uses these significant Level 3 inputs as there is no currentmarket activity for these, or similar, securities nor relevant corroboratingmarket data with readily observable inputs to support a Level 1 or 2 valuation.

 

19

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The following tablesummarizes the change in fair value of the Company’s Level 3 financial assets(ARS’s) for the three months ended March 31, 2008:

 
| Beginning  balance                                          |   | $      | 21,510 |   |
|-------------------------------------------------------------|--------|--------|--------|--------|
| Unrealized  losses, net                                     |   | (597   | )      |
| Adjusted cost  basis of Level 3 security sold in the period |   | (146   | )      |
|                                                        |   |   |   |
| Ending balance                                              |   | $      | 20,767 |   |

 

**14.    Income Taxes**

 

The Company and certainof its subsidiaries operating in the Cayman Islands do not file income taxreturns as the Cayman Islands currently does not impose any income taxes.  The Company files Bolivian, United States andcertain other foreign country income tax returns, and pays the taxes reasonablydetermined to be due.  The tax rules andregulations in these countries are highly complex and subject tointerpretation.  The Company’s income taxreturns are subject to examination by the relevant taxing authorities and inconnection with such examinations, disputes can arise with the taxingauthorities over the interpretation or application of certain tax rules withinthe country involved.  At March 31,2008, the Company’s total unrecognized tax benefits were $1.8 million foruncertain tax positions taken or expected to be taken on tax returns, all ofwhich result in a reduction of the Company’s net operating losscarryforwards.  The unrecognized taxbenefits resulted from tax positions taken during a prior year.  If recognized, the entire $1.8 million oftotal unrecognized tax benefits would affect the effective tax rate.

 

For the first quarter of2008 and 2007 the Company recorded $10.9 million and $0.1 million of income taxexpense, of which approximately $0.8 million and $0.1 million related toforeign withholding taxes.   Theremaining $10.1 million tax expense for the first quarter 2008 consists of $4.7million current and $4.9 million deferred income tax in Bolivia relating to theSan Cristobal mine, and $0.5 million in Switzerland relating to the marketingof concentrates from San Cristobal.  Onthe consolidated balance sheet, the Company has presented the $4.9 million netdeferred income tax obligation as a $3.4 million current deferred tax asset andan $8.3 million non-current deferred tax liability.  The subsidiary owning the San Cristobal minehas utilized all of its $17.3 million net operating loss carryforwards toreduce taxes payable incurred during the first quarter 2008. The income taxcalculation for the San Cristobal mine was significantly impacted by therecognition of, for local tax purposes only, a $9.2 million gain (tax effect of$3.5 million using 37.5% tax rate) relating to inflationary indexation on themines’ non-monetary assets and equity, and also the recognition of, for localtax purposes only, a $28.2 million gain (tax effect of $10.6 million using37.5% tax rate) related to the unrealized foreign exchange gain on US dollardenominated liabilities.  Inflationaryindexation was instituted in Bolivia beginning the fourth quarter 2007, andunrealized foreign exchange gains on US dollar denominated liabilities inBolivia have become significant in recent periods due to the devaluing USdollar relative to the Boliviano.

 

Although the SanCristobal mine generated taxable income in the first quarter 2008, the Companyhas determined, due to the limited history of operations at San Cristobal,there is not sufficient positive evidence of future taxable income to overcomethe presumption that the losses observed in previous quarters willcontinue.  As a result, a valuationallowance remains on the Company’s net deferred tax assets.  However, as production at the San Cristobalmine continues, there may be sufficient positive evidence in future periods toallow the Company to determine that certain deferred tax assets have becomerealizable.  This could cause a releaseof a portion or all of the Company’s valuation allowances, which would resultin a reduction of the Company’s tax provision at that time.

 

In addition, followingthe guidance of FASB Interpretation No. 18, “Accounting for Income Taxesin Interim Periods” (“FIN 18”) paragraph 22b., the limited history of operatingearnings at San Cristobal, as well as the taxable income effect of inflationarygains and unrealized foreign exchange gains, has led the Company to conclude itcannot reasonably rely on estimates of future taxable income to determine anannual effective tax rate.  Thus, theCompany has used the actual effective tax rate for the year-to-date period asthe best estimate of the annual effective tax rate.

 

20

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**15.****       Shareholders’ Deficit**

 

The following table setsforth the changes in shareholders’ deficit during the first three months of2008:

 
| ** **                                        | ** ** | ** **                                               | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | **Accum-**             | ** **   | ** **  | ** ** |
|---------------------------------------------------|------------|----------------------------------------------------------|------------|-------------|------------|-------------|------------|-------------|------------|------------------------|--------------|-------------|------------|
| ** **                                        | ** ** | ** **                                               | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | **-ulated**            | ** **   | ** **  | ** ** |
| ** **                                        | ** ** | ** **                                               | ** ** | ** **  | ** ** | ** **  | ** ** | ** **  | ** ** | **Other**              | ** **   | ** **  | ** ** |
| ** **                                        | ** ** | ** **                                               | ** ** | ** **  | ** ** | **Addi**    | ** ** | ** **  | ** ** | **Compre**             | ** **   | ** **  | ** ** |
| ** **                                        | ** ** | ** **                                               | ** ** | ** **  | ** ** | **-tional** | ** ** | **Accum**   | ** ** | **-hensive**           | ** **   | **Total**   | ** ** |
| ** **                                        | ** ** | **Ordinary Shares**                                 | ** ** | **Paid-in** | ** ** | **-ulated** | ** ** | **income**  | ** ** | **Shareholders’** | ** **   |
| ** **                                        | ** ** | **Shares**                                               | ** ** | **Amount**  | ** ** | **Capital** | ** ** | **Deficit** | ** ** | **(loss)**             | ** **   | **Deficit** | ** ** |
| ** **                                        | ** ** | **(in thousands except share data)** | ** ** |
| **Balance,  December 31, 2007**              | ** ** | **58,909,625**                                           | ** ** | **$**       | **589**    | ** **  | **$**      | **677,203** | ** ** | **$**                  | **(761,783** | **)**       | **$**      | **(110** | **)** | **$** | **(84,101** | **)** |
| Stock  compensation accrued                       |       | —                                                   |       | —      |       | 1,070       |       | —      |       | —                 |         | 1,070       |       |
| Stock granted as  compensation ($16.36 per share) |       | 21,850                                                   |       | 0.2         |       | —      |       | —      |       | —                 |         | 0.2         |       |
| Unrealized loss  on marketable equity securities  |       | —                                                   |       | —      |       | —      |       | —      |       | (568                   | )            | (568        | )          |
| Net loss                                          |       | —                                                   |       | —      |       | —      |       | (9,253      | )          | —                 |         | (9,253      | )          |
| **Balance,  March 31, 2008**                 | ** ** | **58,931,475**                                           | ** ** | **$**       | **590**    | ** **  | **$**      | **678,273** | ** ** | **$**                  | **(771,036** | **)**       | **$**      | **(678** | **)** | **$** | **(92,851** | **)** |

 

*StockOption Plans* – The Company has established a plan toissue share options and other awards of the Company’s shares to officers,directors, employees, consultants and agents of the Company and itssubsidiaries (the ‘‘Plan’’).

 

The Company recognizesstock-based compensation costs using a graded vesting attribution methodwhereby costs are recognized over the requisite service period for eachseparately vesting portion of the award. The Company recognized stock-based compensation costs of $1.1 millionand $1.0 million for the three month periods ended March 31, 2008 and 2007respectively.

 

A summary of the Company’sstock options issued under the Plan at March 31, 2008 and changes duringthe three months then ended is presented in the following table:

 
| **Options**                         | ** ** | **Number of  Shares** | ** ** | **Weighted  Average  Exercise  Price Per  Share** | ** ** |
|-------------------------------------|------------|----------------------------|------------|--------------------------------------------------------|------------|
| Outstanding at  beginning of period |       | 2,475,209                  |       | $                                                      | 15.36      |   |
| Granted during  period              |       | 352,215                    |       | 13.51                                                  |       |
| Forfeited or  expired during period |       | (138,350                   | )          | 16.97                                                  |       |
| Exercised during  period            |       | —                     |       | —                                                 |       |
| Outstanding at  end of period       |       | 2,689,074                  |       | 15.04                                                  |       |
| Exercisable at  end of period       |       | 1,923,616                  |       | 14.89                                                  |       |
| Granted and  expected to vest       |       | 724,047                    |       | 15.40                                                  |       |
|                                     |            |                            |            |                                                        |            |  |

 

The fair value of eachoption award is estimated on the date of grant using the Black-Scholesoption-pricing model.

