**U.S. SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

**Form 10-KSB/A-1**

 

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

|   | For the fiscal year endedDecember 31, 2006 |
|--------|--------------------------------------------|

 

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

|   | For the transition period from _________ to                            __________ |
|--------|-----------------------------------------------------------------------------------|

 

Commission File Number0-50218

 

**BEKEM METALS, INC.**

(Name            of Small Business Issuer in its charter)

 

| **Utah**                                                         |   | **87-0669131**      |
|------------------------------------------------------------------|--------|---------------------|
| (State or other jurisdiction of                                  |   | (I.R.S. Employer    |
| incorporation or organization)                                   |   | Identification No.) |
|                                                             |   |                |
| **170 Tchaikovsky Street, 4th                            Floor** |   |                |
| **Almaty, Kazakhstan**                                           |   | **050000**          |
| (Address of principal executive offices)                         |   | (Zip code)          |

 

Issuer's telephone number:+**7 3272 582 386**

 

Securities registered pursuant to section 12(b) of the Exchange            Act:**None**

 

Securities registered pursuant to section 12(g) of the Exchange            Act:**Common, $0.001 par value**

 

Check            whether the Issuer (1) filed all reports required to be filed by section 13 or 15(d) of            the Exchange Act during the past 12 months (or for such shorter period that the            registrant was required to file such reports), and (2) has been subject to such filing            requirements for the past 90 days. (1) YesxNoo

 

Check            if there is no disclosure of delinquent filers in response to Item 405 of Regulation            S-B contained in this form, and no disclosure will be contained, to the best of            registrant's knowledge, in definitive proxy or information statements incorporated by            reference in Part III of this form 10-KSB or any amendment to this Form 10-KSB.o

 

Check            if the Issuer is a shell company.o

 

The            issuer's revenue for its most recent fiscal year was: $105,304.

 

The            aggregate market value of the issuer's voting stock held as of March 20, 2007, by            non-affiliates of the issuer was approximately $45,054,015, based on the average of the            bid price and the ask price for the Company's common stock on that date, as reported on            the OTCBB.

 

As of            March 5, 2007, the issuer had 125,172,011 shares of its $0.001 par value common stock            outstanding.

 

Transitional Small Business Disclosure            Format**.**YesoNox

Documents incorporated by reference:**None**

 

 

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**Table of Contents**

 

| PART I                                      |
|---------------------------------------------|
|                                        |   |   |
|                                        | Explanatory Note | 2 |
|                                        |   |   |
| Items 1 & 2.                            | Description of Business and Properties | 5 |
|                                        |   |   |
| Item 3.                                     | Legal Proceedings | 29 |
|                                        |   |   |
| Item 4.                                     | Submission of Matters to a Vote of Security                            Holders | 29 |
|                                        |   |   |
| PART II                                     |
|                                        |   |   |
| Item 5.                                     | Market for Common Equity, Related Stockholders Matters                            and Small Business Issuer Purchases of Equity Securities | 29 |
|                                        |   |   |
| Item 6.                                     | Management’s Discussion and Analysis of Financial                            Condition and Results of Operations | 33 |
|                                        |   |   |
| Item 7.                                     | Financial Statements | 41 |
|                                        |   |   |
| Item 8.

                              | Changes in and Disagreements with Accountants on                            Accounting and  Financial Disclosure | 41 |
|                                        |   |   |
| Item 8A.                                    | Controls and Procedures | 41 |
|                                        |   |   |
| Item 8B.                                    | Other Information | 43 |
|                                        |   |   |
| PART III                                    |
|                                        |   |   |
| Item 9.                                     | Directors, Executive Officers, Promoters, Control                            Persons and Corporate Governance; Compliance with Section 16(a) of the                            Exchange Act | 43 |
|                                        |   |   |
| Item 10.                                    | Executive Compensation | 48 |
|                                        |   |   |
| Item 11.                                    | Security Ownership of Certain Beneficial Owners and                            Management | 51 |
|                                        |   |   |
| Item 12.                                    | Certain Relationships and Related Transactions, and                            Director Independence | 53 |
|                                        |   |   |
| Item 13.                                    | Exhibits | 54 |
|                                        |   |   |
| Item 14.                                    | Principal Accountant Fees and Services | 54 |
|                                        |   |   |
|                                        | SIGNATURES | 55 |
|                                        |   |   |

 

1

 

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**EXPLANATORY NOTE**

 

Bekem Metals, Inc. (hereinafter referred to as “us,”            “we,” the “Company” or “Bekem”) is filing this            Amendment No. 1 on Form 10-KSB/A-1 (the “Amendment”) to its Annual Report            for the fiscal year ended December 31, 2006, which was filed with the Securities and            Exchange Commission (“SEC”) on April 2, 2007 (the “Original            Report”) in response to certain comments raised by the staff of the SEC. While            the staff commented on a number of issues, as discussed in more detail herein the            primary issue raised by the staff was whether the presentation of the Company as a            “production stage” enterprise was proper, or whether, it would be more            consistent with SEC Industry Guide 7, “*Description of            Property by Issuers Engaged or to Be Engaged in Significant Mining            Operations*” (“Industry Guide 7”) to present            the Company as an “exploration stage” enterprise.

 

The disclosure and the financial statements included in the Original            Report present us as a production stage enterprise. At the time we prepared and filed            the Original Report we believed we were a production stage enterprise for a number of            reasons including:

 

|   | **•** | the licenses we hold from the Ministry of Energy and                            Mineral Resources of the Republic of Kazakhstan (“MEMR”) to                            the Kempirsai and Mamyt deposits are production licenses that require                            us to extract certain quantities of nickel, cobalt and brown coal in                            order to retain those licenses; |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | the deposits have a history of commercial production                            during the 1980s and 1990s; and |
|--------|------------|-----------------------------------------------------------------------------------------------------------------|

|   | **•** | we had engaged in some limited mineral extraction                            activities in accordance with the terms of our licenses. |
|--------|------------|---------------------------------------------------------------------------------------------------------------------------------------|

             

We also considered the fact that we had historical reserve reports            prepared during the Soviet era that both the State Resources Committee and the MEMR            recognized as indicative of commercially producible reserves of nickel and cobalt ores            and brown coal at the Kempirsai and Mamyt deposits. While we did not include a            discussion of those reserves in the Original Report, because we were unsure whether the            reserve reports would meet the standards established by the SEC, we did believe,            coupled with the other factors discussed above, that the reserve reports supported our            presentation as a production stage enterprise.

 

Following discussion with the staff of the SEC and further research we            now agree that the determination of reserves and production stage activities made by            Kazakhstani governmental authorities is not binding upon or authoritative under            Industry Guide 7. We further agree with the staff’s position that until such time            as we have a reserve report prepared in accordance with the standards recognized by the            SEC, the Company should be presented as an exploration stage enterprise. The purpose of            Amendment is to, among other things, revise the presentation of the Original Report to            present the Company as an exploration stage enterprise.

 

Items 1 and 2 “*Description of Business            and Properties*” of the Original Report is hereby            revised to clarify that as of December 31, 2006 the Company was in the exploration            stage. Items 1

 

2

 

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and 2            have also been revised to add small scale maps showing the location and access to each            of the Company’s properties, to expand disclosure regarding the characteristics            of our nickel and cobalt deposits and to provide additional information such as,            sampling collection and preparation and analytical procedures followed and quality            assurance/quality control protocols developed used in the Company’s exploration            program.

 

Item 6 “*Management’s Discussion and            Analysis of Financial Condition and Results of            Operations*” of the Original Report is hereby revised to            likewise present the Company as an exploration stage enterprise. Disclosure regarding            “*Other income (expense)*”            and “*Revenue*” in Item 6            have also been revised. In the Original Report, the Company had included in            “*Revenue*” $52,948            charged to a third-party for locomotive services provided by the Company. After further            review, it was determined that this amount should have been recorded as            “*Other income            (expense)*”. The disclosure in Item 6 has been revised            to address this change and its effects. The discussion of            “*Critical Accounting            Policies*” has been revised to provide enhanced            discussion and analysis of the Company’s critical accounting policies and            assumptions in accordance with SEC Releases No. 33-8350, 34-48960 and FR-72.

 

The audited consolidated financial statements and notes to the financial            statements included in Item 7 “*Financial            Statements*” of the Original Report are hereby revised            to present the Company as an exploration stage enterprise rather than a production            stage enterprise. As noted above, the “*Consolidated            Statements of Operations*” has also been revised to            reflect a reduction in            “*Revenue*” and a            corresponding increase in “*Other income            (expense)*”, to correct the reporting of deferred            compensation expense. In addition, the weighted average number of share outstanding was            corrected in the “*Consolidated Statements of            Operations*.” The notes to the financial statements have            been revised to:

 

|   | **•** | provide clarification regarding the Company’s                            disclosure regarding impairments of long-lived assets and long-lived                            assets to be disposed of; |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | show that SAB 108 did not have a material effect on the                            Company’s financial statements; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------|

|   | **•** | discuss why the Company was able to acquire its interest                            in Kyzl Kain Mamyt LLC at a price significantly below the fair value of                            its long term assets; |
|--------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | clarify the restrictions on use of bank deposits;                            and |
|--------|------------|----------------------------------------------------------------------------------|

|   | **•** | include unaudited Note 14                            “*Subsequent                            Events*” regarding litigation between                            the Company and the MEMR in connection with the purported unilateral                            cancelation of the Company’s contracts and licenses to the                            Kempirsai and Mamyt deposits. |
|--------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The reclassification resulted in a $118,180 increase in            “*Net Loss*”, which did            not change “*Basic Loss Per Common            Share*.”

 

Item 8A “*Disclosure Controls and            Procedures*” of the Original Report is hereby revised to            more specifically state the conclusions of the Company’s certifying officers with            respect to whether the Company’s disclosure controls and procedures were            effective at accomplishing all of the items included within the definition of            disclosure controls and procedures, as defined in Rule 13a-15(e) of the Exchange Act of            1934, as amended and to address changes to our disclosure controls and            procedures.

 

3

 

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In accordance with Rule 12b-15 under the Securities Exchange Act of            1934, this Amendment also includes currently dated certifications from the            Company’s Chief Executive Officer and Chief Financial Officer as required by            Sections 302 and 906 of the Sarbanes-Oxley Act of 2002. The certification exhibits and            Item 13 “*Exhibits*” have            been revised accordingly.

 

This Amendment speaks only of the original filing date of the Original            Report and, except for those Items disclosed in this explanatory note, is unchanged            from the Original Report. This Amendment does not reflect events after the filing of            the Original Report or modify or update those disclosures affected by subsequent            events. Therefore, you should read this Amendment together with our other reports that            update and supersede the information contained in this Amendment.

 

**FORWARD LOOKING STATEMENTS**

 

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

 

****

 

4

 

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**PART I**

 

|   | **Items 1 & 2.** | **Description of Business and Properties** |
|--------|----------------------|--------------------------------------------|

 

**Company History**

 

We are engaged in the exploration of nickel, cobalt and brown coal            deposits in the Republic of Kazakhstan.

             

We incorporated in the state of Utah under the name EMPS Research            Corporation on January 30, 2001. Until the end of the 2004 fiscal year, our primary            business focus was the development, marketing and licensing of our patented technology            for use in commercially separating nonmagnetic particulate material by building and            testing a high frequency eddy-current separator (“HFECS”).

 

We changed our name to Bekem Metals, Inc., on March 16, 2005 following            our acquisition of Condesa Pacific, S.A., a British Virgin Islands international            business company, and its wholly owned subsidiary Kaznickel, LLP in January of 2005.            With the acquisition of Kaznickel, our primary business focus shifted from the            development of our HFECS technology to exploring for nickel and cobalt in Kazakhstan.            On July 24, 2006 Condesa transferred its interest in Kaznickel to Bekem, making            Kaznickel a wholly-owned subsidiary of Bekem. On October 1, 2006 Bekem sold Condesa to            a third party for nominal value.

             

The primary asset of Kaznickel is an exploration and production            concession issued by the government of the Republic of Kazakhstan which grants            Kaznickel the exclusive right, through February 2008, unless extended, to explore for            nickel, cobalt and other minerals in a 12,232 acre area in northeastern Kazakhstan            known as the Gornostayevskoye (“Gornostai”) deposit. The concession further            provides that if we make a commercial discovery of nickel, cobalt or other minerals            within the concession territory, we can apply for and receive the exclusive rights to            commercially produce and sell nickel and cobalt ore through February 2026.

             

On October 24, 2005 we acquired Kazakh Metals, Inc. (“KMI”),            and its wholly owned subsidiary Kyzyl Kain Mamyt (“KKM”), LLP in exchange            for 61,200,000 shares of our common stock. KKM holds the exclusive subsoil use contract            to extract and process nickel and cobalt ore from its Kempirsai deposit, which is            comprised of the Kara-Obinskoye, and Stepninskoye sections (collectively referred to as            the “Kara-Obinskoye section”) and Novo-Shandashinskoye section, and brown            coal from its Mamyt deposit. Unless otherwise indicated by the context of the            disclosure, the Kara-Obinskoye section, the Novo-Shandashinskoye section and the Mamyt            deposit are collectively referred to herein as the “Kempirsai deposit.”            Under the applicable accounting reporting rules, KMI was considered the accounting            acquirer.

             

5

 

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**Business of the Company**

 

**The Nickel Market**

 

According to United States Geological Survey (“USGS”) the            world mine reserves of nickel and the world mine reserves base of nickel in 2006 were            64 million tons and 140 million tons, respectively. In 2006 total nickel production was            approximately 1,550,000 tons. Russia was the largest producer of nickel in the world            with a 20% market share, followed by Canada with 15%, Australia with 12%, and Indonesia            with 9%.

             

There is some debate in the market as to whether nickel prices will            continue to increase. In 2006 the average price for nickel was about $24,287 per ton,            up from $14,372 in 2005. The average London Metal Exchange (“LME”) price            for nickel in January 2007 was $36,811 per ton.

             

There are several factors that can affect the overall worldwide nickel            demand and prices in the future, which include the following:

             

|   | **•** | Expansion of new nickel mining capacity; |
|--------|------------|------------------------------------------|

|   | **•** | New processing technologies; |
|--------|------------|------------------------------|

|   | **•** | Stainless-steel worldwide demand. |
|--------|------------|-----------------------------------|

 

6

 

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There are a number of new nickel mining projects that are projected to            meet demand over the next five years. The Brazilian CVRD (former INCO) has been            constructing a laterite mining complex at Goro near the southeastern tip of New            Caledonia. It is anticipated that the New Caledonian nickel will be recovered onsite            using pressure acid leaching technology. Australia’s leading nickel producer, BHP            Billiton, is also developing a large laterite deposit near Ravensthorpe, Western            Australia. Several other companies are considering employing some form of acid leaching            technology to recover nickel in Cuba, Guatemala and the Philippines. The USGS has            reported, however, that some nickel consumers are concerned that the global demand for            nickel could outstrip supply before new mining projects can be completed. At least five            automobile manufactures plan to use nickel-metal hydride batteries to power their            gasoline-electric hybrid vehicle for the 2008 and 2009 model years, which would lead to            a significant increase in nickel demand.

             

According to CRU Strategies, an independent business analysis and            consultancy group focused on the mining, metals, power, cables, fertilizer and chemical            sectors, the compounded annual growth rate (“CAGR”) of primary nickel            consumption in the last 5 years was 4.1%. In the next five years the CAGR is expected            to grow strongly up to 4.3% annually. Increasing world consumption of stainless steel            is being driven in large part by China’s continued rapid economic expansion.            Strong economic growth in the rest of the world will also support nickel consumption.            The CRU Strategies analysis indicates that over 320,000 tons more primary nickel will            be required by 2011 compared with 2006, and that supply and demand of primary nickel            would be evenly matched in the next five years if the industry developed laterite ore            bodies, especially limonite deposits utilizing high pressure acid leach            technology.

             

Stainless-steel production, the single largest end use market segment of            nickel, is expected to grow steadily in the next five years, relying heavily on the            primary nickel supply for its expansion. Of course, high nickel prices force some steel            mills to substitute chromium and manganese in place of nickel; while this lowers the            cost of producing, it also lowers the corrosion-resistance of the steel. This            lower-quality steel is used mainly in consumer applications where the low price of the            final product is more important than corrosion resistance. Resistance to corrosion            makes nickel an essential element both in alloys and as a catalyst. For aerospace,            electric power and petrochemical industries, this resistance to corrosion is essential,            as well as for use in gray-iron castings to toughen the iron, promote graphitization            and improve machineability.

             

 

7

 

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**Our Properties**

 

             

As discussed above, through our subsidiaries, we hold the rights to the            Kempirsai nickel, cobalt and brown coal deposits, which are located in northwestern            Kazakhstan and the Gornostai nickel and cobalt deposit located in northeastern            Kazakhstan.

             

8

 

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**Location and access to our properties**

             

             

The Kempirsai deposit is located in the Khromtausky region of            northwestern Kazakhstan, approximately 130 kilometers northeast of Aktobe, Kazakhstan.            The nickel and cobalt deposits are located approximately 35 kilometers south of            Badamsha village, Aktobe region, Kazakhstan and the brown coal deposit is located            approximately 30 kilometers east of Badamsha village, Aktobe region, Kazakhstan.            Badamsha is a village of approximately 6,000 people. The Aktubinsk-Karabutak asphalt            highway runs within 14 kilometers to the south of the nickel and cobalt deposit. The            nickel, cobalt and brown coal deposits can be accessed through a network of country            roads. The Orsk-Kanadagash state railway runs nearby the Kempirsai deposit and, through            our subsidiary KKM, we own 55 kilometers of our own railway. Our railway connects the            Kempirsai deposit to a reloading station and to a Russian railway.

             

9

 

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The Gornostai deposit is located in the Beskaragaiskiy region of            northeastern Kazakhstan, approximately 110 kilometers west of Semey, Kazakhstan and 30            kilometers east of Kurchatov, Kazakhstan. The Gornostai deposit is divided into the            South and North sections by the navigable Irtysh River. The Gornostai deposit may be            accessed by an asphalt highway that crosses the northern part of the South section of            the deposit. The Semey-Astana railway also passes through the northern part of the            South section of the deposit.

             

**Title to Properties**

             

We hold several subsoil use contracts that grant us the right to explore            for and extract nickel, cobalt and brown coal at the Kempirsai deposit. We also hold an            subsoil use contract that currently grants us the right to explore for nickel, cobalt            and other minerals within the Gornostai deposit. Upon discovery of commercially            producible reserves we can apply to move to commercial production. For additional            information regarding our contracts please see the following table.

             

10

 

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

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

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

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

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

extended.