 

A summary of the statusof the Company’s restricted stock grants issued under the Employees’ Plan at March 31,2008 and changes during the three months then ended is presented in thefollowing table:

 

21

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| **Restricted Stock Grants**   | ** ** | **Number  of Shares** | ** ** | **Weighted Average  Grant Date Fair  Value Per Share** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|---------------------------------------------------------------------------------|------------|
| Outstanding at  beginning of the period |       | 183,700                    |       | $                                                                               | 17.00      |   |
| Granted during  period                  |       | 104,400                    |       | 13.25                                                                           |       |
| Restrictions  lifted during the period  |       | (21,850                    | )          | 15.29                                                                           |       |
| Forfeited during  period                |       | —                     |       | —                                                                          |       |
| Outstanding at  end of the period       |       | 266,250                    |       | 15.66                                                                           |       |
|                                         |            |                            |            |                                                                                 |            |  |

 

The fair value of eachrestricted stock grant is based on the closing price of the Company’s shares onthe date of grant.

 

*DeferredCompensation Plan* – The Company has established aNon-Employee Director Deferred Compensation and Equity Award Plan (the “DeferredCompensation Plan”). Pursuant to the Deferred Compensation Plan the directorswill receive a portion of their compensation in the form of Restricted StockUnits issued under the Plan. The Restricted Stock Units typically vest one yearafter the date of grant so long as the individual is still serving as adirector. Each Restricted Stock Unit entitles the director to receive oneunrestricted Ordinary Share for each vested Restricted Stock Unit upon thetermination of the director’s board service.

 

A summary of the statusof the Restricted Stock Unit grants issued under the Deferred Compensation Planat March 31, 2008 and changes during the three months then ended ispresented in the following table:

 
| **Restricted Stock Units**    | ** ** | **Number of  Shares** | ** ** | **Weighted Average  Grant Date Fair  Value Per Share** | ** ** |
|-----------------------------------------|------------|----------------------------|------------|---------------------------------------------------------------------------------|------------|
| Outstanding at  beginning of the period |       | 25,806                     |       | $                                                                               | 19.18      |   |
| Granted during  period                  |       | —                     |       | —                                                                          |       |
| Restrictions  lifted during the period  |       | —                     |       | —                                                                          |       |
| Forfeited during  period                |       | (2,184                     | )          | —                                                                          |       |
| Outstanding at  end of the period       |       | 23,622                     |       | 19.05                                                                           |       |
|                                         |            |                            |            |                                                                                 |            |  |

 

The fair value of eachRestricted Stock Unit grant is based on the closing price of the Company’sshares on the date of grant.

 

**16.****       Minority Interest**

 

*Sumitomo Corporation*

 

During 2006 the Companysold to Sumitomo 35% interests in the subsidiaries that own the San Cristobalmine, market project concentrates and hold the metal derivative positionsrequired by the project lenders. The Company continues to own 65% of thesesubsidiaries.

 

Subsequent to the September 2006close of the transaction with Sumitomo, the Company incurred certain lossesprimarily related to marking to market its open metal derivativepositions.  Such losses would normally beshared by Sumitomo in proportion to its 35% interest in the subsidiaryrecording the losses.  However, GAAP doesnot permit the allocation of losses to the minority interest in excess of the minorityowner’s recorded interest in the subsidiary. Accordingly, the Company hasabsorbed approximately $0.4 million of losses that normally would have beenallocated to Sumitomo at March 31, 2008. The Company expects to recover the remaining $0.4 million of losses itabsorbed, and any additional losses it may absorb 

 

22

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related to Sumitomo’sminority interest, from future earnings prior to the allocation of earnings toSumitomo or from future contributions by Sumitomo.  During the first quarter 2008 the Companyrecorded a $40.8 million minority interest benefit related to Sumitomo’sinterest in certain losses primarily related to the open metal derivativepositions required by the Facility (see Note 12), and includes recovery of$20.4 million in losses previously absorbed by the Company. Also during thefirst quarter 2008, Sumitomo advanced an additional $33.3 million to fund itsshare of operating costs related to the San Cristobal mine, and the Company recorded$2.1 million of interest due Sumitomo on its share of advances to fund the SanCristobal mine.

 

Under the terms ofthe sale, the Company retained certain interests in Sumitomo’s share of futuresilver and zinc production from the San Cristobal mine.  During the first quarter 2008 the Companyreceived payments in the amount of $1.9 million from Sumitomo and at March 31,2008 the Company had recorded a receivable in the amount of $5.5 million fromSumitomo related to its retained interests in Sumitomo’s share of the SanCristobal mine silver and zinc production. These amounts are included in minority interest in loss of consolidatedsubsidiaries in the accompanying statement of consolidated operations andcomprehensive income (loss).

 

*SC Tesa*

 

During 2005 theCompany entered into a long-term contract with SC Tesa to construct a powerline and transport power to the San Cristobal mine from the Bolivian powergrid. The Company loaned SC Tesa $22.3 million to construct the power linewhich will be repaid through credits against charges for the delivery of power(see Note 10).  Per the guidance of FIN46R the Company fully consolidates the accounts of SC TESA.

 

Because SC TESA isconsolidated for financial reporting purposes, the intercompany profit earned bySC TESA is eliminated and the Company recognizes a minority interest offset toSC TESA’s earnings or loss. During the first quarter 2008 SC TESA recorded a$0.4 million loss.  The Company absorbedthe full $0.4 million loss and did not record a minority interest in the lossbecause to do so would result in a negative minority interest liability whichis not permitted under GAAP.  At March 31,2008 the total loss absorbed by the Company to date was approximately $1.3million.  The Company expects to recoverthe full $1.3 million loss absorbed to date and any other losses it may absorbagainst SC TESA’s future earnings.

 

**17.  Sale of Concentrates**

 

The Company sells itsconcentrates directly to smelters at market-based prices less deductions forrefining and treatment charges.  TheCompany recognizes a sale upon receipt of provisional payment, as this is theearliest point that both risk of loss and title transfer to the smelter.

 

Concentrate sales areinitially recorded based on 100% of the provisional sales prices. Theprovisional sales price is based on estimated metals contained in theconcentrates (based on assay data) and the forward metals prices at theexpected settlement date net of amounts retained by the smelter to cover itsrefining and treatment costs. Sales based on a provisional sales price containan embedded derivative that is required to be separated from the host contractfor accounting purposes. The embedded derivative does not qualify for hedgeaccounting and is marked to market through earnings each period prior to finalsettlement. Until final settlement, adjustments to revenue are recorded on amark-to-market basis to reflect changes to the forward metals prices for theestimated date of settlement and changes in metal quantities are adjusted uponreceipt of new information and assays. The primary risk associated withrecognition of sales on a provisional basis is the possibility of metal pricefluctuations between the date initially recorded and the date of finalsettlement. If a significant decline in metal prices occurs between theprovisional pricing date and the final settlement date, the Company could berequired to return a portion of the sales proceeds received based on theprovisional invoice. The Company has not yet completed negotiations withsmelters to establish refining and treatment costs for all shipments madeduring calendar 2008.  Costs fortreatment charges are expected to increase substantially for 2008 due to theincreased demand for smelter capacity resulting from an increased concentratesupply on the world market. Smelting charges for lead concentrates haveapproximately doubled while charges for zinc concentrates have risen about30%.  The Company has 

 

23

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recorded refining andtreatment costs for shipments during the period reflecting its best estimate ofthe final negotiated terms for 2008.

 

**18.****       Commitments andContingencies**

 

*PerformanceBonus* – The Company has agreed to pay a bonus to the SanCristobal mine construction management contractor contingent upon certainproject completion parameters. The Company and the construction managementcontractor are currently reviewing the project completion status. The Companybelieves it is probable that it will be required to pay the constructionmanagement contractor a portion of the bonus up to $1.3 million and has accruedthat amount.

 

*ProjectFinance Facility Commitments*– Per the amended terms andconditions of the Facility the proceeds from the sale of concentrates from theSan Cristobal mine are deposited in a bank account controlled by the lenders.The lenders release funds from the account to facilitate working capitalrequirements for the San Cristobal mine as needed.  Twice a year in June and December,beginning in December 2008, the Facility principal payment will bewithdrawn from the account with 45% of any excess cash, as defined, also beingapplied as a principal payment and the remaining 55% distributed to the Companyand Sumitomo.

 

In addition, perthe amended terms and conditions of the Facility the Company was required todeposit $91.0 million of cash in a margin account to collateralize the openmetal derivative positions the Company holds as required by the Facility. Themargin account will decrease by one-third on the first business day following December 31stof each of the years 2008 through 2010. At March 31, 2008 the $91.0 million was held in the margin accountwith $30.3 million recorded as current restricted cash and $60.7 millionrecorded as non-current restricted cash.

 

*AuctionRate Securities* – At March 31, 2008 the Company isholding ARS, with an adjusted carrying value of $20.8 million that it has beenunable to liquidate because of failed auctions. The Company has recognized liquidation losses and other than temporaryimpairment charges of approximately $34.5 million related to ARS investmentssince the auctions began to fail in mid-2007. It is possible that the Company may experience further impairmentcharges or liquidation losses on the remaining ARS it holds (see Note 4).

 

*PoliticalContingencies*– At various times since his election,President Morales and others in his administration have made public statementsregarding their desire to exert greater state control over natural resourceproduction in Bolivia. The Bolivian government may alter its policies withrespect to the mining industry in the future. In addition, the Bolivian government has recently enacted variouschanges to applicable mining taxes. These changes include increasing the income tax rate from 25 percent to37.5 percent when metals prices are above specified thresholds, eliminating thecreditability of the complementary mining tax (CMT) against the income tax whenmetals prices are above specified thresholds (deductibility of the CMT againstthe income tax is allowed), and establishing a separate CMT rate of up to 6percent for silver.  These changes, whichbecame effective December 14, 2007, will result in a higher income taxburden for the Company.   Maintained inthe tax law applicable to mining is the refund to exporters of a percentage ofimport duties and value added tax.  Alsocurrently being considered is the elimination of the 25 percent surtax fortaxable income over a threshold amount. The potential for the government to make additional changes that wouldhave the effect of increasing the total tax burden on the San Cristobal minecontinues to exist, and any such changes could adversely affect the earningsand cash flow generated by the mine and the Company’s ability to recover itsinvestment in the mine and to meet its liabilities to the San Cristobal lendersand the counterparties holding the metal derivative positions required by thoselenders.

 

In May 2006,the Constitutional Court of Bolivia issued a ruling declaring certain articlesof the 1997 Mining Code unconstitutional.  The Court’s ruling is noteffective until May 2008 and the Court urged the Bolivian Congress toenact legislation during that time which may supersede the ruling.  In April 2008, the Lower House of theBolivian Congress enacted legislation, which replaced certain articles of theMining Code.  The proposed legislation will require approval by the Senateto become a law.  The proposedlegislation would limit the rights associated with mining concessions includingthe right to transfer, inherit, or mortgage the concession.  Although the Company understands that theCourt’s ruling and subsequent legislation will not be applied retroactively,the ruling could limit the transferability of the Company’s 

 

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mining concessions and may call into question theenforceability of the pledges of our concessions to the lenders under theFacility.

 

In December 2007,the Bolivian Constituent Assembly approved a draft constitution for theRepublic of Bolivia.  The draftconstitution, if approved, could significantly affect the legal frameworkgoverning mining in Bolivia.  The draftconstitution appears to affirm the May 2006 Constitutional Court rulingthat limits the transferability of mining concessions.  It is not certain how existing concessionsand pledges, including San Cristobal’s concessions and pledges to the projectfinance lenders, would be affected by those provisions of the draftconstitution.  In addition, the draftconstitution provides that companies with existing concessions will be requiredto enter into mining agreements with the state within a year followingratification of the constitution by national referendum.  The draft constitution does not specify theeffect on existing concessions or provide either general or specific terms forthe mining agreements.

 

The Company,together with Sumitomo, is engaged in continuing discussions with governmentrepresentatives regarding various proposals and their potential effects on SanCristobal.  The Company is unable topredict which additional changes, if any, will be made to current mining taxlegislation and the Mining Code.

 

*OtherContingencies* – As previously disclosed, the Company hasconcluded, based on the results of an internal investigation conducted underthe direction of its Audit Committee, that certain senior employees of one ofits South American subsidiaries were involved in making impermissible paymentsof approximately $125,000 to government officials in 2003 and 2004 inconnection with an inactive, early stage exploration property that is notrelated to any of the Company’s active exploration or operatingproperties.  Based on findings to date,no changes to the Company’s previously filed financial statements are warrantedas a result of these matters.  TheCompany has contacted the Department of Justice (“DOJ”) and SEC and reportedthe results of its internal investigation. The Company has been informed that the SEC and DOJ have commenced an investigationwith respect to these matters, including possible violations of the ForeignCorrupt Practices Act.  The Company iscooperating fully with the SEC and DOJ investigations. The Company cannotpredict with any certainty the final outcome of the investigations, includingany fines or penalties that may be imposed.

 

**19.****      ****Foreign Currency**

 

Gains and losses onforeign currency transactions consist of the following:

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                      | ** ** | **March 31,**               | ** ** |
| ** **                                                                      | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ** **                                                                      | ** ** | **(in thousands)**          | ** ** |
| Gain on  re-measurement of monetary assets denominated in other than US dollars |       | $                                | 4,863      |   | $ | 984 |   |
| Total                                                                           |       | $                                | 4,863      |   | $ | 984 |   |

 

The re-measurement ofmonetary assets is related to certain taxes receivable and other accountsdenominated in Bolivia’s local currency.

 

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**20.  Supplemental cash flow information**

 

The following tablereconciles net income (loss) for the period to cash from operations:

 
| ** **                                                                                           | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                           | ** ** | **March 31**                | ** ** |
| ** **                                                                                           | ** ** | **2008**                         | ** ** | **2007** | ** ** |
| ** **                                                                                           | ** ** | **(in thousands)**          | ** ** |
| Cash flows from  operating activities:                                                               |       |                             |       |   |   |
| Net income  (loss)                                                                                   |       | $                                | (9,253     | ) | $ | 111,979 |   |
| Adjustments to  reconcile net income (loss) to net cash provided by (used in) operating  activities: |       |                             |       |   |   |
| Amortization and  depreciation                                                                       |       | 10,621                           |       | 114 |   |
| Amortization of  deferred financing costs                                                            |       | 1,252                            |       | — |   |
| Accretion of asset  retirement obligation                                                            |       | 169                              |       | 139 |   |
| Amortization of  premiums and discounts.                                                             |       | (180                             | )          | (58 | ) |
| Mark-to-market  (gain) loss on derivative positions                                                  |       | 76,526                           |       | (108,306 | ) |
| Deferred income  taxes                                                                               |       | 4,937                            |       | — |   |
| Minority  interest in loss of consolidated subsidiary                                                |       | (40,822                          | )          | (4,930 | ) |
| Stock  compensation...                                                                               |       | 1,071                            |       | 707 |   |
| Changes in  operating assets and liabilities:                                                        |       |                             |       |   |   |
| Increase in  trade accounts receivable                                                               |       | (16,821                          | )          | — |   |
| Decrease in  accrued interest receivable                                                             |       | 398                              |       | 244 |   |
| Port fees  applied to Port of Mejillones note receivable.                                            |       | 682                              |       | — |   |
| (Increase)  decrease in prepaid expenses and other assets net of amounts capitalized                 |       | (2,988                           | )          | 1,732 |   |
| Increase in  inventories                                                                             |       | (20,744                          | )          | (8,759 | ) |
| Increase in  value added tax recoverable, net                                                        |       | (11,698                          | )          | (9,456 | ) |
| Increase in  accrued interest payable                                                                |       | 898                              |       | — |   |
| Increase in  accounts payable and accrued liabilities net of amounts capitalized                     |       | 7,288                            |       | 193 |   |
| Other increase  (decrease)                                                                           |       | 106                              |       | (72 | ) |
| Net cash  provided by (used in) operating activities                                                 |       | $                                | 1,442      |   | $ | (16,473 | ) |

 

The following table setsforth supplemental cash flow information and non-cash transactions:

 
| ** **                                             | ** ** | **(in thousands)** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|
| **Supplemental  disclosure:**                          |       |                    |       |   |   |
| Interest paid,  net of amounts capitalized             |       | $                       | 11,516     |   | $ | — |   |
|                                                   |       |                    |       |   |   |
| **Supplemental  disclosure of non-cash transactions:** |       |                    |       |   |   |
| Capitalized  stock based compensation costs            |       | $                       | —     |   | $ | 247 |   |
| Depreciation  expense capitalized                      |       | —                  |       | 2,028 |   |
| Initial measurement  of asset retirement obligation    |       | 756                     |       | 153 |   |
| Equipment  acquired through capital lease              |       | —                  |       | 22,967 |   |

 

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**Item2:   Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

**General**

 

The following discussion and analysis summarizes the results ofoperations of Apex Silver Mines Limited (“Apex Silver” or “we”) for the threemonth period ended March 31, 2008 and changes in our financial conditionfrom December 31, 2007.  Thisdiscussion should be read in conjunction with Management’s Discussion andAnalysis included in our Annual Report on Form 10-K for the period ended December 31,2007.

 

Apex Silver is a mining, exploration and development company that owns65% of and operates the San Cristobal silver, zinc and lead mine in Bolivia. Wehave focused our resources primarily on the development of our San Cristobalmine, which began producing silver bearing lead and zinc concentrates duringthe third quarter 2007 and reached sustained operation levels in the fourthquarter 2007. Prior to the third quarter 2007 we did not have mining operationsfrom which product was being produced and sold; consequently, we have notpreviously reported operating income.