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

and

Production | 1349                                                    | Exploration period expires Feb. 26, 2008 unless                            extended. Production period expires Feb. 26, 2026 unless                            extended. |

             

The Kempirsai deposit was discovered and actively explored during the            Soviet era. In the 1980s, the State Reserves Committee approved the reserves (based on            Soviet standards) and approved the Kempirsai deposit for commercial production. The            Kempirsai deposit was actively mined during the 1980s and early 1990s. Active mining at            the Kempirsai deposit ceased in 1996. The working program associated with these            licenses for the Kempirsai nickel, cobalt and Mamyt brown coal deposits are production            contracts, those contracts do not require us to undertake significant exploration            activities. While we do not have fixed exploration obligations, in order to retain our            licenses we are required to engage in certain activities. For details regarding our            minimum mine production requirements see “*Working            Programs of our Subsidiaries*” in this Item 1 & 2            “*Description of Business and            Properties*.”

             

The subsoil use contract to the Gornostai deposit was issued in February            2004. At the time it was issued, the MEMR determined that additional exploration of the            deposit was necessary to determine the existence of commercially producible mineral            reserves. Therefore, the subsoil use contract provides a period for exploration. Under            the terms of the contract for the Gornostai deposit, we were granted the right to            explore for nickel and cobalt for two years. The exploration term provides for two            two-year extensions upon our request. We requested and were granted our first            extension, extending the current exploration period to February 2008. Upon discovery of            commercially producible nickel and/or cobalt reserves, we may notify the MEMR and            convert from exploration stage to commercial production stage. If we make no commercial            discoveries before the end of the exploration period, as extended, our rights to the            territory will revert back to Republic of Kazakhstan. Upon completion of exploration,            we will return to the Republic of Kazakhstan the rights to all areas within the            licensed territory wherein no commercial discoveries of nickel and/or cobalt were            made.

             

When we complete exploration of the Gornostai deposit, assuming we make            commercial discoveries, we will apply to the MEMR to move to commercial production. At            that time we will be required to pay a 0.1% commercial discovery bonus based on the            initial determination of our mineral resources by the MEMR.

 

11

 

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The term of each of our subsoil use contracts vary. Under our contracts            we have the right to negotiate with the MEMR for extensions of the terms of those            contracts. If we are unsuccessful in negotiating extensions, upon the expiration of            those contracts our interest in and rights to those properties terminates and reverts            back to the government of the Republic of Kazakhstan, but we retain the rights to all            tangible and intangible assets we acquire for exploration, extraction and production at            these deposits.

             

All of our subsoil use contracts are currently in good standing.            Retention of our contracts, however, is contingent upon our complying with our annual            minimum work program requirements and other subsoil use contract obligations. If we            fail to satisfy our annual minimum working program requirements we could be subject to            fines and penalties or even to the potential forfeiture of our contracts and all rights            we have thereunder.

             

Under the terms of our subsoil use contracts we are required to provide            industrial training to our employees in an amount not less than 1% of the total minimum            work program expenses we incur each year.

             

For additional details regarding the terms and obligations associated            with our subsoil use contracts and licenses please see            “*Tax and Royalty Scheme in the Republic of            Kazakhstan*” and “*Working            Programs of our Subsidiaries*” in Item 1 & 2            “*Description of Business and Properties”,            “Summary of Material Contractual Commitments*” in            Item 6 “*Management’s Discussion and            Analysis*” and “*Note 4            – Property, Plant and Mineral Interests*”,            “*Note 9 – Asset Retirement            Obligation*” and “*Note 12            – Commitments and Contingencies*” contained in the            Notes to our Consolidated Financial Statements.

             

**Working Programs of our Subsidiaries**

             

For us to maintain our rights to the Kempirsai and Gornostai deposits we            must satisfy the work program requirements of the MEMR for each property. Each year we            must submit a proposed annual work program under each subsoil use contract or license            to the MEMR. This annual work program must be reviewed and approved by the MEMR. The            current work program under our KKM contracts and licenses calls for KKM to extract the            following amounts of ore from the Kempirsai deposit and brown coal from the Mamyt            deposit:

             

 

|   | **Tons of Ore** | **Tons of Brown Coal** |
|--------|-----------------|------------------------|
| 2006   | -0-             | 20,000                 |
| 2007   | 175,000         | 60,000                 |
| 2008   | 350,000         | 200,000                |
| 2009   | 1,000,000       | 200,000                |
| 2010   | 1,000,000       | 200,000                |
| 2011   | 1,000,000       | 200,000                |
| 2012   |            | 200,000                |
| 2013   |            | 200,000                |
| 2014   |            | 200,000                |
| 2015   |            | 200,000                |
| 2016   |            | 200,000                |
| 2017   |            | 200,000                |
| 2018   |            | 200,000                |

 

12

 

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Under our 2006 work program for Kaznickel, we were required to drill at            least 17,498 meters on the Gornostai deposit. We drilled only 12,652 meters during            2006. We have been successful in negotiating an amendment to our work program with the            MEMR to allocate the balance of the 4,846 meters to the drilling program for 2007. Our            total drilling requirement for the 2007 calendar year is 12,961 meters. Through            February 2007, we have drilled a total of 5,990 meters.

             

Should we fail to complete the minimum work program in any year, the            MEMR could review the work program, request an update and amendment to the work            program, impose fines and penalties upon us or even revoke our subsoil use contracts            and licenses.

             

**Geology and mineralization of our deposits**

             

***Kempirsai***

             

As mentioned above, the Kempirsai nickel and cobalt deposit is comprised            of two deposits: Kara-Obinskoye, and Novo-Shandashinskoye. These deposits are located            approximately 5-10 kilometers from each other. The results of exploration carried out            during the Soviet era show that nickel and cobalt ore is located within the Kempirsai            deposit ultramafic massif. The minerals are found in laterite form and are associated            with leached nontronized serpentinites. The ore bodies have a blanket-like shape and            tend to lie conformably on the underlying rocks. The depth of ore bodies from the            surface is 0-40 m. In vertical section they are mainly horizontal in attitude and show            variable thickness. Thickness varies from 2.0 meters to 30.0 meters, with an average            thickness of 6.0 meters. Average stripping ratio is 1.5 cubic meters per ton. The            nickel content of the ore within the Kempirsai deposit varies from 0.8% to 3.0% and            cobalt – from 0.025% to 0.08%. The average nickel and cobalt content for the            Kara-Obinskoye are 1.1% and 0.066% respectively. The average nickel and cobalt content            for the Novo-Shandashinskoye deposit are 1.38% and 0.045%.

             

The ore reserves of the Kempirsai deposit were evaluated during the            Soviet era based on Soviet standards. The Soviet standards, however, are not consistent            with the standards established by the SEC. Therefore, consistent with Industry Guide 7,            we have included no claims as to the ore reserves that may be contained within the            Kempirsai deposit. Until such time as we establish commercially producible reserves            within the Kempirsai deposit you should consider the Kempirsai project to be            exploratory in nature. The Kempirsai deposit is currently being evaluated by Wardell            Armstrong, a qualified independent engineering firm. We anticipate they will issue a            preliminary report during the second quarter 2007. For additional information regarding            reserves please see            “*Reserves*” in this Items            1 & 2 “*Description of Business and            Properties*.”

             

13

 

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***Gornostai***

             

Exploration activities conducted during the Soviet era and by us since            we acquired the rights to the deposit have identified 21 ore bodies through drilling            within the South section of the deposit and two ore bodies in the North section. The            area of the deposit is located within the Gornostai ultramafic belt. The area of            deposit is characterized by three distinct zones of ochre, nontronite, and leached and            disintegrated serpentinite:

             

|   | **•** | *Ochre zone*represents the                            upper part of the serpentinite weathered crust. |
|--------|------------|-------------------------------------------------------------------------------------------------------|

|   | **•** | *Nontronite zone*is more                            widespread than the ochre zone with thickness varying from 2 up to 10 m                            (sometimes reaching 30 m) |
|--------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

|   | **•** | *Zone of leached and disintegrated                            serpentinite*is the most widespread amongst                            the three zones. The zone mean thickness is 15-20 m (in some cases up                            to 50 m). |
|--------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

             

The minerals are found mainly in laterite form. The ore bodies have            embedded form, are mainly horizontal in attitude and show variable thickness. The            nickel content in the ore bodies varies from 0.7% to 2.3% and cobalt from 0.05% to            0.37%. The ore bodies are typically located at depths between 0 to 20 meters from the            surface, allowing from strip mining. The lengths of the ore bodies range from 200            meters to 4,050 meters and widths range from 200 meters to 2,000 meters. Thickness            varies from 0.8 meters to 15 meters. Average ore body thickness is around 4.2 meters,            with an estimated average stripping ratio of 1.8 cubic meters per ton. Of the drilling            done to date, the average content of nickel is 0.85% and cobalt 0.059%.

             

Based on the exploration activities undertaken on the deposit, we            believe the size of the ore bodies, their simple form and shallow bedding will allow            the deposit to be mined by open pit method with a low stripping ratio.

             

Despite the exploration work completed during the Soviet time and by us            since acquiring this deposit, we do not have a current ore reserve estimate for the            Gornostai deposit that complies with the standards established by the SEC. Accordingly,            and consistent with Industry Guide 7, we provide no claims as to the ore reserves that            may be contained within the Gornostai deposit. Moreover, because we are currently in            the exploration stage of our contract and have not yet established commercially            producible reserves, the Gornostai project should be deemed exploratory in nature. This            deposit is currently being evaluated by Wardell Armstrong. We expect Wardell Armstrong            will complete their evaluation and issue their preliminary report during the second            quarter of 2007. For additional information regarding reserves please see            “*Reserves*” in this Items            1 & 2 “*Description of Business and            Properties*.”

             

14

 

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**History and current state of our deposits**

             

***Kempirsai***

             

The KKM subsoil use contract to the nickel and cobalt deposits covers a            575,756 acre territory, in northwestern Kazakhstan. This contract was issued by the            MEMR and incorporates License series MG#420 and MG#426. These licenses to the nickel            and cobalt deposits cover a period expiring on October 12, 2011. This contract may be            extended upon agreement between KKM and the MEMR. KKM also holds a subsoil use contract            that incorporates License series MG #9-D for a brown coal deposit located within 40            kilometers of its nickel and cobalt deposit. This contract expires on December 11, 2018            with the possibility of further extensions.

             

*Historical exploration and production            activities*

             

Deposits in the area of the Kempirsai deposit were first discovered in            the 1930s. The Kempirsai deposit was discovered in 1938 and explored during the Soviet            era. During the late 1970s the Kara-Obinskoye and Novo-Shandashinskoye sections were            explored by core drilling on a 12.5-25m x 25m grid. The volume of exploration works            done on the deposits were as follows:

             

| **Deposit**          |   | **Number of Holes** |   | **Meters** |   | **Samples** |
|----------------------|--------|---------------------|--------|------------|--------|-------------|
|                 |   |                |   |       |   |        |
| Kara-Obinskoye       |   | 4,498               |   | 79,400     |   | 46,490      |
| Novo-Shandashinskoye |   | 780                 |   | 7,770      |   | 6,135       |

 

The State Reserves Committee approved the Kara-Obinskoye and            Novo-Shandashinskoye reserves for commercial production in the 1980s. These deposits,            along with others in the region, were assigned to YuzhUralNickel during the Soviet era.            YuzhUralNickel is a Russian company with a nickel processing plant in Russia located            approximately 90 kilometers north of the Kempirsai deposit. Approximately 171 million            tons of nickel ore have been mined from deposits in the area where the Kempirsai            deposit is located, including 770,000 tons from the Kara-Obinskoye and            Novo-Shandashinskoye sections of the Kempirsai deposit. During peak production in the            late 1980s, almost five million tons of ore were mined annually from the Kempirsai            deposit. Active mining of the Kempirsai deposit was discontinued in 1996.

             

The Kempirsai deposit remained the property of YuzhUralNickel after the            break up of the Soviet Union until 1996, when a joint venture between YuzhUralNickel            and the Kazakhstan State Property Committee was formed. Because of a lack of Russian            interest in developing this deposit in Kazakhstan, the joint venture was unsuccessful.            In 1999 the rights to the Kempirsai and Mamyt deposits were acquired by KKM from the            joint venture. Due to a lack of funding and processing capability, combined with market            conditions and the nickel content of Kempirsai ore, KKM has not engaged in active or            significant mining activity since acquiring the deposits.

             

15

 

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Historically, the Kempirsai deposit was open-pit mined, with maximum            mining depths of approximately 20 meters. We anticipate that the Kempirsai deposit will            be open-put mined in the future.

             

*Plant, equipment and infrastructure*

             

KKM owns fuel tanks, locomotives, rail cars, railway cranes, bridge            cranes, railway cisterns, maintenance equipment, excavators, motor graders, passenger            vehicles, passenger buses, heavy dump trucks, hoppers, scales, lathes, forging hammers,            presses, grinding, milling and boring machines, boilers, electrical substations, office            equipment, business machines, portable communication equipment, laboratory equipment            and multiple buildings. The machinery was manufactured between 1950 and the present.            The buildings were built between the 1940’s and the early 1990’s. Our            equipment and infrastructure in its current state has the capacity to mine            approximately 250,000 tons of ore annually. Much of our existing equipment and            buildings will need repair and refurbishing prior to being put into active operation.            We estimate the cost of these repairs to be approximately $1,000,000. Once repaired, we            expect our infrastructure and equipment to have a standing capacity to mine up to            500,000 tons of ore annually.

             

In addition to the rail and road infrastructure discussed above, 220 and            110 kilovolt high voltage power lines run nearby the Kempirsai deposit and the            Buhara-Ural gas pipeline runs approximately 10 km to the east of the Kempirsai deposit,            (see “Kempirsai Project Location Map” included in “Location and            access to our properties” in this Item 1 & 2 “Description of Business            and Properties.”) We can access water from the lakes around Badamsha. In the            future, we also plan to use coal from our Mamyt deposit to supply power for an ore            processing plant.

             

*Costs*

             

Since acquiring the rights to the Kempirsai deposit in 1999, KKM has            expended approximately $14,000,000 million at the Kempirsai deposit, including            approximately $5,500,000 from the date we acquired KMI in October 2005 through December            31, 2006. We anticipate future planned costs to be up to $600 million, depending on            technology and capacity of the processing plant we plan to build at the Kempirsai            deposit as discussed herein greater detail in the            “*Processing*” section of            this Item 1 & 2. “*Description of Business and            Property*.” We plan to spend approximately $3.4 million            in 2007, depending on ore sells, in the further development of the Kempirsai deposit            and in the “*Plan of            Operations*” section of Item 6.            “*Management’s Discussion and            Analysis*.”

             

***Gornostai***

             

In February 2004, Kaznickel acquired a concession for exploration and            development of the Gornostai nickel and cobalt deposit (contract No. 1349 registered by            the MEMR), covering 12,232 acres in eastern Kazakhstan.

             

16

 

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We are at the exploration stage on the Gornostai deposit. This deposit            was discovered in 1958. From 1960 to 1968 a series of geological and prospecting            surveys and evaluation work was performed on both sections of the deposit by the            Semipalatinsk Expedition to evaluate available nickel and cobalt ore reserves. The            surveys identified and explored 21 ore bodies on the South section and two ore bodies            on the North section of the deposit. These exploration works tested the deposit to            depths of around 50-75 meters in the South section and up to 150 meters in the North            section.

             

In the South section, drilling was undertaken on a 200-400 meter x            100-200 meter grid. In total 2,067 shallow depth holes with a total length of about            60,000 m and several deep holes with a total length of 2,857 meters were drilled. 48            pits varying in depth between 4.3 – 24.6 meters (570 meters in total) were            explored around drill hole to check core sample results. In 1965 two pits were explored            for metallurgical samples. Sample weights were 1.3 and 3.6 tons. Samples were tested at            the VNIITzvetmet Institute in Ust-Kamenogorsk, Kazakhstan.

             

In the North section, drilling was undertaken primarily on a 1600 meter            x 400 meter grid. Ore bodies of significant thickness, up to 40 meters, with nickel            content up to 3.64% (average 1.55%) were identified. These deposits were located at            depths between 40-90 meters.

             

The Gornostai deposit was abandoned, however, as reserves around Norilsk            in Russia were considered more attractive because of larger reserves and higher nickel            content. Moreover, the Norilsk reserves were already at the production stage. In            addition, a Soviet army nuclear test site, similar to the Nevada Test Site, was located            near the Gornostai deposit. The surrounding territory, including the deposit, was            considered a secret military zone. For these reasons, further exploration of the            deposit was discontinued in 1968.

             

The last nuclear testing in the area was conducted more than 15 years            ago. Recent tests show that the radiation levels in the soil, water and air are within            normal ranges.

             

*Exploration activities*

             

Since acquiring Kaznickel, consistent with the terms of the current            three-year work program for the deposit approved by the MEMR in 2005, we have engaged            in exploration activities within the Gornostai licensed territory to determine the            characteristics of this deposit. During 2006 we drilled 488 holes to a total depth of            12,652 meters, and an average depth of 30 meters per hole, and have taken 6,755            geochemical and core samples to CenterGeoAnalit LLP, a nationally accredited            independent laboratory located in Karaganda, Kazakhstan, to perform spectrum and            quantity analysis to identify the content of nickel, cobalt and iron. During 2005 we            drilled 42 holes to a total depth of 1,065 meters, and an average depth of 30 meters            and have taken 595 samples to the Institute of Nonferrous Metals, located in Oskemen,            Kazakhstan. Under the three-year work program, we are required to drill an additional            12,961 meters in 2007. In addition to the drilling works that have been completed, a            small area of the Gornostai deposit was strip mined in 1991.

             

17

 

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As discussed above, currently the exploration stage of our license runs            through February 2008. We have the option to extend exploration stage through December            31, 2009. During the exploration stage we are required to engage in certain activities            to determine the existence of commercially producible mineral reserves. We have planned            the following exploration activities for 2007, which we believe will be sufficient to            both satisfy our minimum work program requirements and to help us establish            commercially producible reserves within the Gornostai deposit. Once we establish            commercially producible reserves, we plan to move to commercial production at the            Gornostai deposit.

             

             

| **Activity**                                                                                                                                                                                                      |   | **Quantity**             |   | **Anticipated Timetable**            |   | **Estimated Cost**                                                                       |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|--------------------------------------|--------|------------------------------------------------------------------------------------------|--------|
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |   |
| Core drilling South section

including mobilization/ demobilization                                                                                                                                               |   | 15,000 meters

615 holes |   | January 2007 through

June 2007      |   | ***$1,315,000***

                             

                              |   |
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |   |
| Core drilling North section                                                                                                                                                                                       |   | 700 meters

5 holes      |   | June 2007 through

July 2007         |   | ***$62,000***                                                                            |   |
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |   |
| Pits for checking drilling results                                                                                                                                                                                |   |                     |   | July 2007 through

September 2007    |   | ***$51,000***                                                                            |   |
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |   |
| Core sampling                                                                                                                                                                                                     |   | 8,700 samples            |   | January 2007 through

July 2007      |   | ***$42,000***                                                                            |   |
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |   |
| Survey, hydrology and engineering                                                                                                                                                                                 |   |                     |   | March 2007 through

July 2007        |   | ***$58,000***                                                                            |   |
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |   |
| Core preparation                                                                                                                                                                                                  |   | 8,900 samples            |   | January 2007 through

September 2007 |   | ***$52,000***                                                                            |   |
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |   |
| Assaying and metallurgical tests                                                                                                                                                                                  |   | 9,000 samples            |   | February 2007 through

October 2007  |   | ***$135,000***                                                                           |   |
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |   |
| Interpretation of exploration results and preparation of                            the report and reserve estimate for submission to the State Reserves                            Committee (“SRC”) |   |                     |   | July 2007 through

April 2008        |   | ***$50,000***                                                                            |   |
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |   |
| Approval of report and reserve estimate by                            SRC                                                                                                                                         |   |                     |   | April 2008 to

September 2008        |   | ***$0***                                                                                 |   |
|                                                                                                                                                                                                              |   |                     |   |                                 |   |                                                                                     |

             

We have retained three local drilling contractors, SemGeo LLP, Topaz and            Tomai-Burservice to perform core drilling activities. Each of these drilling            contractors holds a state license to provide services as a drilling contractor and has            years of drilling experience in the local market.

             

18

 

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Core sampling, core logging and results interpretation will be carried            out by our own in-house geologists, who have 10-30 years experience in such activities.            Core preparation will be conducted by the preparation laboratory of SemGeo LLP, a third            party with years of experience in the local market. Assaying will be done by            CenterGeoAnalit LLP.

             

*Core sampling, assaying and quality assurance/quality            control*

             

Core sampling will be conducted over the full length of the hole. In            general, sample intervals will be 1-2 meters, which will produce 2-5 kilograms of            sample from each interval. The core will not be cut because the rocks are fractured.            Samples will be undertaken of the whole core.

             

All sample preparation will be done at the SemGeo LLP laboratory, which            is located approximately 120 kilometers from the Gornostai deposit. Whole core samples            are sent to SemGeo in 2-5 kilogram labeled Hessian bags which are stacked in racks and            dried at approximately 90° C. Samples are then sent to a small jaw crusher that            reduces the whole sample to 4-5 millimeters. The sample is then sent to a roll crusher            where it is reduced to 1-2 millimeters. The equipment is cleaned with compressed air            between samples. Samples are then split by cone and quartering with opposite quadrants            combined before being sent to the disc grinder where the sample is reduced in size to            74 micrometers. Every fifth sample is checked by sieving to see if it complies with            this grain size. As an additional check, every thirtieth sample is waste rock to act as            a “blank” control.

             

From the sample preparation facility, approximately 60 grams of            pulverized sample will be sent to the CenterGeoAnalit LLP laboratory for assay, while            the pulps are kept at the sample preparation facility. Assaying includes the            quantitative determination of the main ore components, including nickel, cobalt and            iron.

             

Composite samples will be produced to determine the chemical composition            of slag-forming oxides, detrimental impurities and accompanying components in the ores.            Composites are made up from three to five individual samples from one intersection by            taking material from duplicates of analytical samples proportional to their length. The            maximum weight of a composite sample will be 250 grams.

             

For quality control, each of 30 samples includes approximately 10%            checks comprising of one blank, one duplicate and one standard. As standards, we use            the certified Reference Samples from GEOSTATS PTY LTD (Australia). We have 11 standards            with nickel grade varying from 0.02% to 1.51%. In the event an assay result of the            Reference Sample shows >2 or <2 standard deviations from the accredited value,            the whole batch will be re-assayed.

 

19

 

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*Submission of report and reserves estimate to the State Resources            Committee*

             

We will retain a third party to work with our in-house geologists to            prepare the report and reserve estimate for submission to the State Resources Committee            in connection with our application to move to the Gornostai deposit from exploration            phase to commercial production phase. We have not yet selected a party to provide this            service.

             

*Infrastructure*

             

In addition to the road and rail infrastructure discussed above, low            tension power lines follow the railway are run within the Gornostai deposit. A high            tension power line is located approximately 6-7 km to the south of the central part of            the South deposit. We have access to water from Irtysh River. Unlike the Kempirsai            deposit, there are no buildings and minimal equipment at the Gornostai            deposit.

             

*Costs*

             

Since acquiring the rights to the Gornostai deposit in February 2004,            Kaznickel has spent approximately $3,000,000 in exploration activities at the Gornostai            deposit. Of this amount, approximately $2,500,000 was spent from January 2005, when we            acquired Kaznickel, to December 31, 2006. As with the Kempirsai deposit, we anticipate            costs to be as high as $600,000,000, depending on capacity and technology of the type            of processing plant we build at the Gornostai deposit as discussed herein greater            detail in the “Processing” section of this Item 1 & 2.            “*Description of Business and            Property*.” We plan to spend approximately $1,800,000 in            exploration activities within the Gornostai deposit during fiscal 2007. For additional            details please see the “*Plan of            Operations*” section of Item 6.            “*Management’s Discussion and            Analysis*”.

             

**Processing**

             

We currently have no processing facilities at either the Gornostai or            Kempirsai deposits. Once we establish to existence of commercially producible reserves,            we intend to construct a processing facility. Historically, pyrometallurgy has been the            most common processing procedure utilized to process nickel and cobalt ores.            Hydrometallurgical technology has improved to the point that it is now an acceptable            alternative to pyrometallurgy for processing nickel and cobalt ores. Both technologies            require large plants, costly construction and expensive equipment often requiring            capital infusions of hundreds of millions of dollars.

             

The KMI acquisition gave us the rights to a proprietary technology for            processing nickel and cobalt ores. While this technology has not previously been used            to process nickel and cobalt ores, it is based on the same principles used to process            titanium and other rare earth metals in Kazakhstan and Russia. The processing technique            utilizes hydrogen chloride to leach out the nickel and cobalt ores with sublimation of            the nickel and cobalt chlorides occurring at 1,050-1,100 (Degrees) Celsius. This            technology utilizes a closed-circle utilization chamber, which results in no emissions            while achieving extraction rates comparable to pyrometallurgy and            hydrometallurgy.

 

20

 

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The following table provides additional information regarding recovery            rates and cost per ton of metal recovered associated with pyrometallurgical,            hydrometallurgical and hydrochlorination plants:

             

|                                                                                   | Pyrometallurgy | Hydrometallurgy | Hydrochlorination(1) |
|----------------------------------------------------------------------------------------|----------------|-----------------|----------------------|
|                                                                                   |           |            |                 |
| Average nickel recovery rate(2)                                                        | 80%            | 95-99%          | 93%                  |
| Average cobalt recovery                            rate(                            2) | 75-80%         | 90-95%          | 85-88%               |
| Cost per ton of metal recovered                                                        | $8,000         | $4,000          | $5,000               |

             

(1) As this process is still in the research and development            stage, all figures given are estimates based on the estimates calculated by the Mining            Bureau, an independent third party research and development firm focused on mining and            metallurgy in Kazakhstan. These estimates could vary materially if test works show the            need for additional materials, equipment or processes needed to recover nickel and            cobalt.

(2) Ore recovery rates are subject to a number of different            factors, including processing techniques, ore characteristics, etc., which can cause            rates of recovery actually realized to vary.

             

The following table provides a comparison of the estimated initial            construction costs and time required to build pyrometallurgical, hydromettalurgical and            hydrochlorination ore processing plants capable of processing 500,000 and 1,000,000            tons of head ore annually.

             

|                        | Pyrometallurgy    | Hydrometallurgy   | Hydrochlorination(1) |
|-----------------------------|-------------------|-------------------|----------------------|
| **500,000 tons annually**   |              |              |                 |
| Initial construction cost   | $100-150 million  | $500-600 million  | $100 million         |
| Estimated construction time | 24 months         | 24 months         | 24 months            |
|                        |              |              |                 |
| **1,000,000 tons annually** |              |              |                 |
| Initial construction cost   | $250-$350 million | Over $650 million | $100 million         |
| Estimate construction time  | 24-36 months      | 36+ months        | 24 months            |

             

(1) As this process is still in the research and development            stage, all figures given are estimates based on the estimates calculated by the Mining            Bureau, an independent third party research and development firm focused on mining and            metallurgy in Kazakhstan. These estimates could vary materially if test works show the            need for additional materials, equipment or processes needed to recover nickel and            cobalt.

             

We have constructed a pilot plant at our Kempirsai deposit to test our            hydrochlorination process. Initially we had planned to complete the pilot plant and            begin testing during the second quarter 2006. The pilot plant was completed in October            2006 and we began testing the mineral concentrating capability of our hydrochlorination            processing technology at the pilot plant level in October 2006. The initial tests of            the pilot plant used head ore from our Kempirsai deposit. The average nickel content of            our Kempirsai head ore is approximately 1.1 percent per ton. PIT Geoanalitika, an            independent Kazakh company, conducted chemical analysis of several different samples of            the pilot plant concentrates and found that nickel content following the            hydrochlorination process increased to 10 to 15 percent. We feel these initial results            justify further research and development to optimize the process at the scale of a            pilot plant with a view to employing the technology in commercial production in the            future.

             

21

 

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Our pilot processing plant has a processing capacity of 12.5 tons of ore            per day. We processed an aggregate of 10 tons of ore through the pilot plant from            October 2006 to January 2007. For reasons discussed in more detail below, we have            processed no additional ore since January 2007.

             

Initially we estimated that we would need approximately six months to            test our hydrochlorination process at the pilot plant level to determine its commercial            viability. Testing, however, has progressed more slowly than initially expected due to            a number of factors. First, the use of chlorides in the process and difficulties in            getting isolation in the rotating kiln significantly enhances the potential risk to            personnel and the environment, so we have had to proceed carefully. Second, because            this process has not previously been used to commercially process nickel and cobalt, we            have had to develop processes and procedures without the benefit of relying on others            experience. Third, because of the use of chlorides and associated acids, the necessary            equipment for the pilot plant has been difficult to design, locate and procure. Fourth,            during the testing stage, following each test run we halt the pilot plant, disassemble            the rotating kiln and test and replace the inner lining of the kiln to ensure the            integrity of the equipment used in the process. Fifth, due to unusually harsh weather            conditions at our Kempirsai deposit this winter, including up to 13 feet of snow and            temperature as low as 31 to 40 degrees below zero Fahrenheit, we were forced to            discontinue operations at the pilot plant in January 2007 and have not operated the            pilot plant for testing of hydrochlorination since that time. The idle time at the            pilot plant has been used to improve the inner lining of the rotating kiln to withstand            the temperatures of more than 1,200 degrees Celsius, check and replace the pipes            transporting the acids throughout the pilot plant facility, recheck, order and replace            the heating and cooling system, and various other parts and blocks of the pilot plant            and to investigate the possible acquisition of agglomeration and magnetic separation            equipment.

             

Weather permitting, we plan to recommence testing at the pilot plant in            April 2007. We have planned a series of tests designed to establish the economic            feasibility of the processing technology and to formulate the required procedures,            protocols and operational guidelines for commercial utilization of the            hydrochlorination process. We expect this testing will be completed in the fourth            quarter 2007 and have budgeted $200,000 for the cost of this testing and            development.

             

Once we have completed these tests and analyzed the results, we will            make a final determination as to the feasibility of our hydrochlorination technology            for the commercial production of our deposits.

             

In light of the delays experienced to this point and the planned testing            through the end of the 2007 fiscal year, coupled with the time requirements to build a            commercial hydrochlorination processing plant, should the technology prove technically            and economically feasible, we have been researching other options that might allow us            to get to commercial production at Kempirsai more quickly. To this end, we have            approached several leading design and metallurgy institutes to supply feasibility            studies for a commercial processing plant utilizing pyrometallurgy as a main technology            to produce ferronickel from our Kempirsai deposit.

 

22

 

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We are considering proposals for the construction of a ferronickel            pyrometallurgical commercial processing plant at the Kempirsai deposit. We anticipate            the plant will be built in several phases. The first phase would include the            construction of a plant with capacity to process up to 500,000 tons of head ore            annually. Depending upon the success of the first phase of the plant, we would then            have the option to increase the capacity to 1,000,000 tons of head ore processing            capacity annually over several years. We anticipate this expansion would occur in            additional phases. We have allocated $940,000 this year for pre-feasibility and            feasibility studies upon which we can base a decision with regard to commencement of            construction of phase one of a pyrometallurgical plant at the Kempirsai deposit. We            expect to receive a detailed feasibility study within the next several            months.

             

Irrespective of our decision regarding the feasibility of a            pyrometallurgical processing plant at the Kempirsai deposit, we plan to continue            testing and development of our hydrochlorination process as discussed above.

             

**Reserves**

             

We do not have a current estimate of the ore reserves contained within            our concessions. While we have reserve estimates prepared during Soviet times, we do            not know the accuracy of those reserve estimates and do not believe them to be to the            standards established by the SEC. As disclosed herein, we are working with Wardell            Armstrong, a qualified independent engineering firm, to provide us with a preliminary            ore resource estimate of our deposits that will conform to the Australasian Joint Ore            Reserves Committee (“JORC Code”). We anticipate this report will be            completed during the second quarter 2007.

             

We anticipate that the preliminary Wardell Armstrong report will            indicate that currently we have only ore resources. Under the SEC standard and the JORC            Code, mineral deposits qualify as “reserves” only to the extent some part            of the deposit can be economically and legally extracted or produced at the time of the            reserve determination. At the present time, we do not know whether the ore in our            deposits can be economically extracted or produced. For this purpose, we intend to            retain an independent third party during 2007 to conduct a preliminary feasibility            study to provide information on mining, processing, metallurgical, economic and other            relevant factors to determine whether each of our deposits can be economically            produced. We anticipate this preliminary feasibility study on the Kempirsai deposit            will be undertaken in the second half of 2007 and should be completed sometime during            the first quarter 2008. We expect a preliminary feasibility study on the Gornostai            deposit will be undertaken some time in 2008. At the time these preliminary feasibility            studies are conducted, we will ask Wardell Armstrong to conduct a follow up evaluation            of our deposits consistent with SEC standards.

             

Because our deposits are without known reserves, you should consider our            proposed programs to be exploratory in nature.

 

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**Tax and Royalty Scheme in the Republic of Kazakhstan**

             

We are subject to the following taxes and royalties payable to the            Republic of Kazakhstan:

 

| **Class of Tax or Royalty** | **Basis of Tax** | **Payable Period** | **Annual Rate** |
|-----------------------------|------------------|--------------------|-----------------|
| Corporate Income Tax        | Profits          | Monthly            | 30%             |
| Social Tax                  | Payroll          | Monthly            | 21-26%          |
| VAT                         | Value added      | Monthly            | 14-20%          |
| Property Tax                | Property         | Quarterly          | 1%              |
| Royalty (ore)               | Output volume    | Monthly/Quarterly  | 2.21%           |
| Royalty (brown coal)        | Output volume    | Monthly/Quarterly  | 0.9%            |
| Excess Profit Tax           | Net income       | Annually           | 4-60%           |

             

**Competition**

 

Recent high prices for nickel and cobalt are the result of the growing            demand from such economies, such as China and India, and certain industries, such as            stainless steel, experienced a near 8% increase in demand in 2006 as compared to 2005.            This spike in worldwide demand is not being met by current supply as the current            capacity of nickel producers is limited and new plant commissions have been postponed            several times. Also contributing to the price increase is the uneasy situation in New            Caledonia and Indonesia, where the local populations have held protests at mines and            plants, as well a series of strikes held in Canada at the CVRD and Xtrata owned            properties. All of these issues have contributed to increased prices and historically            low levels of the nickel held at LME-approved warehouses, reaching as low as 3,600            tons.

             

Cobalt prices have also reached as high as $66,000 per ton recently due            to several factors. The main reason for the price increase is the deal between Norilsk            Nickel, the world’s largest producer of nickel, and OM group. In exchange for            selling OM’s plant in Finland to NorNickel, NorNickel has agreed to sell all of            its produced cobalt to directly to OM, thus potentially limiting the volume of cobalt            available on the market.

             

Total nickel production worldwide was approximately 1,550,000 tons in            2006, according to USGS. Norilsk Nickel is the largest nickel producer followed by            CVRD, BHP Billiton Plc, Eramet Group and Xtrata. These five companies account for            approximately 66% of the world’s primary nickel production, while more than 30            medium to small size companies produce the remaining 34%.

             

Until recently, there were no nickel-producing companies in Kazakhstan.            In February 2004, Oriel Resources, a London-based company, acquired 90% of Muzbel LLC,            which holds exploration and extraction rights for the Shevchenko nickel deposit in            northern Kazakhstan. The Shevchenko Nickel Project Feasibility Study showed that proven            and probable nickel laterite ore reserves were 104.4 million tons of 0.79%            nickel.

             

24

 

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In October 2006, Oriel Resources was acquired by IPH Polychrom Holding            BV and Croweley International Limited. Based on the latest announcement, Oriel plans to            develop its chrome deposit in Kazakhstan and review its plans for the Schevchenko            nickel deposit in Kazakhstan.

             

Companies compete with each other generally across the globe and are            best categorized by their size, reserve base, ore richness and production method, due            to different extracting technologies applied, and the final product. Competition in            this industry focuses largely on price and nickel content, whether it is sold in            unwrought or chemical form. High nickel content material is sold at higher prices and            is most sought after among customers.

             

We do not anticipate direct competition from Oriel Resources should they            pursue the plan to build a nickel processing plant. Nickel and cobalt are part of a            global market and a worldwide demand, in which the supply is limited and the number of            industries that use nickel and cobalt is increasing, thus ensuring a constant demand            for additional production of nickel and cobalt.

             

We believe that the proximity of our Gornostai deposit to China and            other Asian countries will provide us a competitive advantage. We have already been            approached by Chinese metal companies interested in purchasing finished product once we            reach production stage. As of this date we have not entered into definitive            negotiations with any party.