 

**Overview**

 

San Cristobal Operations

 

During the first quarter 2008 we continued to improve production ratesat our San Cristobal mine.  We milled 2.4million tonnes of ore during the quarter, producing approximately 75,000 tonnesof silver bearing lead and zinc concentrates. The concentrates producedcontained approximately 2.9 million ounces of payable silver, 29,300 tonnes ofpayable zinc and 10,000 tonnes of payable lead. During the first quarter 2008 we sold 69,300 tonnes of concentratescontaining approximately 3.5 million ounces of payable silver, 24,600 tonnes ofpayable zinc and 12,300 tonnes of payable lead and recorded net revenues of$136.9 million.   From concentrate salesin the first quarter 2008 we received a gross value per unit of $18.29 perounce of payable silver; $1.07 per pound of payable zinc and $1.32 per pound ofpayable lead.  A portion of theconcentrates sold during the first quarter 2008 were produced and shippedduring 2007.  All concentrates producedhave met the contract specifications of our smelter customers.

 

Both concentrator throughput rates and metals recovery rates continuedto show month to month improvements in the first quarter. Throughput for thequarter averaged approximately 66% of designed capacity of 40,000 tonnes perday, and we continue to experience days of throughput at or in excess ofdesigned capacity.  First quarter 2008concentrator throughput amounts increased by approximately 20% and concentrateproduction amounts increased by 65% over fourth quarter 2007 amounts.

 

We continue to focus on improving the reliability of process water andplant availability and on optimizing ore blends and recovery rates.  Throughput during the first quarter 2008 wasconstrained primarily due to a shortage of process water.  Redrilling of failed wells and pump repairswere completed during the quarter and are producing water as expected.  However, as concentrator throughput hasincreased the plant is consuming approximately 20% more water per tonne of oremilled than anticipated, primarily due to water content in tailings dischargedfrom the tailing thickener that is higher than expected.  We are evaluating modifications to theoperation of the tailings thickener to increase the amount of waterrecirculated back to the plant. Additional modifications to the water collection and pumping system,including additional lines and higher pumping capacity, are being installed andby mid-year we expect to have adequate water for consistent throughput atdesigned rates.

 

Mill throughput was also constrained during the first quarter by thevariation in ore types including fine and coarse material.  Increasing amounts of fines caused materialhandling issues in the ore stockpile reclaim system, which reduced the amountof ore delivered to the concentrator.  Wehave changed our stockpile operating practices to improve the flow of orethrough the reclaim system to the concentrator which should increase plantavailability and operations consistency. The variation in ore types also complicates the process of optimizingore blends and recovery rates.  We areengaged in pilot plant and other testing to 

 

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assist us in determining the most appropriate methods for blending oretypes that include fine and coarse ore variations to continue to improve metalrecovery without impacting mill throughput.

 

Primarily because of lower than anticipated production volumes, firstquarter 2008 average cash operating costs of negative $0.79 per ounce ofpayable silver produced (net of lead by-product credits) and $1.02 per pound ofpayable zinc were higher than expected. In addition, we expect 2008 treatment charges to increase due toincreased demand for smelter capacity resulting from increased worldconcentrate supplies.  Industry smeltingcharges for lead concentrates generally have approximately doubled while chargesfor zinc concentrates have risen about 30%. We are in the process of finalizing negotiations with its smeltercustomers on the terms for concentrate treatment charges, and we includedestimated increases in our first quarter average cash operating costs.

 

Also due primarily to lower first quarter production, we now projectfull year 2008 production of 15 million ounces of payable silver, 215,000tonnes of payable zinc and 75,000 tonnes of payable lead.  We also now expect average cash operatingcosts to be higher than previously forecast, with a range of approximatelynegative $1.75 to negative $2.25 per payable ounce of silver (net of leadby-product credits) and a range of approximately $0.70 to $0.80 per payablepound of zinc.

 

Liquidity

 

Following contributions of $82.1 million ($48.8 million our share) toSan Cristobal during the first quarter 2008, our aggregate unrestricted cashand investments (excluding illiquid auction rate securities) at March 31,2008 totaled 40.2 million.  We currentlydo not expect to be required to contribute additional amounts to San Cristobalin 2008, as we expect that cash flows from concentrate sales will fundremaining 2008 operating costs, taxes, capital expenditures, debt service andderivative settlement costs.  If the SanCristobal ramp-up and production are delayed, or if projected metals productionor mine and concentrator cost estimates are not achieved, we could requireadditional debt of equity financing. There can be no assurance that we could obtain such financing onacceptable terms, or at all.  (See —Liquidityand Capital Resources).

 

Settlement of metal derivative positions

 

During 2005, we entered into certain forward sales, puts and calls forsilver, zinc and lead in order to comply with certain requirements of ourproject finance facility (the “Facility”). Because of significant increases inspot and forward prices for silver, zinc and lead, we have recognizedsignificant non-cash, mark-to-market losses on these metal derivativepositions. Since these metal derivative positions began to mature in July 2007,we have been required to make cash payments to settle the maturing positions.During the first quarter 2008 we made cash payments of $52.0 million to settlethe metal derivative positions maturing during that period.  The amount of cash required to settle theremaining metal derivative positions will not be known until the positions areclosed on their future settlement dates. At March 31 2008 prices, we expect cash settlement costs associatedwith our remaining derivative positions maturing in 2008 to be approximately $239 million,with approximately equal amounts of derivatives maturing monthly.

 

Political Matters in Bolivia

 

In late 2007, the Bolivian government enacted various changes toapplicable mining taxes which will increase the tax burden on the San Cristobalmine. Also in late 2007, the Bolivian Constituent Assembly approved a new draftconstitution that provides, among other things, that mining companies will berequired to enter into mining agreements with the state, although the terms ofthose agreements are not described. In order to become effective, the draftconstitution must be approved by the Bolivian people through a nationalreferendum.  We cannot predict whether orwhen the constitution will be approved.

 

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**Non-GAAP Financial Measures**

 

Our management uses several non-GAAP measures to provide an indicationof the cash generating capabilities of the San Cristobal mine and to manage andevaluate operating performance.  Thesemeasures include “gross value per unit”, “gross value from payable metalscontained in concentrates sold” and “average cash operating cost”.  These measures should not be considered inisolation or as a substitute for measures of performance prepared in accordancewith GAAP. These measures are not necessarily indicative of operating profit orcash flow from operations to be determined under GAAP and may not be comparableto similarly titled measures of other companies.

 

The term “gross value from payable metalscontained in concentrates sold” refers to the gross value determined under thesmelter contracts, prior to deduction for amounts retained by the smelters tocover treatment and refining charges. The term “gross value per unit” refers to the “gross value frompayable metals contained in concentrates sold” divided by the quantity ofpayable metals contained in the concentrates sold (ounces of silver and poundsof zinc and lead).

 

The following tables reconciles these non-GAAP measures to the GAAP measure,sale of concentrates for the quarter ended March 31, 2008:

 
| ** **                                                       | ** ** | **Concentrates**        | ** ** | ** **      | ** ** |
|------------------------------------------------------------------|------------|-------------------------|------------|-----------------|------------|
| ** **                                                       | ** ** | **Zinc/Silver**         | ** ** | **Lead/Silver** | ** ** | **Total** | ** ** |
| ** **                                                       | ** ** | **(in thousands)** | ** ** |
| Gross value from  payable metals contained in concentrates sold  |       | $                       | 69,326     |            | $          | 92,050 |   | $ | 161,376 |   |
| Less: Deductions  by smelters for treatment and refining charges |       | (16,568                 | )          | (7,955          | )          | (24,523 | ) |
| Sale of  concentrates                                            |       | $                       | 52,758     |            | $          | 84,095 |   | $ | 136,853 |   |

 
| ** **                                                                 | ** ** | ** **                                                    | ** ** | ** **        | ** ** | ** ** | ** ** | **Mark-to-Market**    | ** ** | ** ** | ** ** |
|----------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|-------------------|------------|------------|------------|-----------------------|------------|------------|------------|
| ** **                                                                 | ** ** | ** **                                                    | ** ** | ** **        | ** ** | ** ** | ** ** | **and Final**    | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | ** **                                                    | ** ** | ** **        | ** ** | ** ** | ** ** | **Settlements**       | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **Contained Metals**                                     | ** ** | **of Prior** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | **Silver**                                                    | ** ** | **Zinc**          | ** ** | **Lead**   | ** ** | **Period Sales** | ** ** | **Total**  | ** ** |
| ** **                                                                 | ** ** | **(in thousands except gross value per unit)** | ** ** |
| Gross value from  payable metals contained in concentrates sold            |       | $                                                             | 63,533     |              | $          | 57,822     |       | $                     | 35,578     |       | $          | 4,443 |   | $ | 161,376 |   |
| Divided by:  Quantity of metals sold (silver ounces, zinc and lead pounds) |       | 3,473                                                         |       | 54,130            |       | 27,007     |       |                  |       |       |       |
| Gross value per  unit                                                      |       | $                                                             | 18.29      |              | $          | 1.07       |       | $                     | 1.32       |       |       |   |   |   |
|                                                                            |            |                                                               |            |                   |            |            |            |                       |            |            |            |  |  |  |  |  |