             

**Risk Factors**

             

***Business Risks***

             

*Need for Additional            Capital**.*Since focusing our            efforts on nickel and cobalt exploration our capital resources have consisted almost            exclusively of funds we have borrowed from related and non-related parties and from a            private sale of our equity securities. In July 2006 we raised $28,000,000 through a            private placement of our equity securities. As of December 31, 2006, we had cash on            hand of $8,583,680. We believe this should be sufficient capital to fund our operations            until the end of 2007. We currently have very limited capacity to generate revenue.            Should we determine to pursue construction of an ore processing plant to produce            ferronickel, we expect the cost to build a facility capable of processing 500,000 tons            of head ore per year will be about $50,000,000 and the cost to construct an ore            processing facility capable of processing 1,000,000 tons of head ore per year will            range from $100,000,000 to $150,000,000. We will have very little ability to generate            revenue until we build and begin operating this plant. We expect that it will be 2009            or later, if ever, before we have the ability to generate revenue sufficient to meet            our operating needs. Therefore, we anticipate the need for substantial additional            capital resources by the end of the 2007 fiscal year. And we expect to be totally            dependent upon investment funds to support our operations until such time as we begin            to generate sufficient revenue to fund operations. We expect these funds will consist            primarily of funds raised in equity and/or debt financing activities. We currently have            no firm commitment from any party to provide us additional equity or debt financing and            there is no guarantee that we will obtain additional financing on acceptable terms, or            at all. If we are unsuccessful in obtaining additional funding by the end of 2007, we            will likely have insufficient funds to continue operations or to meet our minimum            annual work program requirements. If we cannot fulfill our minimum work program            requirement, we could be subjected to fines and penalties and even to the possible            forfeiture of our subsoil use contracts and licenses.

 

25

 

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

             

*Competition**.*Our principal competitors are large established companies with            substantial financial resources and market share. If we establish commercially            producible reserves and move to production stage, we will have to compete for customers            with these companies.

             

*New Technology*. We are developing            the proprietary technology. Although this technology has been used successfully to            recover other metals, it has not been used in the commercial recovery of nickel and            cobalt. We have completed construction of the pilot processing facility and continuing            test operations to further establish the feasibility of the technology. There is no            assurance that our pilot facility will operate as we expect. After testing of the pilot            facility we will begin construction of a facility to process commercial quantities of            ore. There is no assurance the technology operated in a test facility will scale to a            commercial facility successfully or operate at expected extraction efficiencies and            operating costs to support profitable commercial operation. In the event our technology            does not work as expected, we will be required to construct a facility using other            technology, which would increase our need for investment capital and would also            increase our operating costs and breakeven point.

             

*Failure to Satisfy the Terms of Our Subsoil Use            Contracts*. Under our subsoil use contracts, we are            required to satisfy our annual minimum work program requirements. There is no guarantee            that we will be able to continue to meet these commitments in the future. If we fail to            satisfy these commitments we may be subject to penalties and fines and, potentially, to            the loss of one or more of our subsoil use contracts. The cancellation of our contracts            would have a material adverse effect on our business, results of operations and            financial condition. Although we would seek waivers of any breaches or seek to            renegotiate the terms of our commitments in the event we do not believe we can meet            such commitments, we cannot assure you that we would be successful in doing            so.

             

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

             

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

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

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

 

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

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

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

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

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

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

 

Any of these factors could materially adversely affect our business and            financial condition. At this time, we are unable to estimate what, if any, changes may            occur or the resulting effect of any such changes on us.

             

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

             

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

             

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

             

*Environmental Regulations*. We are            subject to stringent federal, state and local laws and regulations relating to the            release or disposal of materials into the environment or otherwise relating to            environmental protection. These laws and regulations may require the acquisition of            permits before extraction activities commence, restrict the types, quantities and            concentration of substances that can be released into the environment in connection            with extraction and production activities and impose substantial liabilities for            pollution resulting from our operations. Failure to comply with these laws and            regulations may result in the assessment of administrative, civil and criminal            penalties, incurrence of investigatory or remedial obligations or the imposition of            injunctive relief. Changes in environmental laws and regulations occur frequently, and            any changes that result in more stringent or costly waste handling, storage, transport,            disposal or cleanup requirements could require us to make significant expenditures to            maintain compliance, and may otherwise have a material adverse effect on us as well as            the industry in general. Under these environmental laws and regulations, we could be            held strictly liable for the removal or remediation of previously released materials or            property contamination regardless of whether we were responsible.

 

27

 

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

             

**Other Properties**

             

Bekem leases approximately 400 square feet of office space located at            324 South 400 West, Suite 225, Salt Lake City, Utah 84101 for its administrative and            registered office in the United States. We pay annual rents of approximately $7,800 for            this space pursuant to a lease agreement that expires December 31, 2007 with an option            to extend the lease for an additional year.

             

We also maintain a representative office in Almaty, Kazakhstan, where we            lease 1,575 square feet of office space. The lease agreement expires on December 31,            2007. The monthly lease payment is $5,250. Under the terms of our lease agreement, the            owner of the space could terminate our lease at any time and require us to vacate the            premises.

             

Kaznickel LLP rents approximately 1,840 square feet office in Semey,            Kazakhstan, for approximately $4,000 per month. Semey is the closest city to the            Gornostai deposit. This lease agreement expires in May 2007. Kaznickel also rents            approximately 4,450 square feet of warehouse space in Semey for $4,000 per month.            Kaznickel uses this space to store test ore. Also, Kaznickel LLP rents a 350 square            feet office in Astana, Kazakhstan, for approximately $1,600 per month. This space is            leased on a year-to-year basis. If at any time the owner of this space decides they            need or want the space for other purposes, Kaznickel has no right to continue to occupy            the space and could be forced to move.

             

KKM rents approximately 1,260 square feet of office space in Aktobe,            Kazakhstan. KKM pays approximately US $4,000 per month for this space under a one-year            lease agreement. This space is leased on a year-to-year basis. If at any time the owner            of this space decides they need or want the space for other purposes, Kaznickel has no            right to continue to occupy the space and could be forced to move.

             

We believe each of the various office spaces rented by us and our            subsidiaries are suitable and adequate for our needs.

             

**Employees**

             

We currently have approximately 416 full-time employees. We hire our            employees under local labor contracts complying with the governing laws of the Republic            of Kazakhstan. We believe we have satisfactory relations with our employees. We            anticipate the need to hire additional personnel as operations expand. To date, neither            our operations nor the operations of any of our subsidiaries have been interrupted by            strikes or work stoppages. We have managed to maintain turnover of our work force at a            low level. With the ongoing labor market monitoring, we believe that future new labor            requirements can be satisfied and there is no significant risk of labor            shortage.

 

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**Research and Development**

             

During 2006, we spent approximately $2,400,000 in research and            development developing the hydrochlorination technology. Approximately $2,000,000 was            capitalized as the pilot plant and approximately $400,000 was recognized as an expense            in 2006. None of these costs have been borne directly by any of our            customers.

             

**Reports to Security Holders**

             

We file annual and quarterly reports with the SEC. The public may read            and copy any materials filed by the Company with the SEC at the SEC’s Public            Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain            information on the operation of the Public Reference Room by calling the SEC at (202)            551-8090. We are an electronic filer and the SEC maintains an Internet site that            contains reports and other information regarding the Company that may be viewed at            http://www.sec.gov.

 

|   | **Item 3.** | **Legal Proceedings** |
|--------|-------------|-----------------------|

 

To the knowledge of management, there is no material litigation or            governmental agency proceeding pending or threatened against Bekem or its management.            Further, we are not aware of any material pending or threatened litigation or            governmental agency proceeding to which Bekem or any of our directors, officers or            affiliates are, or would be, a party.

**** 

|   | **Item 4.** | **Submission of Matters to a Vote of Security                            Holders** |
|--------|-------------|------------------------------------------------------------------------------------|

 

No matters were submitted to a vote of security holders during the            quarter ended December 31, 2006.

 

**PART II**

 

|   | **Item 5.** | **Market for Common Equity, Related Stockholder Matters                            and Small Business** |
|--------|-------------|---------------------------------------------------------------------------------------------------------|

|   | **     Issuer Purchases of Equity                            Securities** |
|--------|-----------------------------------------------------------------------------------------------|

 

Our shares are currently traded on the Over-the-Counter Bulletin Board            ("OTCBB") under the symbol BKMM. As of March 20, 2007 we had approximately 150            shareholders holding 125,172,011 common shares. Of the issued and outstanding common            stock, approximately 7,813,708 are free trading, the balance are "restricted            securities" as that term is defined in Rule 144 promulgated by the Securities and            Exchange Commission.

             

Published bid and ask quotations from January 1, 2005 through December            31, 2006, are included in the chart below. These quotations represent prices between            dealers and do not include retail markup, markdown or commissions. In addition, these            quotations do not represent actual transactions.

 

29

 

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|                | **Bid**  | **Ask** |
|---------------------|----------|---------|
| **2006**            | **High** | **Low** | **High** | **Low** |
| Jan. 3 thru Mar. 31 | $2.00    | $1.25   | $10.01 | $1.35 |
| Apr. 3 thru June 30 | 1.95     | 1.05    | 2.20 | 1.50 |
| July 3 thru Sep. 29 | 2.00     | 1.60    | 2.25 | 1.70 |
| Oct. 2 thru Dec. 29 | 1.80     | 1.75    | 2.00 | 1.85 |
|                |     |    |
|                | **Bid**  | **Ask** |
| **2005**            | **High** | **Low** | **High** | **Low** |
| Jan. 1 thru Mar. 31 | $3.95    | $2.00   | $7.50 | $4.00 |
| Apr. 1 thru June 30 | 3.55     | 2.50    | 7.00 | 3.25 |
| July 1 thru Sep. 30 | 2.90     | 2.40    | 6.00 | 3.00 |
| Oct. 1 thru Dec. 31 | 2.60     | 2.00    | 4.00 | 2.60 |

 

The above information was obtained from Pink Sheets LLC, 304 Hudson            Street, 2nd Floor, New York, New York 10013.

             

**Dividends**

 

We have not paid, nor declared, any dividends since our inception and do            not intend to declare any such dividends in the foreseeable future. Our ability to pay            dividends is subject to limitations imposed by Utah law. Under Utah law, dividends may            be paid to the extent that the corporation's assets exceed it liabilities and the            corporation is able to pay its debts as they become due in the usual course of            business.

 

**Securities Authorized for Issuance Under Equity Compensation            Plans**

 

|                                                                              | **Number of securities to be issued upon exercise of                            outstanding options, warrants and rights** | **Weighted-average exercise price of outstanding                            options, warrants and rights** | **Number of securities remaining available for future                            issuance under equity compensation plans (excluding securities                            reflected in column (a))** |
|-----------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------------------------------------------------------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **Plan category**                                                                 | (a)                                                                                                                        | (b)                                                                                                        | (c)                                                                                                                                                                                                   |
| Equity compensation plans approved by security                            holders | -0-                                                                                                                        | $-0-                                                                                                       | 1,916,877                                                                                                                                                                                             |
| Equity compensation

plans not approved by security holders                       | 2,400,000                                                                                                                  | $1.17                                                                                                      | -0-                                                                                                                                                                                                   |
| Total                                                                             | 2,400,000                                                                                                                  | $1.17                                                                                                      | 1,916,877                                                                                                                                                                                             |

 

 

30

 

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In March 2003, we adopted the EMPS Research Corporation 2003 Stock            Option Plan (the "Plan") reserving 5,000,000 common shares for distribution under the            Plan. The purpose of the Plan is to allow us to offer key employees, officers,            directors, consultants and sales representatives an opportunity to acquire a            proprietary interest in the Company. The various types of incentive awards which may be            provided under the Stock Option Plan enable us to respond to changes in compensation            practices, tax laws, accounting regulations and the size and diversity of our            business.

 

On February 16, 2004, we granted options to two parties to purchase            1,000,000 shares each for technology and asset acquisition and business development            services. The options were not exercisable until such time as we acquired assets with a            fair value of at least $2,000,000, as determined by the board of directors. The            exercise price of the options was $0.10. The options were scheduled to expire on            February 16, 2009. We granted the option holders a registration right in connection            with the exercise of the options and/or the resale of the underlying common shares. On            August 23, 2005 we issued 588,888 shares of our restricted common stock to the option            holders in exchange for the cancellation of these options.

             

On October 20, 2006 the board agreed to award restricted stock grants to            the following four officers or employees of the Company;

 

| Name                |   | Position with the Company                    |   | Number of Shares |
|---------------------|--------|----------------------------------------------|--------|------------------|
| Marat Cherdabayev   |   | Chief Executive Officer, President, Director |   | 421,772          |
| Yermek Kudabayev    |   | Chief Financial Officer                      |   | 383,429          |
| Nurlan Tajibaev     |   | Vice President, Director                     |   | 191,715          |
| Alexander Rassokhin |   | Exploration Manager                          |   | 86,207           |

                

The stock grants were valued at $1.95 per share, which represented the            closing market price of our stock on October 20, 2006. The stock grants were made under            our 2003 Stock Option Plan. The shares have been issued and are outstanding and are            being held in escrow by the Company subject to the applicable vesting schedule for each            grant. The grantees have the right to vote the shares, receive dividends and enjoy all            other rights of ownership over the entire grant amount from the grant date, except for            the right to dispose of or otherwise encumber the shares prior to satisfying the            applicable vesting schedule. Shares will only vest to the grantee if the grantee is            employed by the Company on the applicable vesting date. Any unvested shares at the time            a grantee’s employment with the Company ceases, for any reason, shall be            forfeited back to the Company.

 

Mr. Cherdabayev’s shares will vest as follows: one-fourth (105,443            shares) on the first anniversary of the grant date; one-fourth (105,443 shares) on the            second anniversary of the grant date and the remaining one-half (210,886 shares) will            vest on the third anniversary of the grant date.

 

Mr. Kudabayev’s shares will vest as follows: one-fourth (95,857            shares) in April 2007 and one-fourth (95,857 shares) in April 2008, provided that the            Company has timely filed its reports with Securities and Exchange Commission. The final            one-half (191,715 shares) will vest in April 2009. Vesting during each year is            contingent upon the Company timely filing of its reports with the Securities and            Exchange Commission each year. Moreover, vesting in the third year is also contingent            upon the Company having commenced commercial operations.

 

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Mr. Tajibaev’s shares will vest as follows: one-fourth (47,929            shares) on the first anniversary of the grant date and one-fourth (47,929 shares) on            the second anniversary of the grant date, provided that in each year the Company meets            the yearly deadlines for the pilot plant construction, completion and operations as            dictated by the board of directors. The final one-half (95,857 shares) will vest on the            third anniversary of the grant date conditioned that the Company timely meets the third            year deadlines for the pilot plant construction, completion and operations during the            third year, and the Company having commenced commercial            operations.            

 

Mr. Rassokhin’s shares will vest as follows: one-fourth (21,552            shares) on the first anniversary of the grant date and one-fourth (21,552 shares) on            the second anniversary of the grant date, provided that in each year the Company timely            performs the drilling work program requirements as dictated by the Republic of            Kazakhstan’s Ministry of Energy and Mineral Resources. The final one-half (43,103            shares) will vest on the third anniversary of the grant date, conditioned upon the            Company timely performing the drilling work program requirements, as dictated by the            Republic of Kazakhstan’s Ministry of Energy and Mineral Resources during the            third year and the Company having commenced commercial operations.

 

We have issued no other securities under the Plan.

             

In connection with a private placement we concluded on July 14, 2006, we            issued to Aton Securities, the placement agent for the private placement, warrants to            purchase up to 2,400,000 shares of our restricted common stock. The exercise price of            the warrants is $1.17 per share. The warrants will be immediately exercisable and            expire on January 14, 2008.

             

**Unregistered Sales of Equity Securities**

 

As discussed above, pursuant to the board of directors desire to attract            and retain experienced and educated executives on October 20, 2006 the board agreed to            award restricted stock grants to Marat Cherdabayev, Yermek Kudabayev, Nurlan Tajibaev            and Alexander Rassokhin. For additional details regarding the terms and conditions of            those restricted stock grants please see “*Securities            Authorized for Issuance Under Equity Compensation            Plans*” immediately preceding this section. Each of            these individuals is a non US person resident in Kazakhstan. The restricted stock            grants were made pursuant to an exemption from the registration requirements of the            Securities Act of 1933, provided under Regulation S of the Securities Act of            1933.

 

**Repurchases of Equity Securities**

 

We did not repurchase any of our equity securities during the year ended            December 31, 2006.

 

**Transfer Agent**

 

Our transfer agent and registrar is Interwest Transfer Company, Inc.,            1981 East 4800 South, Suite 100, Salt Lake City, Utah 84117, Telephone (801)            272-9294.

 

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|   | **Item 6.** | **Management’s Discussion and Analysis of                            Financial Condition and Results of Operations** |
|--------|-------------|----------------------------------------------------------------------------------------------------------------------------|

             

For a complete understanding, this Management's Discussion and Analysis            of of Financial Condition and Results of Operations should be read in conjunction with            the Consolidated Financial Statements and Notes to the Consolidated Financial            Statements contained in this Form 10-KSB.

 

Since inception we have generated no revenue. We have spent millions of            dollars to date and anticipate that we will spend significant additional capital before            we begin to realize significant revenue from operations. As discussed above in Items 1            & 2 “*Description of Business and            Properties*” based on our expectation that we will            discover commercially producible reserves, we are currently investigating the            possibility of constructing a pyrometallurgical processing plant to produce ferronickel            at our Kempirsai deposit to allow us to begin realizing revenues as soon as possible.            At this time, we are investigating to determine the financial viability of this option.            If we determine that construction of a pyrometallurgical processing plant to produce            ferronickel is our best option for realizing cash flow from Kempirsai, and we are able            to obtain the necessary funding to finance construction, we would not expect a first            phase of the plant, with capacity to process up to 500,000 tons of ore annually, to be            completed and operational prior to the first quarter 2009. If our hydrochlorination            process proves to be economically viable for commercial production of nickel and            cobalt, we would not expect to have the first phase of a commercial hydrochlorination            plant completed prior to 2010. Because we do not currently generate cash flow and we do            not anticipate generating significant cash flow until 2009 or later, if at all, we will            be completely dependent on investor’s funds, if any, to support our activities            until such time as we are able to generate sufficient revenues to cover our            expenses.

             

In July 2006 we raised $28,000,000 through a private placement of our            equity securities. Of that amount, as of December 31, 2006, we had spent approximately            $18,000,000. Of these funds, approximately $12,200,000 was used to repay loans,            $1,000,000 was used to meet our minimum working program obligations, approximately            $2,200,000 was spent researching and developing our hydrochlorination technology and            $2,600,000 was used as working capital. At December 31, 2006, we had cash on hand of            $8,583,680. The funds raised in July represent only a small portion of the funds we            will need to reach commercial production. We anticipate the need to seek significant            additional funding by the end of fiscal 2007. There is no assurance that we will be            able to obtain additional funding in the future on favorable terms, or at            all.

 

**Results of Operations**

 

As you read this Results of Operations section it is important to keep            in mind that we acquired KMI and its operating subsidiary KKM on October 24, 2005.            While KKM has not engaged in significant operations in recent years, it has engaged in            significantly greater operations than Bekem or Kaznickel in years past. Prior to the            acquisition of KMI, we were engaged in exploration of our Gornostai deposit. However,            because of a lack of funds our exploration activities were limited. The increases in            expenses in fiscal 2006 compared to fiscal 2005 are primarily the result of our            acquisition of KKM and not the result of significantly increased operations of Bekem or            Kaznickel. We also incurred more expenses in fiscal 2006 because we had capital            available from our private placement to undertake greater activity.

 

33

 

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***General and Administrative Expenses***

 

With the acquisition of KKM, our general and administrative expenses            increased from $1,018,148 during 2005 to $3,136,715 during 2006. This 208% increase in            general and administrative expenses is attributable to the significant increase in            employees and employee-related costs as a result of the acquisition of KKM, as well as,            costs associated with having licensed territories in both northeastern and northwestern            Kazakhstan, increased office rents and travel expenses. As a result of this acquisition            and growth of our Almaty office the number of employees of the Company increased from            31 to 418 and employee and employee-related costs increased from $50,000 to $1,800,000.            In the upcoming fiscal year we expect general and administrative expenses will continue            to increase, but at a lower rate than experienced during the 2006 fiscal year, as we            continue our efforts to develop our hydrochlorination process and seek to employ new            technical specialists.

 

***Research and Development Costs***

             

We realized research and development costs of $2,389,507 related to the            development of our pilot processing plant, $2,000,000 which was capitalized because it            also represents tangible assets with alternative future use and added to the cost of            the pilot plant during the twelve months ended December 31, 2006 and $389,507 that was            expensed during the 2006 fiscal year, compared to $131,562 during the 2005 fiscal year.            We expect our research and development costs will increase during the next fiscal year            as we continue testing our pilot processing plant.

             

***Exploratory Costs***

             

Our exploratory costs increased from $697,496 during the twelve months            ended December 31, 2005 to $1,470,247 incurred during the twelve months ended December            31, 2006 as a direct result of our increased exploratory and drilling works at our            Gornostai deposit, as discussed above. Also, as discussed above, because we are            considered to be at the exploration stage, the exploratory costs are reflected net of            revenues earned from incidental sales of ore or brown coal. We expect our exploration            costs will continue to increase at a rate consistent with or even somewhat higher than            was experienced during 2006 as we continue to expand our drilling efforts at the            Gornostai deposit.

             

***Accretion Expense***

 

We realized accretion expense of $60,632 during the twelve months ended            December 31, 2005. During the twelve months ended December 31, 2006 we realized            accretion expenses of $72,865. As discussed above, this increase in accretion expense            is attributable to our acquisition of the Kempirsai deposit. We believe accretion            expense during upcoming fiscal year will continue at rates consistent with those            realized during the 2006 fiscal year.

 

***Grant Compensation Expense***

             

During the nine months ended September 30, 2007 we incurred $151,583 in            grant compensation expense for restricted stock grants issued to certain officers and            key employees during the fourth quarter 2006. We had no comparable expense during            2005.

 

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***Total Operating Expenses and Loss from            Operations***

             

As a result of our acquisition of KKM and undertaking more exploration            activities in 2006 our total expenses and loss from operations increased 166% from            $1,907,838 during fiscal 2005 to $5,220,917 during fiscal 2006. We expect our total            expenses in 2007 will continue to increase. Also, we expect we will continue to            generate losses until such time as we engage in significant revenue generating            activities, which most likely will not occur before 2009 or 2010.

             

***Interest Income***

 

During the twelve months ended December 31, 2006, we realized interest            on deposits of $47,227. By comparison during the twelve months ended December 31, 2005            we earned no interest on deposits. Interest on deposits increased in 2006 because            during 2006 we raised approximately $28,000,000 in a private placement, which resulted            in our having significantly more funds on deposit during 2006 than 2005. During 2006,            we also realized $38,110 in interest earned from financing resulting from the            prepayment to the Mining Bureau of Kazakhstan of $2,070,000 under the loan agreement            for the period ended December 31, 2006, which bears interest at a rate of 6% per annum.            The Company did not realize corresponding interest during 2005.

             

***Interest Expense***

 

During 2006 we realized interest expense of $1,382,972 compared to            $293,451 during 2005. The increase in interest expense resulted from retiring notes            payable prior to their due dates and the full recognition of the debt discount of            $885,970. Upon acquisition of KMI and KKM, we assumed certain debts with interest rates            that were considered to be below market rates. These particular debts with below market            interest rates were discounted, for reporting purposes, to arrive at interest rates            equivalent to market rates. The total payout of these debts was not adjusted, just the            allocation of principal and interest payments. Upon the payoff of these debts, the            interest expense, or discount, was recognized in full. The recognition of the debt            discount was a one-time occurrence. We do not expect to recognize a similar charge in            future years. The actual dollar amount of funds paid by us for interest during fiscal            2006 was $529,096. As we retired our outstanding notes payable and related party notes            during 2006, we expect interest expense in 2007 will be lower than experienced in prior            years.

 

***Translation Adjustment***

 

The consolidated financial statements are presented in U.S. dollars. The            functional currency of our subsidiary Kaznickel is U.S. dollars. The functional            currency of our subsidiary KKM is Kazakh tenge. Results of operations are translated            into U.S. dollars at the average exchange rates during the reporting period. All            balance sheet accounts of KKM are translated at exchange rates on the date of the            financial statements and translation differences are included in stockholders’            equity as cumulative translation adjustments. However, non-monetary assets and            liabilities of Kaznickel are translated into U.S. dollars, using historical or average            exchange rates and monetary assets and liabilities are translated into U.S. dollars            using exchange rates on the date of the financial statements where translation            differences are included in results of operations.

 

35

 

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***Exchange Loss***

 

During 2006 we realized an exchange loss of $174,278 compared to an            exchange loss of $64,192 during 2005. As with translation adjustment, we recognize            exchange gain or loss as a result of having subsidiaries operating in foreign countries            whose functional currency may or may not be the U.S. dollar. This requires us to            translate results of operations from a foreign currency, in this case Kazakh tenge, to            U.S. dollars at the average exchange rate, where results of operations include exchange            gains or losses on the U.S. dollar monetary assets and liabilities.

 

***Net Loss***

 

For all of the foregoing reasons, during the twelve months ended            December 31, 2006 we experienced a net loss of $4,706,122 compared to a net loss of            $1,271,137 during the twelve months ended December 31, 2005. We anticipate we will            continue to experience increasing net losses until we are able to engage in nickel and            cobalt ore extraction, processing and sales.

 

***Liquidity and Capital Resources***

 

Our capital resources have consisted primarily of funds we have borrowed            from related and non-related parties and the sale of our equity securities. As            discussed above, in July 2006 we raised $28,000,000 through the private placement of            our equity securities. These funds, however, represent only a portion of the funds we            will need to move to commercial production. As of December 31, 2006, we had cash on            hand of $8,583,680. We have used approximately $18,000,000 of the funds raised in the            private offering to repay loans to related and unrelated third parties in the amount of            $12,197,905, for ongoing drilling and exploration of our Gornostai deposit in the            amount of $991,087, $2,000,000 for the construction of our hydrochlorination pilot            plant, $194,147 for testing of our pilot plant and $2,559,321 for working capital. We            anticipate we will use the full $8,583,680 to fund our activities during the 2007            fiscal year. Therefore, we anticipate the need for substantial additional capital            resources by the end of the 2007 fiscal year. We expect these funds will likewise            consist primarily of funds raised in equity and/or debt financing activities. We            currently have no firm commitment from any party to provide us additional equity or            debt financing and there is no guarantee that we will obtain additional financing on            acceptable terms, or at all.

 

During the 2006 and 2005 fiscal years, cash was primarily used to fund            operations and repay notes payable to related and non-related parties. See below for            additional discussion and analysis of cash flow.

 

| **December 31,**                                                               | **2006**                             | **2005**                                                  |
|--------------------------------------------------------------------------------|--------------------------------------|-----------------------------------------------------------|
|                                                                           |                                 |                                                      |
| Net cash used in operating activities                                          | $(5,617,395)                         | $(1,757,443)                                              |
| Net cash provided by (used in) investing                            activities | (2,722,288)                          | 14,206                                               |
| Net cash provided by financing activities                                      | 16,473,112                      | 1,821,031                                            |
| Effect of exchange rate changes on cash                                        | 360,885                         | 7,382                                                |
| **NET INCREASE IN CASH**                                                       | **$**  **8,494,314**  | **$**      **85,176**  |

             

 

36

 

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In fiscal 2006 net cash used in operating activities was $5,617,395,            compared to net cash used in operating activities of $1,757,443 in fiscal 2005. This            increase in net cash used is primarily the result of increases in expenses due to the            acquisition of KMI and its subsidiary KKM which led to a significant increase in net            loss as discussed above. The significant increases in expenses were in the areas of            general and administrative expenses and exploratory costs.

             

Net cash used in investing activities during twelve months ended            December 31, 2006 was $2,722,288. During 2006 we invested $2,577,696 to acquire            equipment, which is primarily used in KKM’s pilot plant. By comparison, in fiscal            2005, cash of $14,206 was provided by investing activities.

 

Net cash provided by financing activities in fiscal 2006 was $16,473,112            compared to net cash provided by financing activities of $1,821,031 in fiscal 2005. As            discussed herein, during the third fiscal quarter 2006, we raised $28,000,000 in a            private placement of our equity securities. This resulted in net proceeds to us of            approximately $26,422,386 after deducting fees and costs. During the 2006 fiscal year,            we realized proceeds from notes payable and notes payable to related parties of            $1,996,731 and $251,900, respectively. These funds were borrowed prior to our private            placement in July 2006 and were used to fund our activities during the first half of            the year. We spent $12,727,001 of the funds raised in the private placement to repay            notes payable, notes payable to related parties and interest expense. As a result, at            December 31, 2006, we had repaid all of our notes payable and notes payable to related            parties.

             

**Plan            of Operations**

 

As of December 31, 2006 we had cash on hand of $8,583,680. As discussed            above, we have budgeted to spend all of these funds during fiscal 2007. Following is a            brief description of how we anticipate allocating our cash on hand during fiscal            2007.

 

***Drilling and core analysis***

 

We will allocate approximately $1,765,000 to drilling and exploration.            This includes drilling of approximately 15,000 meters of the South section of the            Gornostai deposit. Estimated drilling costs include both direct and indirect drilling            costs, including geologist fees and costs for site supervisors, geological data            processors, core sample takers, topographers, site procurement specialists,            etc.

             

***Reserve Report***

             

Wardell Armstrong, a qualified independent engineering firm, has begun            preparing an ore reserve estimate of our deposits. We expect to receive their completed            report during the second quarter 2007. We anticipate the cost of the reserve evaluation            will be approximately $135,000.

 

***Hydrochlorination processing technology testing***

 

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

 

37

 

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***Feasibility Study***

 

We anticipate spending approximately $940,000 for the preparation of            pre-feasibility and feasibility studies for the construction of the pyrometallurgical            plant. This amount could increase if we retain a western consulting firm.

 

***Field modernization***

 

We have allocated approximately $1,000,000 for modernization of vehicles            and equipment at the Kempirsai deposit to allow us to increase our ore extracting            capabilities.

 

***Administrative Expenses***

 

We plan to allocate approximately $3,900,000 for administrative expenses            during the next twelve months, which include expenses of maintaining offices in the            United States and Kazakhstan, for salaries and taxes.

 

***Professional Fees***

 

We expect to incur approximately $530,000 in expenses for services of            our financial auditors and securities attorneys during the next twelve            months.

 

**Additional Activities**

 

As discussed in Item 1 “*Description of            Business and Properties*” we are currently considering            alternatives to a hydrochlorination processing plant to allow us to begin to generate            cash flow from the Kempirsai deposit. We do not currently have sufficient cash on hand            to fund these activities, nor have we budgeted for these items in our 2007 budget.            Therefore, to undertake these activities we will need to obtain additional capital            either through equity or debt financing. We plan to seek this funding through private            equity investments or debt financing to be obtained from banks or shareholders. We            currently have no firm commitment from any party to provide us additional            funding.

 

We are considering the economic viability of a pyrometallurgical            processing plant to produce ferronickel at our Kempirsai deposit. As noted above, we            have allocated $940,000 in our 2007 budget for the preparation of pre-feasibility and            feasibility studies. Assuming the results of those studies are positive, we would like            to move to the design phase of a commercial pyrometallurgical plant, including            obtaining detailed engineering and design for plant construction. This would include            flowsheet design and pilot testing. We estimate the cost to do this will be roughly            $2.5 million.

 

**Summary of Material Contractual Commitments**

 

The following table lists our significant commitments as of December 31,            2006:

 

38

 

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|                                                                                |   | Payments Due by Fiscal Year |
|-------------------------------------------------------------------------------------|--------|-----------------------------|
| ContractualCommitments                                                              |   | Total                       |   | Less than1 year |   | 2-3 years |   | 4-5 years |   | After5 years |
| Monetary  commitments for  exploration                          |   | $1,576,480                  |   | $1,576,480 |   | $         -0- |   | $           -0- |   | $           -0- |
| Due to the  government of  Republic of  Kazakhstan(1) |   | 731,221                     |   | -0- |   | 731,221 |   | -0- |   | -0- |
| Training                                                                            |   | 42,000                      |   | 42,000 |   | -0- |   | -0- |   | -0- |
| Social projects(2)                                                                  |   | 417,906                     |   | -0- |   | -0- |   | 300,000 |   | 117,906 |
| Asset retirement  obligation(3)                                           |   | 951,355                     |   | -0- |   | -0- |   | -0- |   | 951,333 |
| Operating leases                                                                    |   | 230,170                     |   | 230,170 |   | -0- |   | -0- |   | -0- |
|  

**Total**                                                                   |   | $3,949,132                  |   | $1,848,650 |   | $ 731,221 |   | $   300,000 |   | $1,069,239 |

                

(1)In connection with our acquisition            of the exploration contract covering the Gornostai deposit, we are required to repay            the Republic of Kazakhstan for historical costs incurred by it in undertaking            geological and geophysical studies and infrastructure improvements. The repayment terms            of this obligation will not be determined until such time as we apply for and are            granted a contract to engage in commercial production by the Republic of Kazakhstan.            Under our current contract once we determine the property contains commercially            producible reserves, if we wish to commence commercial production, we must apply for            such right prior to the expiration of our exploration and development rights in            February 2026. We anticipate that we will apply for a commercial production contract            within the next 1-3 years. Of course, there is no guarantee when or if we will discover            commercially producible reserves within the Gornostai deposit. Should we decide not to            pursue a commercial production contract, we can relinquish the Gornostai deposit to the            Republic of Kazakhstan in satisfaction of this obligation.

(2)Under the terms of our subsoil use            contracts, we are required to provide funding for social projects relating to employees            of KKM, including improvements to living conditions, etc., in the amount of $117,906.            We are also required to donate $300,000 for the ongoing development of Astana and            Kurchatov, which are cities in Kazakhstan.

(3)Under the terms of our subsoil use            contracts, we are required to remove all equipment and remediate the property. This            remediation work can be done during the term of the subsoil use contract or upon            completion of the terms of the contract.

 

We are required, under our subsoil use contracts to submit a proposed            annual work program to the MEMR for approval. Failure to meet the minimum work program            requirements could cause us to lose our concessions. More information relative to this            requirement is included in Item 1. “*Description of            Business and Properties*” in the section            “*Working Programs of our            Subsidiaries*.”

 

**Off-Balance Sheet Financing Arrangements**

 

As of December 31, 2006 and 2005 we had no off-balance sheet financing            arrangements.

             

**Recent Accounting Pronouncements**

             

In July 2006, the FASB issued FASB Interpretation (FIN) No. 48,*Accounting for Uncertainty in Income Taxes,*which provides guidance on the accounting for uncertainty in income            taxes recognized in financial statements. FIN 48 is effective for fiscal years            beginning after December 15, 2006, with earlier adoption permitted. We are currently            evaluating the impact, if any, the adoption of FIN 48 will have on its financial            reporting and disclosures.

 

39

 

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In February 2006, the FASB issued SFAS No. 155,*Accounting for Certain Hybrid Financial Instruments -- an amendment            of FASB Statements No. 133 and 140.*SFAS No. 155 resolves            issues addressed in SFAS No. 133 Implementation Issue No. D1,*Application of Statement 133 to Beneficial Interests in Securitized            Financial Assets*. SFAS No. 155 will become effective for our            fiscal year that begins after September 15, 2006. The impact of SFAS No. 155 will            depend on the nature and extent of any new derivative instruments entered into after            the effective date.

 

In September 2006, the FASB issued Statement of Financial Accounting            Standards No. 157,*Fair Value Measurements,*which provides enhanced guidance for using fair value to measure assets            and liabilities. SFAS No. 157 establishes a common definition of fair value, provides a            framework for measuring fair value under generally accepted accounting principles, and            expands disclosure requirements about fair value measurements. SFAS No. 157 is            effective for financial statements issued in fiscal years beginning after November 15,            2007, and for interim periods within those fiscal years. We are currently evaluating            the impact, if any, the adoption of SFAS No. 157 will have on its financial reporting            and disclosures.

             

In September 2006, the SEC staff published Staff Accounting            Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when            Quantifying Misstatements in Current Year Financial Statements” (“SAB            108”). SAB 108 addresses quantifying the financial statement effects of            misstatements, specifically, how the effects of prior year uncorrected errors must be            considered in quantifying misstatements in the current year financial statements. This            statement is effective for fiscal years ending after November 15, 2006. We do not            expect the adoption of SAB 108 to have a material effect on its financial            statements.

 

**Critical Accounting Policies**

 

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

 

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

 

40

 

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

 

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

             

|   | **Item 7.** | **Financial Statements** |
|--------|-------------|--------------------------|

 

See Consolidated Financial Statements listed in the accompanying index            to the Consolidated Financial Statements on Page F-1 herein.

 

|   | **Item 8.** | **Changes in and Disagreements with Accountants on                            Accounting and Financial** |
|--------|-------------|----------------------------------------------------------------------------------------------------------|

|   | **     Disclosure** |
|--------|-----------------------------------------|

 

We have made no changes in and had no disagreements with our independent            registered accounting firm on accounting and financial disclosure during the 2006            fiscal year.