 

‘‘Average cash operating cost’’ includesestimated mining, milling, mine related overhead costs, transportation costs,treatment and refining costs and direct marketing costs. Cash operating costsdo not include taxes, depreciation, depletion and amortization, provisions forreclamation and gains or losses on the settlement of metal derivatives.  The average cash operating cost per ounce ofsilver is equal to the pro-rata share of estimated average operating costs forthe period reduced by the estimated value of lead by-product credits for theperiod and divided by the number of ‘‘payable ounces’’ of silver produced. Thelead by-product credits are net of charges related to transportation oflead-silver concentrates and their projected treatment and smelting charges.The ‘‘payable ounces’’ are the number of ounces of silver produced during theperiod reduced by the ounces required to cover refining and treatment chargesfor the period. Average cash operating cost per pound of zinc is equal to thepro-rata share of estimated average operating costs for the period divided bythe number of ‘‘payable pounds’’ of zinc produced.  The ‘‘payable pounds’’ are the number ofpounds of zinc to be produced during the period reduced by the number of poundsrequired to cover estimated refining and treatment charges for the period.Estimated cash operating costs are allocated 

 

29

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between silver and zinc based on the revenue contribution from eachmetal using the same prices we use for the purpose of calculating our reservesunder SEC guidelines.

 

The following tablesreconcile the non-GAAP measure ‘‘average cash operating cost’’ to the GAAPmeasure, costs applicable to sales, for the quarter ended March 31,2008.  Information in the tables ispresented in thousands except cost per unit.

 
| ** **                                                      | ** ** | **Silver** | ** ** | **Zinc** | ** ** | **Total** | ** ** |
|-----------------------------------------------------------------|------------|------------|------------|----------|------------|-----------|------------|
| **Average  cash operating costs per unit of production:**       |       |       |       |     |       |      |       |
| Estimated cash  operating costs                                 |       | $          | 18,496     |     | $          | 65,877    |       | $ | 84,373 |   |
| Lead by-product  credit                                         |       | (20,835    | )          | —   |       | (20,835   | )          |
| Total average  cash operating costs                             |       | $          | (2,339     | )        | $          | 65,877    |       | $ | 63,538 |   |
| Divided by  silver payable ounces, zinc payable pounds produced |       | 2,948      |       | 64,606   |       |      |       |
| Total average  cash operating costs per ounce/pound produced    |       | $          | (0.79      | )        | $          | 1.02      |       |   |   |
|                                                            |       |       |       |     |       |      |       |
| **Reconciliation  of average cash operating costs to GAAP:**    |       |       |       |     |       |      |       |
| Total average  cash operating costs                             |       | $          | 63,538     |     |       |      |       |   |
| Estimated  treatment and refining costs                         |       | (21,841    | )          |     |       |      |       |
| Lead revenue  applied as by-product credit                      |       | 20,835     |       |     |       |      |       |
| Complimentary  mining tax (royalty)                             |       | 8,822      |       |     |       |      |       |
| Change in concentrate and ore inventories                       |       | (2,376     | )          |     |       |      |       |
| Costs applicable  to sales                                      |       | $          | 68,978     |     |       |      |       |   |

 

**Results of Operations**

 

Three Months EndedMarch 31, 2008

 

*Sales of Concentrates.*  During the first quarter 2008 we recordedsales of concentrates of $136.9 million. Included in this amount is $4.4million of settlement and mark-to-market adjustments for sales made in 2007.  We had no such sales of concentrates duringthe first quarter 2007.

 

*Costs Applicable to Sales.*  During the first quarter 2008 costsapplicable to sales totaled $69.0 million. These costs relate to mining,milling, marketing and transportation of concentrate sold to ourcustomers.  We had no such costs duringthe first quarter 2007.

 

*Exploration.*  Exploration expense was $6.2 million for thefirst quarter 2008 compared to $2.7 million for the first quarter 2007.Exploration expense was incurred primarily in Argentina, Mexico and Peru.Exploration costs have increased for the first quarter 2008 as compared to thesame period 2007 as we are performing additional drilling on certain prospectsand incurring costs for preliminary metallurgical, engineering and environmentalwork on certain properties.

 

*Administrative.*  Administrative expense was $4.2 million forthe first quarter 2008 compared to $6.3 million for the first quarter2007.  Administrative expenses areincurred primarily by our corporate activities and consist primarily ofcompensation costs, professional fees paid for accounting and legal services,office and equipment lease costs and other general costs. The decrease inadministrative expenses for the first quarter 2008 compared to first quarter2007 is primarily due to higher professional fees during the first quarter 2007as a result of additional accounting and legal services performed during firstquarter 2007.

 

*Gain(Loss) on Metal Derivatives*. For the first quarter 2008 we recorded a loss related to our metalderivative positions in the amount of $76.5 million compared to a gain of$108.3 million on our metal derivative positions for the first quarter 2007.Gains and losses are the result of marking-to-market our open metal derivativepositions and metal derivative positions settled during the period, as comparedto the previous quarter, based upon changes in spot and forward prices forsilver, zinc and lead. During the periods that the metal derivative positionsare outstanding, gains and losses may fluctuate substantially from period toperiod based on spot prices, forward prices and quoted option volatilities.

 

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*Depreciation,Depletion and Amortization.* We recorded depreciation,depletion and amortization expense of $10.6 million for the first quarter 2008compared to $0.1 million recorded during the first quarter 2007.  The 2008 increase is the result of the commencementof operations at our San Cristobal mine and the recording of depreciation,depletion and amortization related to the processing plant, mining equipmentand other assets related to the mining property.  In addition, during the first quarter 2007, depreciationand amortization costs incurred in connection with the development of the minetotaling $2.0 million were capitalized.

 

*Interestand Other Income.* We recorded interest and other income of$2.0 million for the first quarter 2008 compared to $7.1 million recordedduring the first quarter 2007.  The 2008decrease in interest and other income is the result of lower average cash andinvestment balances that we held during the first quarter 2008 compared to thesame period 2007.  Available interest rateswere also lower for the first quarter 2008 as compared to the same period 2007.

 

*Interest Expense and Other Borrowing Costs.*  During the first quarter 2008 we recognized$16.2 million of interest expense and other borrowing costs.  We recognized no interest expense and otherborrowing costs during the first quarter 2007 as the total related costs of$10.8 million were capitalized.  Interestcosts for both periods are primarily related to the Convertible Senior SubordinatedNotes Due 2024 (the “Convertible Notes”), the Facility and equipment accountedfor as capital leases. The increase in the 2008 costs was primarily the resultof increased borrowings outstanding under the Facility and an increase in theequipment accounted for as capital leases.

 

*IncomeTaxes*.   During thefirst quarter 2008 we recorded income tax expense of $10.9 million as comparedto $0.1 million for the first quarter 2007, due mostly to taxable incomeincurred at the San Cristobal mine.  The2008 effective tax rate significantly differs from the Bolivia statutory rateof 37.5% primarily due to (i) the non-deductibility of metal derivativeslosses which are held primarily in a Cayman Islands subsidiary, (ii) therecognition of, for local tax purposes only, both unrealized foreign exchangegains on the San Cristobal project’s US dollar denominated liabilities andinflationary gains on the San Cristobal projects’ non-monetary assets andequity, and (iii) the full valuation allowance placed on our otherdeferred tax assets, offset by the utilization of San Cristobal’s net operatingloss carryforwards which previously had a full valuation allowance.  Due to the limited history of operatingearnings at San Cristobal combined with the cumulative operating lossesrecorded there prior to the commencement of operations, as well as the taxableincome effect of inflationary gains and unrealized foreign exchange gains, ouryear-to-date effective tax rate is the best estimate of the annual effectivetax rate.

 

*MinorityInterest*.   During thefirst quarter 2008 we allocated losses to the minority interest holder of $40.8million as compared to $4.9 million for the first quarter 2007.  The $40.8 million minority interest benefitis primarily related to Sumitomo’s interest in certain losses primarily relatedto the open metal derivative positions required by the Facility and includesrecovery of $20.4 million in losses previously absorbed by us. GAAP does notpermit the allocation of losses to the minority interest in excess of theminority owner’s recorded interest in the subsidiary and at December 31,2007 we had absorbed approximately $20.6 million of losses that normally wouldhave been allocated to the minority interest. At March 31, 2008 we were able to allocate the current loss and allbut $0.4 million of the previous loss as a result of the increase to theminority owners interest resulting from Sumitomo’s advances of $33.3 million tofund its share of operating costs related to the San Cristobal mine, and $2.1million of interest due Sumitomo on its share of advances to fund the SanCristobal mine.