 

|   | **Item 8A.** | **Controls and Procedures** |
|--------|--------------|-----------------------------|

             

*Evaluation of Disclosure Controls and Procedures*

             

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

 

41

 

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Subsequent to the filing of the Original Report, and in connection with            the comments of the staff of the SEC, we determined that we had erroneously presented            the Company as being in the “production stage” rather than the            “exploration stage.” As a result of this error, the Company has restated            its audited financial statements for the years ended December 31, 2006 and 2005,            and is filing the Amendment for the fiscal year ended December 31, 2006 to restate            these annual audited financial statements. Our management and our board of directors            determined on February 5, 2008, with respect to the annual reports for the fiscal            years ended December 31, 2006 and 2005 and the fiscal quarters beginning January 1,            2006 through September 30, 2007, that we had a material weakness in internal control            over financial reporting because the controls did not identify the error on a timely            basis.

 

In connection with the restatement referred to above, the Company, under            the supervision and with the participation of management, including the Chief Executive            Officer and Chief Financial Officer, re-evaluated the effectiveness of the design and            operation of the disclosure controls and procedures as of the end of the period covered            by this report, which included consideration of the required restatement. Based on the            foregoing, the Chief Executive Officer and Chief Financial Officer concluded that our            disclosure controls and procedures were not effective as of the end of the period            covered by this report and that we had a material weakness in its internal control over            financial reporting because the controls did not identify the error on a timely            basis.

 

In light of this conclusion, the Company performed additional analysis            and procedures to ensure its consolidated financial statements are prepared in            accordance with U.S. generally accepted accounting principles. Accordingly, management            believes that the financial statements included in this report fairly present in all            material respects the Company’s financial condition, results of operations and            cash flows for the periods presented.

 

*Changes in Internal Control Over Financial Reporting*

 

Management had previously concluded that our disclosure controls and            procedures were effective as of December 31, 2006 and reported that there was no change            in the Company’s internal control over financial reporting that occurred during            the quarter ended December 31, 2006 that materially affected, or was reasonably            likely to materially affect, the internal control over financial reporting. However, in            connection with the restatements of the Company’s consolidated financial            statements for the fiscal years ended December 31, 2006 and 2005, as fully            described in Note 13 of this Amendment, management determined that the material            weakness described above existed as of December 31, 2006 and has, as a result,            effected material changes to the Company’s internal control over financial            reporting subsequent to the period covered by this report. Management has implemented            new policies requiring our internal accounting staff and management to receive ongoing            training on accounting for mineral properties in accordance with generally accepted            accounting principles in the United States and Industry Guide 7. Management believes            these additional policies will provide additional and enhanced internal control over            financial reporting and improve the ability of management to identify any potential            errors prior to and during the Company’s consolidated financial statement close            process and prevent recurrence of future errors of this nature.

 

42

 

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|   | **Item 8B.** | **Other Information.** |
|--------|--------------|------------------------|

             

None.

 

**PART III**

 

| **Item 9.** | **Directors, Executive Officers, Promoters, Control                            Persons and Corporate Governance; Compliance with Section 16(a) of the                            Exchange Act** |
|-------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|

 

The following table sets forth our directors, executive officers,            promoters and control persons, their ages, and all offices and positions held.            Directors are elected for a period of one year and thereafter serve until their            successor is duly elected by the stockholders and qualified. Officers and other            employees serve at the will of the Board of Directors.

 

| Name of Director or

Executive Officer |   |  

Age |   | Positions with

the Company                                                |   |  

Director Since |
|----------------------------------------|--------|-------------|--------|----------------------------------------------------------------------------|--------|------------------------|
|                                   |   |        |   |                                                                       |   |                   |
| Marat Cherdabayev                      |   | 31          |   | Chief Executive Officer, President and                            Director |   | November 2004          |
|                                   |   |        |   |                                                                       |   |                   |
| Yermek Kudabayev                       |   | 36          |   | Chief Financial Officer                                                    |   |                   |
|                                   |   |        |   |                                                                       |   |                   |
| James Kohler                           |   | 59          |   | Independent Director                                                       |   | May 2006               |
|                                   |   |        |   |                                                                       |   |                   |
| Timothy Adair                          |   | 42          |   | Independent Director                                                       |   | May 2006               |
|                                   |   |        |   |                                                                       |   |                   |
| Valery Tolkachev                       |   | 38          |   | Independent Director                                                       |   | May 2006               |
|                                   |   |        |   |                                                                       |   |                   |
| Nurlan Tajibaev                        |   | 59          |   | Vice President of Metallurgy and Director                                  |   | October 2006           |

 

The above individuals will serve as the Company’s officers and/or            directors. A brief description of their positions, proposed duties and their background            and business experience follows:

 

**Marat Cherdabayev**. From July 2002 to July            2005, Mr. Cherdabayev served as a director of Caspian Services Group, Inc.,            (“CSI”) a U.S. reporting issuer, and former parent company of Bekem Metals,            Inc. Prior to joining CSI, Mr. Cherdabayev worked for Caspian Services Group Limited            (“CSGL”) in Almaty, Kazakhstan. CSGL is a wholly-owned subsidiary of CSI.            Mr. Cherdabayev was a Business Development Manager for CSGL, and was responsible for            developing a marketing plan for CSGL’s services. Prior to his employment with            CSGL, Mr. Cherdabayev worked for the Department of Project Finance at OJSC            Kazakhtelecom in Almaty, Kazakhstan. Mr. Cherdabayev served as the Head of Project            Planning and Monitoring, with responsibility for analyzing the financial feasibility of            investment projects. He began working for OJSC Kazakhtelecom in January 2001. From            October 2000 to January 2001, Mr. Cherdabayev served as the Advisor to the President of            TNS Plus, a private telecommunications company in Almaty, Kazakhstan. In that capacity,            he developed and advised the president on marketing strategies, marketing analysis and            optimization issues. From January 1999 to June 1999, Mr. Cherdabayev was a Mutual Fund            Accountant for State Street Corporation, in Boston, Massachusetts. His primary duties            included producing and verifying daily financial statements, monitoring general ledger            activity and pricing and reconciling five mutual funds on a daily basis. From January            1998 to June 1998, Mr. Cherdabayev was a Financial Reporting Assistant at Boston Edison            in Boston Massachusetts. Mr. Cherdabayev graduated with a Bachelor of Science in            Business Administration from Northeastern University in June 2000. Mr. Cherdabayev is            not a director of any other SEC reporting company.

 

43

 

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**Yermek Kudabayev**.Mr. Kudabayev earned a            Bachelors degree in Engineer-Economics from the Moscow Institute of Steel and Alloys in            1993. He earned an MBA degree from the Kazakhstan Institute of Management, Economics            and Strategic Research in 1996. Mr. Kudabayev has been a member of the Association of            Chartered Certified Accountants, an international accountancy body, since 2004. He was            issued a Certified Accounting Practitioner Certificate from the International Counsel            of Certified Accountants and Auditors in 2002. He has been a Kazakhstani Certified            Accountant since 1998 and a Certified Kazakhstani Auditor since 2000. Prior to joining            the Company, Mr. Kudabayev served as the Finance Director for Kazkhoil Aktobe LLP from            2003 to April 2006. As the Finance Director, Mr. Kudabayev was responsible for            budgeting, planning, cash flow forecasting and management, strategic research            accounting, taxation and reporting. From 2002 to 2003, Mr. Kudabayev served as the            Director of the Astana, Kazakhstan office of Ernst & Young, where he was            responsible for auditing and coordination of projects in the Astana, Karaganda and            Pavlodar regions of Kazakhstan. From 1997 to 2002 Mr. Kudabayev worked for Arthur            Andersen as a Senior Auditor and as a Manager. Mr. Kudabayev is not a director of any            SEC reporting company.

 

**James F. Kohler**. Mr. Kohler received a B.S.            in geology in 1970 and an M.S. in geology in 1980 from Utah State University. From 2001            to the present he has been employed as the Branch Chief of Solid Minerals with the U.S.            Bureau of Land Management in Salt Lake City, Utah, where he oversees all mining            activity on public lands within the State of Utah. He began working at the U.S Bureau            of Land Management in 1988 as a Senior Geologist, providing geologic support for all            federal solid mineral leasing actions to establish a basis for economic evaluation of            leasing tracts. From 1987-1988 Mr. Kohler served as Senior Geologist with the Utah            Office of High Level Nuclear Waste in Salt Lake City, Utah, where he provided oversight            for high-level nuclear waste repository characterization in Nevada, Texas, and            Washington. From 1981-1986 he was the senior geologist and Manager of coal development            and mining geology for Anaconda Minerals/ARCO Coal Company in Denver, Colorado            supervising geologic support for operating coal mines and acquisitions in the U.S.,            Indonesia and China. From 1977 to 1981 Mr. Kohler was a Supervisory Geologist with the            U.S. Geological Survey in Salt Lake City, Utah. In 2000 Mr. Kohler was awarded the Utah            Governor's Medal for Science and Technology. Mr. Kohler is not a director of any other            SEC reporting company.

 

**Timothy Adair**. Mr. Adair received a Masters            in Business Administration (MBA) from Brigham Young University, located in Provo, Utah,            in 1990. Mr. Adair also received a Bachelors of Science from the same University in            Mechanical Engineering with a minor in Mathematics in 1988. Since 2005, Mr. Adair has            been principally engaged as the Owner/President of Cube Office Designs located in Salt            Lake City, Utah where he has successfully transferred company ownership and management.            Cube Office Designs currently employs 22 persons and has annual revenue of            approximately $1.5 million USD. Prior to purchasing Cube Office Designs, from 1989            through 2004 Mr. Adair was principally engaged as the Human Resources Productivity /            Efficiency Manager with Intermountain Health Care (IHC) of Salt Lake City, Utah. IHC is            a health care provider with 25,000+ employees and annual revenue of 2.5 + billion USD.            While with IHC Mr. Adair consistently implemented cost savings improvements, such as            the standardizing and automating of employee transactions which resulted in annual            savings of $200k. Mr. Adair is also a licensed real estate agent and has been an avid            real estate investor and property manager since 1989 as a partner of ADLAW. Mr. Adair            was a member of the Oracle Applications User Group (OAUG) and the Intermountain            Compensation and Benefits Association (ICBA). Mr. Adair is not a director of any other            SEC reporting company.

 

44

 

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**Valery Tolkachev**. Since 1999, Mr. Tolkachev            has been employed with Aton Investment Company in Moscow, Russia, where he currently            serves as the Managing Director, Capital Markets. From 1991 to 1999, Mr. Tolkachev            served in various positions with various employers including, MDM Bank, InkomBank,            InkomCapital and others. Mr. Tolkachev graduated with Honors from the High Military            School in Kiev, USSR in 1989. In 2005, he completed his studies at the Academy of            National Economy, as a qualified lawyer. Mr. Tolkachev is also a director of BMB Munai,            Inc., and Bekem Metals, Inc., both SEC reporting issuers.

             

**Nurlan Tajibaev**. Mr. Tajibaev has worked in            the metallurgy industry since earning a Bachelors degree in Engineer-Metallurgy from            the Kazakh State Technical University in 1973. Prior to joining Bekem Metals, Mr.            Tajibaev served as the Executive Director of Kyzyl Kain Mamyt, LLP, a wholly-owned            subsidiary of Bekem Metals. Before joining Kyzyl Kain Mamyt in 2003, Mr. Tajibaev            served as Chairman of Canat UK Ltd., a supplier of metallurgical equipment from Europe            and the United States to Kazakhstan, for six years. Mr. Tajibaev also spent twenty            years serving in various capacities, including Senior Engineer, for Aktyubinsk            Ferroalloys Plant and President of Kazchrome Corporation. Mr. Tajibaev is not a            director of any SEC reporting company.

             

|   | *Significant                            Employees* |
|--------|----------------------------------------------------|

 

**Alexander Rassokhin**. In October 2006, Mr.            Rassokhin was appointed to the position of Exploration Manager. He has over thirty            years experience in solid minerals geology. His work experience includes serving as the            President and Exploration Manager of Frontier Mining Ltd. Kazakhstan, where he managed            Frontier’s exploration programs and gold processing in Kazakhstan. Prior to            joining Frontier in 2005, Mr. Rassokhin spent ten years serving as Chief Geologist for            a number of companies operating in Kazakhstan, including Rio Tinto Mining and            Exploration, Ltd., Santa Fe Pacific Gold Kazakhstan Corporation and Newmont Kazakhstan            Gold, Ltd. As Chief Geologist his duties have included identification of new mineral            deposits, preparation of exploration plans and oversight of field explorations. Mr.            Rassokhin also spent fourteen years with the Research Institute of Mineral Resources,            Kazakhstan. Mr. Rassokhin is 53 years old. Mr. Rassokhin is not a director of any SEC            reporting company.

 

There are no family relationships among any of the Company’s            officers, significant employees or directors.

 

|   | *Involvement in Certain Legal                            Proceedings* |
|--------|-----------------------------------------------------------------------|

 

To our knowledge, during the past five years none of the directors or            executive officers has been convicted or is currently the subject of a criminal            proceeding, excluding traffic violations or similar minor offenses, or has been a party            to any judicial or administrative proceeding that resulted in a judgment, decree or            final order enjoining the person from future violations of, or prohibiting activities            subject to, federal or state securities laws, or a finding of any violation of federal            or state securities laws, except for matters that were dismissed without sanction or            settlement.Similarly, in the past two years none of our            directors or executive officers, or any business in which they were a general partner            or executive officer, have been the subject of a bankruptcy proceeding.

 

45

 

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**Compliance with Section 16(a) of the Exchange Act**

 

Directors and executive officers are required to comply with Section            16(a) of the Securities Exchange Act of 1934, which requires generally that such            persons file reports regarding ownership of and transactions in securities of the            Company on Forms 3, 4, and 5. A Form 3 is an initial statement of ownership of            securities. Form 4 is to report changes in beneficial ownership. Form 5 covers annual            statements of change in beneficial ownership.

 

Based solely on management’s review of these reports during the            year ended December 31, 2006, it appears that Valery Tolkachev, Timothy Adair, James            Kohler, Nurlan Tajibaev and Yermek Kudabayev failed to timely file Form 3s at the time            they were appointed as members of the board of directors or as executive officers of            the Company. Messers Tolkachev, Adair and Kohler subsequently filed Form 5s to remedy            the late filings and Mr. Kudabayev filed a Form 4 to remedy the late filing.

 

**Code            of Ethics**

 

Our Board of Directors has adopted a code of ethics that applies to all            of our officers and employees, including our principal executive officer, principal            financial officer, principal accounting officer, controller and persons performing            similar functions. Our website can be found atwww.bekemmetals.com. The code of ethics is posted on our website.

 

**Committees of the Board of Directors**

 

*Audit Committee*

 

We do not currently have a standing audit committee or other committee            performing similar functions, nor have we adopted an audit committee charter. Given the            size of the Company, its available resources and the fact that the OTCBB does not            require us to have an audit committee, the board of directors has determined that it is            in the Company’s best interest to have the full board fulfill the functions that            would be performed by the audit committee, including selection, review and oversight of            the Company’s independent accountants, the approval of all audit, review and            attest services provided by the independent accountants, the integrity of the            Company’s reporting practices and the evaluation of the Company’s internal            controls and accounting procedures. The board is also responsible for the pre-approval            of all non-audit services provided by its independent auditors. Non-audit services are            only provided by our independent accountants to the extent permitted by law.            Pre-approval is required unless a “de minimus” exception is met. To qualify            for the “de minimus” exception, the aggregate amount of all such non-audit            services provided to the Company must constitute not more than 5% of the total amount            of revenues paid by us to our independent auditors during the fiscal year in which the            non-audit services are provided; such services were not recognized by us at the time of            the engagement to be non-audit services; and the non-audit services are promptly            brought to the attention of the board and approved prior to the completion of the audit            by the board or by one or more members of the board to whom authority to grant such            approval has been delegated.

 

46

 

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As we do not currently have a standing audit committee, we do not, at            this time have an “audit committee financial expert” as defined under the            rules of the Securities and Exchange Commission. The board does believe, however, that            should the Company form a standing audit committee in the future, Mr. Timothy Adair, an            independent director, could qualify as an audit committee expert.

 

*Nominating Committee*

 

We do not currently have a standing nominating committee or other            committee performing similar functions, nor have we adopted a nominating committee            charter. Given the size of the Company, its available resources and the fact that the            OTCBB does not require us to have a nominating committee, the board of directors has            determined that it is in the Company’s best interest to have the full board of            directors to participate in the consideration for director nominees. In general, when            the board determines that expansion of the board or replacement of a director is            necessary or appropriate, the board will review through candidate interviews with            members of management, consult with the candidate’s associates and through other            means determine a candidate’s honesty, integrity, reputation in and commitment to            the community, judgment, personality and thinking style, residence, willingness to            devote the necessary time, potential conflicts of interest, independence, understanding            of financial statements and issues, and the willingness and ability to engage in            meaningful and constructive discussion regarding Company issues. The board would review            any special expertise, for example, that qualifies a person as an audit committee            financial expert, membership or influence in a particular geographic or business target            market, or other relevant business experience. To date we have not paid any fee to any            third party to identify or evaluate, or to assist it in identifying or evaluating,            potential director candidates.

 

The nominating committee will consider director candidates nominated by            shareholders during such times as the Company is actively considering obtaining new            directors. Candidates recommended by shareholders will be evaluated based on the same            criteria described above. Shareholders desiring to suggest a candidate for            consideration should send a letter to the Company’s Secretary and include: (a) a            statement that the writer is a shareholder (providing evidence if the person's shares            are held in street name) and is proposing a candidate for consideration; (b) the name            and contact information for the candidate; (c) a statement of the candidate’s            business and educational experience; (d) information regarding the candidate’s            qualifications to be director, including but not limited to an evaluation of the            factors discussed above which the board would consider in evaluating a candidate; (e)            information regarding any relationship or understanding between the proposing            shareholder and the candidate; (f) information regarding potential conflicts of            interest; and (g) a statement that the candidate is willing to be considered and            willing to serve as director if nominated and elected. Because of the small size of the            Company and the limited need to seek additional directors, there is no assurance that            all shareholder proposed candidates will be fully considered, that all candidates will            be considered equally, or that the proponent of any candidate or the proposed candidate            will be contacted by the Company or the board, and no undertaking to do so is implied            by the willingness to consider candidates proposed by shareholders.

 

47

 

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*Compensation Committee*

 

We do not have a standing compensation committee or a charter; rather            our Chief Executive Officer evaluates officer and employee compensation issues subject            to the approval of our board of Directors. Our Chief Executive Officer makes            recommendations to the board of directors as to employee benefit programs and officer            and employee compensation. The compensation of Chief Executive Officer is determined            and approved directly by board of directors. Neither the Chief Executive Officer nor            the board of directors engaged compensation consultants during the year.

 

|   | **Item 10.** | **Executive Compensation.** |
|--------|--------------|-----------------------------|

 

The following table summarizes the total compensation paid for the            fiscal year 2006 to our president and chief executive officer and to each other named            executive officer whose compensation exceeded $100,000 for the year ended December 31,            2006 (the “named executive officers”).

**SUMMARY COMPENSATION TABLE**

 

| **Name and****Principal Position**                | **Year**               | **Salary** | **Stock****Awards**(3) | **All Other****Compensation**(4) | **Total** |
|---------------------------------------------------|------------------------|------------|------------------------|----------------------------------|-----------|
|                                              |                   |       |                   |                             |      |
| *Marat                            Cherdabayev*(1) | 2006    | $119,000   | $28,118                | $66,181                          | $213,299  |
| CEO and President                                 | 2005(5)                | $110,000   | -0-                    | -0-                              | $110,000  |
|                                              |                   |       |                   |                             |      |
| *Yermek                            Kudabayev*(2)  | 2006    | $90,000    | $31,089                | $31,008                          | $152,097  |
| CFO                                               |                   |       |                   |                             |      |

 

|   | (1)Mr. Cherdabayev has                            served as the Chief Executive Officer and President since May                            2005. |
|--------|--------------------------------------------------------------------------------------------------------------------------------------------------|

|   | (2)Mr. Kudabayev has                            served as the Chief Financial Officer since April 2006. |
|--------|---------------------------------------------------------------------------------------------------------|

(3)Represents the dollar amount            recognized for financial statement reporting purposes during 2006 in accordance with            FAS 123(R) with respect to restricted stock grants awarded on October 20, 2006. The            restricted stock grants were valued at $1.95 per share, which represented the closing            market price for our common stock on the date of grant. Mr. Cherdabayev was granted            421,772 shares which vest as follows: one-fourth (105,443 shares) on the first            anniversary of the grant date; one-fourth (105,443 shares) on the second anniversary of            the grant date and the remaining one-half (210,886 shares) will vest on the third            anniversary of the grant date. Mr. Kudabayev was granted 383,429 shares, which vest as            follows: one-fourth (95,857 shares) in April 2007 and one-fourth (95,857 shares) in            April 2008 and the final one-half (191,715 shares) in April 2009. Vesting during each            year is contingent upon the Company timely filing of its reports with the Securities            and Exchange Commission each year. Moreover, vesting in the third year is also            contingent upon the Company having commenced commercial operations. In order for their            grants to vest, Mr. Cherdabayev and Mr. Kudabayev must be employed with the Company on            the vesting date. They forfeit any unvested grants at the time their employment with            the Company terminates.

(4)Represents the following amounts:            Mr. Cherdabayev, pension fund payment $5,296, income tax expense, $21,289, medical            insurance premiums $3,596, paid rent $36,000; Mr. Kudabayev, pension fund payment            $4,346, income tax expense $22,715, medical insurance premiums $3,947.

(5)In our annual report for the year            ended December 31, 2005 we incorrectly reported that Mr. Cherdabayev’s            compensation was $160,000. The disclosure included herein properly disclosed Mr.            Cherdabayev’s total compensation for the 2005 fiscal year.

 

48

 

----

*Pension Fund Payments*

             

In accordance with the legislative requirements of the Republic of            Kazakhstan during 2006 we were required to pay into an employee pension fund an amount            equivalent to 10% of each employee’s monthly wages, (but not more than $547).            Pension fund payments are withheld from employees’ salaries and included with            other salary costs in the income statement. We do not have any other liabilities            related to any supplementary pensions, post retirement health care, insurance benefits            or retirement indemnities.

 

**Employment Agreements**

             

Mr. Cherdabayev entered into a standard local Kazakhstani employment            agreement as dictated under the Labor Legislation of the Republic of Kazakhstan with            the Company on March 1, 2006. The agreement has no term. The agreement is terminable by            Mr. Cherdabayev on 30 days notice and can be terminated immediately by the Company for            failure to perform. The agreement calls for a salary to be paid, subject to annual            merit increases, but does not specify the amount of the salary. The agreement also            provides that the Company may pay Mr. Cherdabayev a bonus in an amount determined by            the Company. The agreement provides for compensation of official business travel            expenses and 28 days of paid vacation. The board of directors has determined that Mr.            Cherdabayev’s annual salary for 2007 will be $132,000, net of income            taxes.

             

Mr. Kudabayev has an employment agreement with the Company effective as            of May 1, 2006 to serve as the Company’s Chief Financial Officer. His employment            agreement is effective for an initial term of one year. The term of this agreement will            continue for three (3) one-year after the initial term unless terminated by either            party before the beginning a renewal term. The employment agreement provides for an            annual salary of $120,000 net of taxes, which shall also be paid by the Company. Mr.            Kudabayev’s salary may be reviewed and adjusted by the board of directors not            less frequently than annually. During the term of his employment, Mr. Kudabayev will be            allowed to participate in such pension, profit sharing, bonus, life insurance,            hospitalization, major medical and other employee benefit plans that may be in effect            from time to time and to the extent he is eligible to participate under the terms of            the particular plan. Mr. Kudabayev shall be eligible for performance bonuses in            accordance with the terms of the Employers Performance Bonus Scheme at the discretion            of the board of directors. Pursuant to his employment contract, Mr. Kudabayev received            a performance based restricted stock grant of 383,429 shares which vests over a period            of three years commencing in April 2007. Mr. Kudabayev’s employment agreement            provides for 28 days of paid vacation.

             

Should the Company terminate Mr. Kudabayev’s employment for good            reason, he shall be entitled to salary for the month in which he is terminated and for            the succeeding three calendar months. An additional month will be added up to a maximum            of twelve months for each year of completed service beginning after two full years of            service. This amount may be reduced in the event Mr. Kudabayev obtains new employment            prior to the completion of the payment period. If he is terminated for cause he shall            only be entitled to compensation through the date of termination. If he is terminated            for disability he shall be compensated for the remainder of the month and for three            succeeding months or until disability insurance benefits commence. If employment is            terminated because of death he shall be entitled to compensation through the end of the            calendar month in which his death occurs.

             

49

 

----

**OUTSTANDING EQUITY AWARDS AT FISCAL YEAR END**

             

The following table sets forth information concerning all option            holdings for the fiscal year ended December 31, 2006 for each of the named executive            officers.

 

|              | **Stock Awards**                                                                    |
|-------------------|-------------------------------------------------------------------------------------|
| **Name**          | **Number of Shares or Units of**

**Stock**

**That**

**Have**

**Not Vested (#)** | **Market Value of Shares or Units of                            Stock**

**That Have**

**Not**

**Vested ($)** | **Equity Incentive**

**Plan Awards:**

**Number of**

**Unearned Shares,**

**Units or Other**

**Rights That**

**Have Not**

**Vested (#)** | **Equity Incentive**

**Plan Awards:**

**Market or Value of Unearned**

**Shares, Units or**

**Other Rights**

**That Have Not**

**Vested ($)** |
|              |                                                                                |   |   |   |
| Marat Cherdabayev | 421,772(1)                                                                          | 801,367 | -0- | -0- |
| Yermek Kudabayev  | -0-                                                                                 | -0- | 383,429(1) | 728,515 |

 

(1)On October 20, 2006, our board of            directors awarded the above listed restricted stock grants to Mr. Cherdabayev and Mr.            Kudabayev. The award to Mr. Cherdabayev was in recognition of his efforts as the            Company’s Chief Executive Officer and President up to the date of the award, and            is not contingent on future performance. Mr. Kudabayev’s award is based on future            performance and is contingent upon such performance as described in more detail below.            The restricted stock grants were made under the Company’s 2003 Stock Option            Plan.The shares have been issued and are outstanding and are            being held in escrow by the Company subject to the vesting schedule placed on the            grant. Mr. Cherdabayev and Mr. Kudabayev have the right to vote the shares, receive            dividends and enjoy all other rights of ownership over the entire grant amount, except            for the right to dispose of or otherwise encumber the shares prior to satisfying the            applicable vesting requirement. These restricted stock awards will only vest to these            individuals if they are employed by the Company on the applicable vesting date. Any            unvested shares at the time such individual’s employment with the Company ceases,            for any reason, shall be forfeited back to the Company.

Mr. Cherdabayev’s shares will vest as follows: one-fourth (105,443            shares) on the first anniversary of the grant date; one-fourth (105,443 shares) on the            second anniversary of the grant date and the remaining one-half (210,886 shares) will            vest on the third anniversary of the grant date.

Mr. Kudabayev’s shares will vest as follows: one-fourth (95,857            shares) in April 2007 and one-fourth (95,857 shares) in April 2008, provided that the            Company has timely filed its reports with Securities and Exchange Commission. The final            one-half (191,715 shares) will vest in April 2009. Vesting during each year is            contingent upon the Company timely filing of its reports with the Securities and            Exchange Commission each year. Moreover, vesting in the third year is also contingent            upon the Company having commenced commercial operations.

             

**DIRECTOR COMPENSATION**

 

| **Name**             | **Fees Earned or****Paid in Cash**           | **Total**                                    |
|----------------------|----------------------------------------------|----------------------------------------------|
|                 |                                         |                                         |
| Timothy Adair        | $4,000                                       | $4,000                                       |
| Marat Cherdabayev(1) | $       0 | $       0 |
| James Kohler         | $4,000                                       | $4,000                                       |
| Nurlan Tajibaev      | $       0 | $       0 |
| Valery Tolkachev(1)  | $4,000                                       | $4,000                                       |

             

(1)In addition to being directors, Mr.            Cherdabayev and Mr. Tajibaev are Company employees, and therefore do not qualify for            compensation as non-employee directors.

 

50

 

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In October 2006, we adopted a compensation plan for our non-employee            directors. We pay an annual director fee to our non-employee directors of $16,000,            payable quarterly. Non-employee directors are also paid $1,000 for each board meeting            attended in person plus reimbursement for travel expenses.

             

**Stock Option Plan**

 

In March 2003, we adopted the EMPS Research Corporation 2003 Stock            Option Plan (the "Plan") reserving 5,000,000 common shares for distribution under the            Plan. The purpose of the Plan is to allow us to offer key employees, officers,            directors, consultants and sales representatives an opportunity to acquire a            proprietary interest in the Company. The various types of incentive awards which may be            provided under the Stock Option Plan enable us to respond to changes in compensation            practices, tax laws, accounting regulations and the size and diversity of our            business.

 

**Employee Stock Purchase Plan**

 

|   | We do not currently have an employee stock purchase plan                            in place. |
|--------|-----------------------------------------------------------------------------------------------|

 

**Director Stock Purchase Plan**

 

|   | We do not currently have a director stock purchase plan                            in place. |
|--------|----------------------------------------------------------------------------------------------|

 

|   | **Item 11.** | **Security Ownership of Certain Beneficial Owners and                            Management** |
|--------|--------------|-----------------------------------------------------------------------------------------------|

 

The term “beneficial owner” refers to both the power of            investment and the right to buy and sell our shares. It also refers to rights of            ownership or the right to receive distributions from the Company and proceeds from the            sale of our shares. Since these rights may be held or shared by more than one person,            each person who has a beneficial ownership interest in shares is deemed to be the            beneficial owner of the same shares because there is shared power of investment or            shared rights of ownership.

 

The following table sets forth as of March 20, 2007, the name and the            number of shares of our Common Stock, par value of $0.001 per share, held of record or            beneficially by each person who held of record, or was known by the Registrant to own            beneficially, more than 5% of the 125,172,011 issued and outstanding shares of our            Common Stock, and the name and shareholdings of each director and of all officers and            directors as group.

 

51

 

----

| **Type of Security**             | **Name and Address**               | **Amount & Nature of Beneficial                            Ownership** | **% of Class** |
|----------------------------------|------------------------------------|----------------------------------------------------------------------------|----------------|
|                             |                               |                                                                       |           |
| Common                           | Bekem Metals, Inc.,                | 24,031,880                                                                 | 19%            |
|                             | Voting Trust(1)                    |                                                                       |           |
|                             | 170 Tchaikovsky Street             |                                                                       |           |
|                             | 4th Floor                          |                                                                       |           |
|                             | Almaty, Kazakhstan 050000          |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | Marat Cherdabayev(1) (2)(6)        | 24,453,652                                                                 | 20%            |
|                             | 170 Tchaikovsky Street             |                                                                       |           |
|                             | 4th Floor                          |                                                                       |           |
|                             | Almaty, Kazakhstan 050000          |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | Hsuih Chi Hun(3)                   | 36,306,120                                                                 | 29%            |
|                             | 1/F., Chap Biu Building            |                                                                       |           |
|                             | Tai Po Market, 15 On Fu Road       |                                                                       |           |
|                             | New Territories, Hong Kong, S.A.R. |                                                                       |           |
|                             | China                              |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | Brisa Equities Corporation(3)      | 21,000,000                                                                 | 17%            |
|                             | 1020 East 900 South                |                                                                       |           |
|                             | Bountiful, Utah 84010              |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | Brilliance Investments Ltd. (4)    | 15,504,408                                                                 | 17%            |
|                             | P.O. Box 5251                      |                                                                       |           |
|                             | CH 6901                            |                                                                       |           |
|                             | Lugano, Switzerland                |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | Central Asian Metals, Inc.(4)      | 15,504,408                                                                 | 12%            |
|                             | P.O. Box 5251                      |                                                                       |           |
|                             | CH 6901                            |                                                                       |           |
|                             | Lugano, Switzerland                |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | GLG Emerging Markets Fund(5)       | 28,000,000                                                                 | 21%            |
|                             | c/o GLG Partnership                |                                                                       |           |
|                             | One Curzon Street                  |                                                                       |           |
|                             | London W1J 5HB                     |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | Yermek Kudabayev(2) (6)            | 383,429                                                                    | *              |
|                             | 170 Tchaikovsky Street             |                                                                       |           |
|                             | 4th Floor                          |                                                                       |           |
|                             | Almaty, Kazakhstan 050000          |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | Nurlan Tajibaev (2) (6)            | 191,715                                                                    | *              |
|                             | 170 Tchaikovsky Street             |                                                                       |           |
|                             | 4th Floor                          |                                                                       |           |
|                             | Almaty, Kazakhstan 050000          |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | James Kohler (6)                   | -0-                                                                        | *              |
|                             | 2011 Maple View Drive              |                                                                       |           |
|                             | Bountiful, Utah 84101              |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | Timothy Adair (6)                  | -0-                                                                        | *              |
|                             | 5062 W. Amelia Earhart Drive       |                                                                       |           |
|                             | Salt Lake City, Utah 84116         |                                                                       |           |
|                             |                               |                                                                       |           |
| Common                           | Valery Tolkachev (6)               | -0-                                                                        | *              |
|                             | 27 Pokrovka St., Bldg.6            |                                                                       |           |
|                             | Moscow, Russia 105062              |                                                                       |           |
|                             |                               |                                                                       |           |
| Officers, Directors and Nominees | 25,028,797                         | 20%                                                                        |
| as a Group: (6 persons)          |                               |                                                                       |

 

*            Less than 1%.

 

52

 

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                      (1)Mr. Marat Cherdabayev owns no shares in his own name.            He is the trustee of the Bekem Metals, Inc., Voting Trust and as such, he maintains            voting and investment control over these shares and therefore may be deemed to be the            beneficial owner of the shares held by the Voting Trust.

                       (2)On October 20, 2006 our board of directors awarded a restricted stock grant to            Mr. Cherdabayev in the amount of 421,772 shares, to Mr. Kudabayev in the amount of            383,429 shares and to Mr. Tajibaev in the amount of 191,715 shares. The shares vest            over a period of three years. The shares have been issued and are outstanding and are            being held in escrow by the Company subject to the applicable vesting schedule for each            grant. The grantees have the right to vote the shares, receive dividends and enjoy all            other rights of ownership over the entire grant amount from the grant date, except for            investment control of the shares, which will not pass to these individuals until the            shares vest. Shares will vest to the grantee only if the grantee is employed by the            Company on the applicable vesting date. Any unvested shares at the time a            grantee’s employment with the Company ceases, for any reason, shall be forfeited            back to the Company. For additional information regarding vesting dates and conditions            see the section entitled “*Securities Authorized for            Issuance Under Equity Compensation Plans*” contained in            Item 5. “*Market for Common Equity, Related Stockholder            Matters and Small Business Issuer Purchases of Equity Securities”*of this report.

                       (3)Mr. Hsuih Chi Hun owns no shares in his own name.            However, he maintains voting and investment control over the shares held of record by            Brisa Equities, Inc., as well as by Landsgate Marketing Limited, Comodidad y Fantasia            en Tierra, S.A. and Las Tierras del Deleite, S.A., and therefore may be deemed to be            the beneficial owner of the shares held by these entities.

                     (4)Brilliance Investments Ltd., as trustee, maintains the            voting and investment control over the shares held of record by Central Asian Metals,            Inc., and therefore, may be deemed to be the beneficial owner of the shares held by            that entity.

                      (5)Includes an immediately exercisable warrant to purchase up to 7,000,000 common            shares at a price of $2.00 per share.

                      (6)Mr. Cherdabayev, Mr. Kudabayev and Mr. Tajibaev are            executive officers of the Company. Mr. Cherdabayev, Mr. Tajibaev, Mr. Kohler, Mr. Adair            and Mr. Tolkachev are directors of the Company.

 

**Change in Control**

 

To the knowledge of the management, there are no present arrangements or            pledges of our securities that may result in a change in control of the            Company.

 

|   | **Item 12.** | **Certain Relationships and Related Transactions and                            Director Independence.** |
|--------|--------------|----------------------------------------------------------------------------------------------------------|

 

On December 2, 2004, we borrowed $92,308 from CJSC Kazmorgeophysica, a            Kazakh company related by virtue of several common shareholders. The short-term loan is            denominated in Kazakh Tenge, interest free and was due on its original terms by            December 31, 2004. During March 2005 the Company borrowed an additional $99,798 from            CJSC Kazmorgeophysica, as a Kazakh Tenge denominated, interest-free, due on demand            note. In addition, during the six months ended March 31, 2005, the Company received            advances in the amount of $26,866 from certain owners, which are short-term in nature            and payable upon demand.

 

During 2005 and 2006, the Company borrowed $3,998,874 from KMI per an            agreement dated August 8, 2005, between KMI and KKM, for the purpose of assisting KKM            in funding its work requirements, including generation of geological data, under its            mineral extraction contract. The former owners of Kazakh Metals, Inc. were funding this            agreement.

 

Also, during 2005 and 2006 the Company borrowed $329,000 from            shareholders to fund the U.S. administrative operations.

             

Our board of directors has determined that the following directors are            “independent directors” as defined in Section 121 of the American Stock            Exchange Company Guide: Timothy Adair, James Kohler and Valery Tolkachev.