 

**Liquidity and Capital Resources**

 

At March 31,2008, our aggregate cash, restricted cash, short and long-term investmentstotaled $198.9 million compared to an aggregate of $220.7 million in cash,restricted cash, short and long-term investments and restricted investments at December 31,2007.  The amounts held at March 31,2008 include $32.5 million of unrestricted cash and cash equivalents, $7.7million of unrestricted short-term investments, $20.8 million of currentlyilliquid ARS classified as long term, $91.0 million of cash that is restrictedto collateralize the metal derivative open positions required by the Facility,of which $30.3 million is expected to become unrestricted on January 2,2009 and is therefore classified as short term, and 

 

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$46.9 million of cash that is restricted to theoperating requirements at the San Cristobal mine and interest and principalpayments the Facility.  At March 31,2008, our aggregate unrestricted cash and investments (excluding ARS) totaled$40.2 million.

 

Overthe next twelve months, we expect to spend approximately $25 million on generalcorporate costs and interest related to the Convertible Notes (see Note 10) and$20 million on exploration.  We plan tofund these expenditures primarily from interest and other income and fromSumitomo’s deferred payment obligation on silver and zinc production at the SanCristobal mine.  For the first quarter2008, we received $2.0 million in interest and other income (some of which wasearned on restricted accounts and remained subject to restrictions) and $1.9million in payments from Sumitomo. Cash from the deferred payment obligation isnot subject to any restrictions.  In theevent general corporate costs, interest and exploration costs exceed currentprojections, we expect that additional cash funding would come from our existingunrestricted cash and investments.  Inaddition, we expect that $30.3 million of cash that is restricted tocollateralize the metal derivative open positions required by the Facility willbecome unrestricted at the beginning of 2009 and will be available for generalcorporate purposes.  If “completion” hasnot been achieved or we are otherwise not in compliance with the terms of theFacility, that amount will not be released until such noncompliance has beencured.

 

Duringthe first quarter 2008, we and Sumitomo contributed $82.1 million to SanCristobal to fund operating costs, income and other taxes, capital costs,financing costs, and settlement of metal derivative positions required inconnection with the Facility. We funded $48.8 million of this amount and theremaining $33.3 million was funded by Sumitomo (the amounts are different thanthe 65%/35% ownership ratio due to funding by Apex prior to year-end 2007, inadvance of Sumitomo’s corresponding funding which occurred at the beginning of2008).   Although operations at SanCristobal continue in the ramp-up phase, management does not believe that weand Sumitomo will need to contribute any additional amounts to San Cristobal tofund operations through the end of 2008 and that cash flows from concentratesales will cover remaining 2008 San Cristobal operating costs, taxes, capitalexpenditures, debt service and metal derivative settlement costs.   As noted below, however, we currentlyanticipate that we and Sumitomo will be required to contribute additionalamounts to the mine in January 2009 in connection with the payment ofBolivian income taxes.

 

TheFacility contains covenants that require us, among other things, to achieve “completion”of the mine as defined in the Facility by year-end 2008.  Failure to achieve “completion” by year-end2008 would constitute a default under the Facility.   One of the requirements for completion isthe funding of operating and debt service reserve accounts, which are estimatedto require an aggregate of $72 million.  Weproject that operating cash flows from our San Cristobal mine will besufficient to fund these reserve accounts by the end of 2008. If operating cashflows are not sufficient to fund the reserve accounts, we and Sumitomo would berequired to fund any shortfall, or request that the Facility lenders extend theperiod to achieve completion, to remain in compliance with the Facility.   There can be no assurance that the lenderswould agree to such an extension.

 

Inaddition, following “completion” of the San Cristobal mine as defined in theFacility, cash flows from the mine must meet certain minimum forward lookingloan coverage ratios which must be computed using metals prices set forth inthe Facility, which are lower than current market prices.  Specifically, for production during 2009, theforward looking debt service coverage ratio will be computed using metalsprices of $7.32 per ounce for silver, $0.61 per pound for zinc, and $0.32 perpound for lead.  At March 31, 2008the current market prices were $17.99 per ounce for silver, $1.04 per pound forzinc, and $1.27 per pound for lead.  Wemust submit annually an updated operating plan to the lenders by November 1using the metals prices set forth in the Facility and projections of actualproduction and operating costs for the following year and life of themine.  Material increases in projected costsor decreases in projected production could cause us to fail to comply with theforward looking financial ratios included in the operating plan.  In this situation, we would have to requestthat the Facility lenders allow increased metals prices in the operating plan,or otherwise modify the Facility, to remain in compliance.  There can be no assurance that the lenderswould agree to such an increase or other such modifications.

 

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Failureto meet one or more of the conditions or covenants required by the Facility, orto cure related violations within specified periods, could cause the lenders todeclare us in default.   If such adefault were declared and remained uncured, amounts borrowed under the Facilitycould become due and payable immediately and we could be required toimmediately settle all outstanding hedge positions associated with the Facility(see Note 12).  We currently do not havesufficient cash and investments to settle fully our share of the obligationrelated to the Facility and hedge liability, and there can be no assurance thatwe would be able to obtain the additional funds necessary to settle suchamounts.  If we were unable to repay theborrowed amounts or otherwise perform our obligations under the Facility, thelenders would be entitled, in certain circumstances, to enforce their lien andtake possession of the secured assets, including the assets that comprise theSan Cristobal mine.  In addition, failureto pay amounts accelerated under the Facility could also result in a defaultunder the terms of our 2.875% and 4.0% Convertible Senior Subordinated Notesdue 2024, which could require the repayment of those amounts.

 

Further,San Cristobal will be required to make an income tax payment, which will varydepending on the income generated by the mine, in January 2009 upon the filingof its annual Bolivian income tax return, representing the majority of its taxliability due for the Bolivian fiscal year ended September 30, 2008.  We estimate that the tax payment could be as much as $90 millionwith our 65% share being as much as much as $59 million.  Based onthose projections, we anticipate that the cash balances held by San Cristobalat that time will not be sufficient to both fund the operating and debt servicereserve accounts required by the Facility (see discussion above) and make thetax payment as required.   This wouldrequire us and Sumitomo to contribute additional amounts to San Cristobal.   We are currently projecting that we will beable to fund our share of San Cristobal’s anticipated cash shortfall in January 2009with available unrestricted cash and investments and we expect that Sumitomowould fund its share.

 

WhetherSan Cristobal will require future funding from Apex Silver and Sumitomo inexcess of current projections will depend on, among other things, the amountand timing of concentrate production, revenues and related cash receipts, andexpenditures, including the settlement of metal derivative positions and paymentof taxes.  Because the mine has not yetreached full production capacity, the amount and timing of production, revenuesand related cash receipts and expenditures are difficult to predict.  If the San Cristobal ramp-up and productionare delayed, or if projected metals recovery rates or operating cost estimatesare not substantially achieved, additional funding may be required.   If San Cristobal requires additional cashfunding, we could require additional debt or equity financing.  There can be no assurance that we couldobtain such debt or equity financing on acceptable terms and conditions or atall.  If Sumitomo funds its pro ratashare of additional San Cristobal funding but we are unable to fund our share,our ownership interest in the mine could be reduced.

 

Weare exploring alternatives for increasing our liquidity in the event that ourcurrent balance of unrestricted cash and investments falls below acceptablelevels.  Alternatives for increasingavailable unrestricted cash and investments could include, among other things,debt or equity financing or selling an additional interest in San Cristobal or oneor more exploration properties.  Inaddition, we could seek certain waivers from the lenders of the Facility toextend the period for meeting completion under the Facility or to assurecompliance with financial ratios.  Therecan be no assurance that any of these strategies, if undertaken, would besuccessful or that we would find the terms and conditions of any of thealternatives acceptable.

 

**Significant Accounting Policies**

 

*RecentlyAdopted Standards*

 

EffectiveJanuary 1, 2008 we adopted the provisions of Financial AccountingStandards No. 157, “Fair Value Measurements” (“FAS No. 157”) for thefinancial assets and liabilities and nonfinancial assets and liabilities whichwe measure at fair value on a recurring (annual) basis.  FAS No. 157 establishes a framework formeasuring fair value in the form of a fair value hierarchy which prioritizesthe inputs into valuation techniques used to measure fair value into threebroad levels.  This hierarchy gives thehighest priority to quoted prices (unadjusted) in active markets and the lowestpriority to unobservable inputs.  Further,financial assets and liabilities should be classified by level in their entiretybased upon the lowest 

 

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level of input that was significant to the fairvalue measurement.  The three levels ofthe fair value hierarchy per FAS No. 157 are as follows:

 

**Level1: **Unadjusted quoted market pricesin active markets for identical assets or liabilities that are accessible atthe measurement date.

 

**Level2: **Quoted prices in inactivemarkets for identical assets or liabilities, quoted prices for similar assetsor liabilities in active markets, or other observable inputs either directlyrelated to the asset or liability or derived principally from corroboratedobservable market data.

 

**Level3: **Unobservable inputs due to the fact that there islittle or no market activity. This entails using assumptions in models whichestimate what market participants would use in pricing the asset or liability.

 

The following tablesummarizes our financial assets and liabilities at fair value at March 31,2008, by respective level of the fair value hierarchy:

 
| ** **                                | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
|-------------------------------------------|------------|------------------|------------|------------------|------------|------------------|------------|-----------|------------|
| Assets:                                   |       |             |       |             |       |             |       |      |       |
| Cash equivalents                          |       | $                | 11,892     |             | $          | —           |       | $         | —     |   | $ | 11,892 |   |
| Short-term  available for sale securities |       | 7,708            |       | —           |       | —           |       | 7,708     |       |
| Trade  receivables                        |       | 19,932           |       | —           |       | —           |       | 19,932    |       |
| Auction rate  securities                  |       | —           |       | —           |       | 20,767           |       | 20,767    |       |
| Derivatives                               |       | —           |       | 6,106            |       | —           |       | 6,106     |       |
|                                      |       | $                | 39,532     |             | $          | 6,106            |       | $         | 20,767     |   | $ | 66,405 |   |
|                                      |       |             |       |             |       |             |       |      |       |
| Liabilities:                              |       |             |       |             |       |             |       |      |       |
| Trade payables                            |       | $                | 1,488      |             | $          | —           |       | $         | —     |   | $ | 1,488 |   |
| Derivatives                               |       | —           |       | 771,648          |       | —           |       | 771,648   |       |
|                                      |       | $                | 1,488      |             | $          | 771,648          |       | $         | —     |   | $ | 773,136 |   |
|                                           |            |                  |            |                  |            |                  |            |           |            |  |  |  |  |  |  |

 

Ourcash equivalents are classified within Level 1 of the fair valuehierarchy.  These securities arecomprised principally of commercial paper and government bonds which have beenvalued using quoted prices in active markets.

 

Ourshort-term investments are classified within Level 1 of the fair valuehierarchy.  These securities arecomprised principally of common stock, commercial paper and government bondswhich have been valued using quoted prices in active markets.

 

Ourtrade receivables and trade payables (to smelters) are classified within Level1 of the fair value hierarchy.  Theseamounts represent embedded derivatives as part of our concentrate sales and aremarked-to-market based upon quoted market prices in the respective commodityfutures market based upon the period of estimated settlement.  Trade payables arise when the overall mark-tomarket valuation of a respective sale falls below the amount we have receivedto date from applicable provisional payments.

 

Allof our metal derivative positions are classified within Level 2 of the fairvalue hierarchy.  These metal derivativepositions are valued from quoted market information reflected in the applicablecommodities price indices for the periods the indices are available.  For periods beyond the available indicesthese metal derivative positions are valued using quoted prices andextrapolation of the commodities price indices from the counterparties holdingthe metal derivative positions.

 

OurARS are classified within Level 3 of the fair value hierarchy.   These securities are valued by us, with theassistance of a third party valuation firm. The ARS are classified into two categories, collateralized debtobligations (“CDO’s”) and corporate debt. The CDO’s are valued by estimating the value of the underlyingcollateral using significant assumptions regarding default, recovery andprepayment rates, and factoring these estimated collateral values inconjunction with the tranche for pay-out of the underlying collateral that wehold in each respective security.  Thecorporate debt ARS are valued based 

 

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upon the estimated present value of expected cashflows using a Monte Carlo simulation model taking into account significantassumptions regarding coupon payments, recovery, and redemption, values.  We uses these significant Level 3 inputs asthere is no current market activity for these, or similar, securities norrelevant corroborating market data with readily observable inputs to support aLevel 1 or 2 valuation.

 

Thefollowing table summarizes the change in fair value of our Level 3 financialassets (ARS’s) for the three months ended March 31, 2008:

 
| Beginning  balance                                          |   | $      | 21,510 |   |
|-------------------------------------------------------------|--------|--------|--------|--------|
| Unrealized  losses, net                                     |   | (597   | )      |
| Adjusted cost  basis of Level 3 security sold in the period |   | (146   | )      |
|                                                        |   |   |   |
| Ending balance                                              |   | $      | 20,767 |   |

 

Effective January 1,2008 we adopted Financial Accounting Standards No. 159, “The Fair ValueOption for Financial Assets and Financial Liabilities-Including an amendment ofFASB Statement No. 115” (“FAS No. 159”).  FAS No. 159 permits entities to chooseto measure many financial instruments and certain other items at fair value.Most of the provisions of FAS No. 159 apply only to entities that electthe fair value option.  However, theamendment to FASB Statement No. 115, “Accounting for Certain Investmentsin Debt and Equity Securities,” (“FAS No. 115”) applies to all entitieswith available-for-sale and trading securities. We did not elect the fair value option for any of our financial assetsor liabilities, and as a result, the adoption of FAS No. 159 did not havea material impact on our financial position or results of operations at March 31,2008 and is not expected to have a material impact in the future.

 

*NewAccounting Standards*

 

For informationregarding new accounting standards, see Note 3 to our unaudited condensedconsolidated financial statements within Part I, Item 1 of this report.

 

## **ContractualObligations**

## ** **

Our primarycontractual obligations at March 31, 2008 are related to the Facilitymetal derivative positions required by the Facility, capital lease obligationsrelated to mining equipment at our San Cristobal mine and interest obligationsrelated to our outstanding convertible debt. There have not been any significant additions or modifications to ourcontractual obligations during the quarter ended March 31, 2008.

 

## **Forward-LookingStatements**

## ** **

Some informationcontained in or incorporated by reference into this report may containforward-looking statements. These statements include comments regarding SanCristobal ramp-up and anticipated production and average cash operating costsin 2008, the timing of achieving consistent mill throughout at designedcapacity and full production rates, the adequacy of process water forproduction, improvement during 2008 in metal recovery rates, anticipatedspending during 2008 and the expectation that we will not be required tocontribute additional amounts to San Cristobal in 2008, anticipated additionalfunding requirements for San Cristobal, the expectation that sales from SanCristobal will cover operating and other costs for the mine during 2008, expectedincreases in smelting and treatment charges, potential need for additional debtor equity financing, planned spending on corporate costs, interest and overhead,contractual arrangements with Sumitomo, including Sumitomo’s obligations withrespect to funding commitments; the likely increased volatility in futureearnings due to forward sales, derivative positions and metals tradingactivity; compliance with the San Cristobal project finance facility; possiblechanges in the mining or taxation policies of the Bolivian government; and thetiming and amounts of spending on the evaluation and expansion of our explorationportfolio. The use of any of the words “anticipate,” “continues,” “estimate,” “expect,”“may,” “will,” “project,” “should,” “believe” and similar expressions areintended to identify uncertainties.  Webelieve the expectations reflected in those forward-looking statements arereasonable.  However, we cannot assurethat these expectations will prove to be correct.  Actual results could differ materially fromthose anticipated in these forward-looking statements as a result of thefactors set forth below and other factors set forth in, or incorporated byreference into this report:

 

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·      worldwide economic and political eventsaffecting the supply of and demand for silver, zinc and lead and related marketprices for each metal;

 

·      political and economic instability inBolivia, including the communities located near the San Cristobal mine, and in othercountries in which we conduct business;

 

·      future actions of the Bolivian governmentwith respect to nationalization of natural resources or other changes in themining or taxation policies of the Bolivian government, including the approval bythe Bolivian people of a draft constitution which could have a significanteffect on mining operations in Bolivia;

 

·      volatility in market prices for silver,zinc and lead;

 

·      financial market conditions;

 

·      uncertainties associated with ramp-up andoperation of a new mine, including the unreliability of production and costestimates in early stages of operations;

 

·      variations in ore grade and othercharacteristics affecting mining, crushing, milling and smelting operations andmineral recoveries;

 

·      variations in plant availability andprocessing rates;

 

·      shortages and reliability of processwater and delivery of operating supplies to the mine site;

 

·      continued training needs of the plantwork force;

 

·      labordisputes or strikes;

 

·      failure to comply with obligations underthe Facility;

 

·      failure to reach agreement with SumitomoCorporation regarding future development or operation of San Cristobal, orfailure to comply with agreements with Sumitomo related to the San Cristobalmine;

 

·      uncertainties regarding future changes inapplicable law or implementation of existing law, including Bolivian lawsrelated to tax, mining, environmental matters and exploration; and

 

·      problems or delays in achieving full millthroughput rates and anticipated recovery rates and metals production at SanCristobal;

 

·      inability to improve recoveries withoutaffecting throughput;

 

·      higher than anticipated mine orconcentrator costs;

 

·      material handling problems in stockpilereclaim system;

 

·      inability to provide funding to SanCristobal or to obtain debt or equity financing on acceptable terms or at all;

 

·      difficulties in blending ore types;

 

·      insufficient funds to complete plannedexploration activities;

 

·      amounts and timing of production, revenuesand related cash receipts, and expenditures;

 

·      thefactors discussed under “Risk Factors” in our Form 10-K for the periodended December 31, 2007.

 

Manyof those factors are beyond our ability to control or predict.  You should not unduly rely on theseforward-looking statements. These statements speak only as of the date of thisreport on Form 10-Q.  Except asrequired by law, we are not obligated to publicly release any revisions tothese forward-looking statements to reflect future events or developments.

 

## **Item3.**    Quantitative andQualitative Disclosures About Market Risk

## ** **

## **InterestRate Risk**

## ** **

Ouroutstanding debt consists primarily of our 4.0% and 2.875% Convertible SeniorSubordinated Notes due 2024 and amounts borrowed under the Facility.  The Convertible Senior Subordinated Notesbear interest at a fixed rate and thus do not have exposure to interest ratechanges.  The Facility bears interest atthe LIBOR rate plus a credit spread. With the full $225 million borrowed under the Facility, a 1% increase inthe LIBOR rate would result in an annual increase in interest expense of $2.25million.  We have not entered into anyagreements to hedge against unfavorable changes in interest rates, but may inthe future manage our exposure to interest rate risk.

 

Weinvest excess cash in U.S. government and debt securities rated “investmentgrade” or better.  The rates received onsuch investments may fluctuate with changes in economic conditions. Based onthe average cash, restricted cash, investments and restricted investmentbalances outstanding during the first three months of 2008, a 1% decrease ininterest rates would have resulted in a reduction in interest income for theperiod of approximately $0.5 million.

 

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## **ForeignCurrency Exchange Risk**

## ** **

Althoughmost of our expenditures are in U.S. dollars, certain purchases of labor,operating supplies and capital assets are denominated in Bolivianos, Euros orother currencies.  As a result, currencyexchange fluctuations may impact the costs of our operations.  Specifically, the appreciation of Bolivianosagainst the U.S. dollar may result in an increase in operating expenses andcapital costs at the San Cristobal mine in U.S. dollar terms.  To reduce this risk, we maintain minimum cashbalances in foreign currencies, including Bolivianos, and complete most of ourpurchases, including purchases relating to the San Cristobal mine, in U.S.dollars.

 

Asecondary effect to transacting mostly in US dollars is the exposure created,for purposes of calculating and paying foreign income tax, in those foreignjurisdictions whose local currency is other than the US dollar.  Certain jurisdictions, including Bolivia,require the recognition of unrealized exchange gains or losses in the calculationof taxable income.  Because the BolivianSan Cristobal mine has been funded with US dollar denominated financing, it hassignificant US dollar liabilities.  Thetranslation from US dollars to the Bolivian currency (the Boliviano or BOB)creates an unrealized gain or loss depending on the movement in exchange ratesduring the period.  As disclosed in theIncome Taxes footnote, an unrealized exchange gain of $28.2 million ($10.6million tax effected at 37.5%) has been recognized for tax purposes in thecurrent period due to the recent devaluation of the US dollar relative to theBoliviano.  This gain is only recognizedfor local jurisdiction purposes, and will never be reflected in GAAP since theUS dollar is the functional currency for the Bolivia subsidiary and therecognition for income taxes is based on unrealized gains and losses.  Should the US dollar strengthen against theBoliviano, the San Cristobal project would be able to deduct any unrealizedlosses incurred, for local tax reporting purposes only, due to holdingliabilities in US dollars.

 

Wehave previously engaged in a limited amount of currency hedging activitiesprimarily related to an equipment order for the San Cristobal mine that wasdenominated in Euros.  At March 31,2008 we did not hold any foreign currency derivative positions.

 

## **CommodityPrice Risk**

## ** **

 With the San Cristobal mine producingconcentrates beginning in the third quarter 2007, our primary source of incomeis from sales of concentrates containing silver, zinc and lead.  As a result, changes in the price of any ofthese commodities could significantly affect our results of operations and cashflows.

 

As arequirement of the Facility, we were required to implement price protection fora portion of our planned silver, zinc and lead production from SanCristobal.  We have entered intocontracts utilizing forward sales, puts and calls.  Non-cash mark-to-market gains and losses fromthese metal derivatives and other derivative positions may fluctuatesubstantially from period to period based on spot and forward prices and optionvolatilities.  The actual final financialimpact of the metal derivative positions required by the Facility will not beknown until the positions are closed on their future settlement dates.  Our outstanding derivative positions provideprice protection representing 9%, 13% and 19% of planned life-of-mine payableproduction of silver, zinc and lead respectively, at San Cristobal butrepresent a significantly higher proportion of our planned production duringthe six years in which the metal derivative positions are in place. For thefirst six years of production and including the put option contracts that weown, we have price protection representing approximately 21%, 24% and 36% ofplanned production of silver, zinc and lead, respectively. See Note 12 for adetailed schedule of our metal derivative positions by year of settlement.

 

Duringthe first three months of 2008 we recorded a loss on our metal derivativepositions in the amount of $76.5 million. As of March 31, 2008 the fairvalue of our open metal derivative positions reflected a net $765.5 millionliability.  We began to settle the metalderivative positions required by the Facility during the third quarter 2007 andhave made cash payments totaling $100.3 million to date.  At the time of final settlement, the gain orloss recorded excludes previously recognized non-cash mark-to-market gains orlosses. The actual financial impact of the remaining metal derivative positionswill not be known until the positions are closed on their future settlementdates.  Non-cash mark-to-market gains andlosses from the open metal derivative positions have fluctuated substantiallyfrom period to period based on spot and forward prices and option volatilitiesand will most likely continue to do so as long as the metal derivativepositions are outstanding. See “Management’s Discussion and Analysis ofFinancial Condition and Results of Operations – Results of Operations”.

 

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# **Item 4. Controls and Procedures**

# ** **

(a)   Evaluation of DisclosureControls and Procedures

 

Duringthe fiscal period covered by this report, our management evaluated, with theparticipation of our Chief Executive Officer and Chief Financial Officer, theeffectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934.

 

Basedon this evaluation, our Chief Executive Officer and Chief Financial Officerhave concluded that, as of the end of the period covered by this report, ourdisclosure controls and procedures were effective to ensure that information weare required to disclose in the reports that we file or submit under theSecurities Exchange Act of 1934, is recorded, processed, summarized andreported within the time periods specified in the Securities and ExchangeCommission’s rules and forms relating to us, including our consolidatedsubsidiaries, and was accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate, toallow timely decisions regarding required disclosure.

 

(b)   Change in Internal Control overFinancial Reporting

 

There has been no change identified in our internalcontrol over financial reporting that occurred during the last fiscal quarterthat has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

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PART II: OTHER INFORMATION

 

## **Item 1.**    Legal Proceedings

## ** **

There were no material developments to proceedings previously discussedin our Form 10-K for the year ended December 31, 2007.

 

## **Item1A. Risk Factors**

## ** **

There were no materialchanges from the risk factors as previously discussed in our Form 10-K forthe year ended December 31, 2007.

 

## **Item2.**    UnregisteredSales of Equity Securities and Use of Proceeds

## ** **

None.

 

## **Item3.**    Defaults UponSenior Securities

## ** **

None.

 

## **Item4.**    Submission ofMatters to a Vote of Security Holders

## ** **

None.

 

**Item 5.****   ****Other Information**

 

None.

 

**Item 6.****   ****Exhibits**

 
| 31.1 | Certification of Chief  Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act                                                |
|------|-------------------------------------------------------------------------------------------------------------------------------------------------|
| 31.2 | Certification of Chief  Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act                                                |
| 32   | Certification of Chief  Executive Officer and Chief Financial Officer pursuant to 18 U.S.C., 1350  (Section 906 of the Sarbanes-Oxley Act) |

 

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SIGNATURES

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on behalf of the undersigned thereunto dulyauthorized.

 

 
|                                                  | APEX SILVER MINES  LIMITED |
|-------------------------------------------------------|----------------------------|
|                                                  |                       |
|                                                  |                       |
| Date:     May 12,  2008 | By:                        | \s\ Jeffrey G.  Clevenger |
|                                                  |                       | Jeffrey G. Clevenger |
|                                                  |                       | President and Chief  Executive Officer |
|                                                  |                       |   |
|                                                  |                       |   |
| Date:     May 12,  2008 | By:                        | \s\ Gerald J. Malys |
|                                                  |                       | Gerald J. Malys |
|                                                  |                       | Senior Vice President  and Chief Financial Officer |

 

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