 

53

 

----

 

| **Item 13.** | **Exhibits.** |
|--------------|---------------|

 

|   | The following exhibits are included as part of this                            report: |
|--------|----------------------------------------------------------------------------------------|

 

 

| Exhibit No.  | Exhibit                                                                                                                            | Location       |
|--------------|------------------------------------------------------------------------------------------------------------------------------------|----------------|
|         |                                                                                                                               |           |
| Exhibit 10.1 | Employment Agreement – Yermek Kudabayev                                                                                      | *              |
|         |                                                                                                                               |           |
| Exhibit 10.2 | Stock Grant Agreement – Marat                            Cherdabayev                                                         | *              |
|         |                                                                                                                               |           |
| Exhibit 10.3 | Stock Grant Agreement – Yermek                            Kudabayev                                                          | *              |
|         |                                                                                                                               |           |
| Exhibit 10.4 | Stock Grant Agreement – Nurlan Tajibaev                                                                                      | *              |
|         |                                                                                                                               |           |
| Exhibit 10.5 | Stock Grant Agreement – Alexander                            Rassohkin                                                       | *              |
|         |                                                                                                                               |           |
| Exhibit 21.1 | List of Subsidiaries                                                                                                               | *              |
|         |                                                                                                                               |           |
| Exhibit 31.1 | Certification of Principal Executive Officer Pursuant to                            Section 302 of the Sarbanes-Oxley Act of 2002. | Filed herewith |
|         |                                                                                                                               |           |
| Exhibit 31.2 | Certification of Principal Financial Officer Pursuant to                            Section 302 of the Sarbanes-Oxley Act of 2002. | Filed herewith |
|         |                                                                                                                               |           |
| Exhibit 32.1 | Certification of Principal Executive Officer Pursuant to                            Section 906 of the Sarbanes-Oxley Act of 2002. | Filed herewith |
|         |                                                                                                                               |           |
| Exhibit 32.2 | Certification of Principal Financial Officer Pursuant to                            Section 906 of the Sarbanes-Oxley Act of 2002. | Filed herewith |

*****Incorporated by reference to exhibits of            the same number filed with our Annual Report on Form 10-K (File No. (000-50218)), filed            on April 2, 2007.

 

**Item            14. Principal Accountant Fees and Services**

 

Hansen, Barnett and Maxwell served as the Company’s independent            registered public accounting firm for the years ended December 31, 2006 and 2005 and is            expected to serve in that capacity for the current year. Principal accounting fees for            professional services rendered for us by Hansen, Barnett & Maxwell for the years            ended December 31, 2006 and 2006, are summarized as follows:

             

|          | **2006** | **2005** |
|---------------|----------|----------|
| Audit         | $86,074  | $77,800  |
| Audit related | -        | -        |
| Tax           | $ 2,000  | $ 2,000  |
| All other     | -        | -        |
| Total         | $88,074  | $79,800  |

             

 

54

 

----

*Audit Fees*. Audit fees were for            professional services rendered in connection with the Company’s annual financial            statement audits and quarterly reviews of financial statements for filing with the            Securities and Exchange Commission.

             

*Tax Fees*. Tax fees related to services for            tax compliance and consulting.

 

*Board of Directors Pre-Approval Policies and            Procedures*. At its regularly scheduled and special meetings,            the Board of Directors, in lieu of an established audit committee, considers and            pre-approves any audit and non-audit services to be performed by our independent            registered public accounting firm. The Board of Directors has the authority to grant            pre-approvals of non-audit services.

 

**SIGNATURES**

 

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

 

**BEKEM METALS, INC.**

 

 

| Date: March 18, 2008 | /s/ Yermek Kudabayev    |   |
|----------------------|-------------------------|--------|
|                 | Yermek Kudabayev        |
|                 | Chief Executive Officer |

 

 

55

 

----

 

 

 

 

**BEKEM METALS, INC. AND SUBSIDIARIES**

 

**(An Exploration Stage Company)**

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING            FIRM**

**AND**

**FINANCIAL STATEMENTS**

 

**December 31, 2006 and 2005**

 

**HANSEN,BARNETT&            MAXWELL, P.C.**

A            Professional Corporation

CERTIFIED PUBLIC ACCOUNTANTS

 

----

 

| **BEKEM METALS, INC. AND SUBSIDIARIES**                                                              |
|------------------------------------------------------------------------------------------------------|
| **(An Exploration Stage Company)**                                                                   |
|                                                                                                 |   |
| **TABLE OF CONTENTS**                                                                                |
|                                                                                                 | **Page** |
|                                                                                                 |   |
| Report of Independent Registered Public Accounting                            Firm                   | F-3 |
|                                                                                                 |   |
| Consolidated Financial Statements:                                                                   |   |
|                                                                                                 |   |
| Consolidated Balance Sheets – December 31, 2006                            and 2005 (Restated) | F-4 |
|                                                                                                 |   |
| Consolidated Statements of Operations for the years                            ended                 |   |
| December 31, 2006 and 2005, and for the period from                            March 5,              |   |
| 2004 (Date of Inception) through December 31, 2006                            (Restated)             | F-5 |
|                                                                                                 |   |
| Consolidated Statements of Shareholders’ Equity                            for the years ended |   |
| December 31, 2005 and 2006, and for the period from                            March 5,              |   |
| 2004 (Date of Inception) through December 31, 2006                            (Restated)             | F-6 |
|                                                                                                 |   |
| Consolidated Statements of Cash Flows for the years                            ended                 |   |
| December 31, 2006 and 2005, and for the period from                            March 5,              |   |
| 2004 (Date of Inception) through December 31, 2006                            (Restated)             | F-7 |
|                                                                                                 |   |
| Notes to Consolidated Financial Statements                                                           | F-8 |

 

 

F-1

----

**HANSEN,            BARNETT&            MAXWELL, P.C.**

 

|   | **Registered with the Public Company** |
|--------|----------------------------------------|

|   | **Accounting Oversight Board** |
|--------|--------------------------------|

 

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

 

 

 

             

|   | A Professional Corporation |
|--------|----------------------------|

|   | CERTIFIED PUBLIC ACCOUNTANTS |
|--------|------------------------------|

|   | 5 Triad Center, Suite 750 |
|--------|---------------------------|

|   | Salt Lake City, UT 84180-1128 |
|--------|-------------------------------|

|   | Phone: (801) 532-2200 |
|--------|-----------------------|

|   | Fax: (801) 532-7944 |
|--------|---------------------|

|   | www.hbmcpas.com |
|--------|-----------------|

 

 

**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING            FIRM**

 

 

To the            Board of Directors and the Shareholders

Bekem            Metals, Inc. and Subsidiaries

 

We            have audited the accompanying consolidated balance sheets of Bekem Metals, Inc. and            Subsidiaries as of December 31, 2006 and 2005, and the related statements of            operations, shareholders’ equity (deficit), and cash flows for the years ended            December 31, 2006 and 2005, and for the period March 5, 2004 (Date of Inception)            through December 31, 2006. These financial statements are the responsibility of the            Company’s management. Our responsibility is to express an opinion on these            financial statements based on our audits.

 

We            conducted our audits in accordance with the standards of the Public Company Accounting            Oversight Board (United States). Those standards require that we plan and perform the            audits to obtain reasonable assurance about whether the financial statements are free            of material misstatement. An audit includes examining, on a test basis, evidence            supporting the amounts and disclosures in the financial statements. An audit also            includes assessing the accounting principles used and significant estimates made by            management, as well as evaluating the overall financial statement presentation. We            believe that our audits provide a reasonable basis for our opinion.

 

In            our opinion the consolidated financial statements referred to above present fairly, in            all material respects, the financial position of Bekem Metals, Inc. and Subsidiaries as            of December 31, 2006 and 2005, and the results of its operations and its cash flows for            the years ended December 31, 2006 and 2005, and for the period March 5, 2004 (Date of            Inception) through December 31, 2006 in conformity with U.S. generally accepted            accounting principles.

 

As            discussed in Note 13, the accompanying consolidated financial statements have been            restated for the effects of correcting the presentation to reflect an exploration stage            enterprise, to correct the reporting of deferred compensation expense for the years            ended December 31, 2006 and 2005, and to correct the weighted average number of shares            outstanding.

 

|   | **HANSEN, BARNETT & MAXWELL, P.C.** |
|--------|-----------------------------------------|

 

Salt            Lake City, Utah

March 28, 2007

 

F-2

 

----

 

| **BEKEM METALS, INC. AND SUBSIDIARIES**                                                   |
|-------------------------------------------------------------------------------------------|
| **(An Exploration Stage Company)**                                                        |
| **CONSOLIDATED BALANCE SHEETS**                                                           |
|                                                                                      |   |   |
| *December 31,*                                                                            |   | **2006** |   | **2005** |
|                                                                                      |   | **(Restated)** |   | **(Restated)** |
| **ASSETS**                                                                                |   |   |   |   |
|                                                                                      |   |   |   |   |
| **Current Assets**                                                                        |   |   |   |   |
| Cash                                                                                      | $  | 8,583,680  | $ | 89,366  |
| Trade accounts receivable                                                                 |   | 2,776  |   | 18,657  |
| VAT recoverable                                                                           |   | 186,915  |   | 61,936  |
| Inventories                                                                               |   | 185,063  |   | 240,054  |
| Prepaid expenses and other current assets                                                 |   | 139,293  |   | 42,393  |
| Deferred compensation                                                                     |   | 757,920  |   | -  |
| **Total Current Assets**                                                                  |   | 9,855,647  |   | 452,406  |
|                                                                                      |   |   |   |   |
| Property, plant and mineral interests (net of                            accumulated      |   |   |   |   |
| depreciation of $144,030 and $57,709)                                                     |   | 13,870,563  |   | 10,938,368  |
| Non-current deferred compensation                                                         |   | 1,202,587  |   | -  |
| Other assets                                                                              |   | 169,130  |   | 39,241  |
|                                                                                      |   |   |   |   |
| **Total Assets**                                                                          | $  | 25,097,927  | $ | $ 11,430,015  |
|                                                                                      |   |   |   |   |
| **LIABILITIES AND SHAREHOLDERS' EQUITY                            (DEFICIT)**             |   |   |
|                                                                                      |   |   |   |   |
| **Current Liabilities**                                                                   |   |   |   |   |
| Accounts payable                                                                          | $  | 530,665  | $ | 424,306  |
| Accrued expenses                                                                          |   | 274,739  |   | 276,291  |
| Due to related party                                                                      |   | 9,644  |   | 5,518  |
| Current portion of long-term notes payable                                                |   | -  |   | 3,660,230  |
| **Total Current Liabilities**                                                             |   | 815,048  |   | 4,366,345  |
|                                                                                      |   |   |   |   |
| Deferred tax liabilities                                                                  |   | 433,645  |   | 2,275,192  |
| Long -term notes payable                                                                  |   | -  |   | 797,178  |
| Long-term notes payable - related parties                                                 |   | -  |   | 4,075,012  |
| Asset retirement obligation                                                               |   | 951,355  |   | 833,840  |
| **Total Liabilities**                                                                     |   | 2,200,048  |   | 12,347,567  |
|                                                                                      |   |   |   |   |
| **Commitments and Contingencies**                                                         |   | -  |   | -  |
|                                                                                      |   |   |   |   |
| **Shareholders' Equity (Deficit)**                                                        |   |   |   |   |
| Preferred stock; $0.001 par value, 20,000,000                            shares           |   |   |   |   |
| authorized, no shares outstanding                                                         |   | -  |   | -  |
| Common stock; $0.001 par value, 150,000,000 shares                            authorized, |   |   |   |   |
| and 125,172,011 and 100,088,888 shares issued and                            outstanding  |   | 125,172  |   | 100,089  |
| Additional paid-in capital                                                                |   | 29,025,272  |   | 515,879  |
| Accumulated deficit                                                                       |   | (6,222,349) |   | (1,516,227) |
| Accumulated other comprehensive loss                                                      |   | (30,216) |   | (17,293) |
| **Total Shareholders' Equity (Deficit)**                                                  |   | 22,897,879  |   | (917,552) |
|                                                                                      |   |   |   |   |
| **Total Liabilities and Shareholders' Equity                            (Deficit)**       | $ | 25,097,927  | $ | 11,430,015  |
|                                                                                      |   |   |   |   |

 

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

 

F-3

 

----

 

| **BEKEM METALS, INC. AND SUBSIDIARIES**                                      |
|------------------------------------------------------------------------------|
| **(An Exploration Stage Company)**                                           |
| **CONSOLIDATED STATEMENTS OF OPERATIONS**                                    |
|                                                                         |   |   |   |   |   |   |
|                                                                         |   |   |   |   |   | **For the Period from** |
|                                                                         |   |   |   |   |   | **March 5, 2004** |
|                                                                         |   | **For the Years Ended** |   | **(Date of Inception)** |
|                                                                         |   | **December 31,** |   | **through** |
|                                                                         |   | **2006** |   | **2005** |   | **December 31, 2006** |
|                                                                         |   | **(Restated)** |   | **(Restated)** |   | **(Restated)** |
|                                                                         |   |   |   |   |   |   |
| **Revenue**                                                                  |   | $                                              -  |   | $               -  |   | $                   -  |
|                                                                         |   |   |   |   |   |   |
| **Operating Expenses**                                                       |   |   |   |   |   |   |
| General and administrative expenses                                          |   | 3,136,715  |   | 1,018,148  |   | 4,254,372  |
| Research and development costs                                               |   | 389,507  |   | 131,562  |   | 792,168  |
| Exploratory costs                                                            |   | 1,470,247  |   | 697,496  |   | 2,167,743  |
| Accretion expense on asset retirement                            obligations |   | 72,865  |   | 60,632  |   | 133,497  |
| Grant compensation expense                                                   |   | 151,583  |   | -  |   | 151,583  |
|                                                                         |   |   |   |   |   |   |
| **Total Operating Expenses**                                                 |   | 5,220,917  |   | 1,907,838  |   | 7,499,363  |
|                                                                         |   |   |   |   |   |   |
| **Loss From Operations**                                                     |   | (5,220,917) |   | (1,907,838) |   | (7,499,363) |
|                                                                         |   |   |   |   |   |   |
| **Other Income (Expense)**                                                   |   |   |   |   |   |   |
| Interest income                                                              |   | 85,337  |   | -  |   | 85,337  |
| Other income                                                                 |   | 2,371  |   | 19,490  |   | 21,861  |
| Interest expense                                                             |   | (1,382,972) |   | (293,451) |   | (1,676,423) |
| Translation adjustment                                                       |   | (32,572) |   | 38,190  |   | 5,618  |
| Exchange loss                                                                |   | (174,278) |   | (64,192) |   | (234,734) |
|                                                                         |   |   |   |   |   |   |
| **Net Other Expense**                                                        |   | (1,502,114) |   | (299,963) |   | (1,798,341) |
|                                                                         |   |   |   |   |   |   |
| **Net Loss Before Minority Interest and                            Taxes**   |   | (6,723,031) |   | (2,207,801) |   | (9,297,704) |
| Deferred tax benefit                                                         |   | 2,016,909  |   | 917,238  |   | 2,934,147  |
| Loss attributed to minority interest                                         |   | -  |   | 19,426  |   | 141,208  |
|                                                                         |   |   |   |   |   |   |
| **Net Loss**                                                                 |   | $    (4,706,122) |   | $   (1,271,137) |   | $   (6,222,349) |
|                                                                         |   |   |   |   |   |   |
| **Basic Loss per Common Share**                                              |   | $             (0.04) |   | $            (0.03) |   |   |
| **Weighted-Average Shares used in**                                          |   |   |   |   |   |   |
| **Basic Loss per Common Shares**                                             |   | 111,480,627  |   | 48,645,053  |   |   |
|                                                                         |   |   |   |   |   |   |
|                                                                              |  |  |  |  |  |  |  |  |

 

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

 

F-4

 

----

 

| **BEKEM METALS, INC. AND SUBSIDIARIES**                                                  |
|------------------------------------------------------------------------------------------|
| **(An Exploration Stage Company)**                                                       |
| **CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY                            (DEFICIT)** |
| **FOR THE PERIOD FROM MARCH 5, 2004 (DATE OF                            INCEPTION)**     |
| **THROUGH DECEMBER 31, 2006**                                                            |
|                                                                                     |   |   |   |   |   |   |
|                                                                                     |   |   |   | **Accumulated** |   |   |
|                                                                                     |   |   |   | **Other** |   | **Total** |
|                                                                                     | **Common Shares** | **Additional** | **Comprehensive** | **Accumulated** | **Shareholders'** |
|                                                                                     | **Shares** | **Amount** | **Paid-in Capital** | **Loss** | **Deficit** | **Equity (Deficit)** |
| **Balance - March 5, 2004**                                                              |   |   |   |   |   |   |
| (Date of inception)                                                                      |   | $           - | $                   - | $                  - | $                     - | $                     - |
| Shares issued for cash, August 12, 2004                                                  | 8,400,000 | 8,400 | 174,274 | - | - | 182,674 |
| Shares issued for 60% interest in                                                        |   |   |   |   |   |   |
| Kaznickel, November 19, 2004,                                                            |   |   |   |   |   |   |
| $0.02 per share                                                                          | 12,600,000 | 12,600 | (12,600) | - | - | - |
| Net loss for period                                                                      |   | - | - | - | (245,090) | (245,090) |
| **Balance, December 31, 2004**                                                           | 21,000,000 | $ 21,000 | $        161,674 | $                  - | $       (245,090) | $        (62,416) |
|                                                                                     |   |   |   |   |   |   |
| Net loss for period                                                                      |   |   |   |   | (1,271,137) | (1,271,137) |
| Cumulative translation adjustment                                                        |   |   |   | (17,293) |   | (17,293) |
| **Comprehensive Loss**                                                                   |   |   |   |   |   | $   (1,350,846) |
|                                                                                     |   |   |   |   |   |   |
| Minority interest shares issued in                                                       |   |   |   |   |   |   |
| acquisition of EMPS Research                                                             |   |   |   |   |   |   |
| Corporation, January 24, 2005                                                            | - | - | (11,706) | - | - | (11,706) |
| Shares issued for cash, August 8, 2005                                                   | 61,200,000 | 61,200 | 38,800 | - | - | 100,000 |
| Shares issued for the acquisition of                                                     |   |   |   |   |   |   |
| the minority interests of Bekem Metals,                                                  |   |   |   |   |   |   |
| Inc., October 24, 2005                                                                   | 17,888,888 | 17,889 | 327,111 | - | - | 345,000 |
| **Balance, December 31, 2005 - Restated**                                                | 100,088,888 | $100,089 | $         515,879 | $      (17,293) | $     (1,516,227) | $      (917,552) |
|                                                                                     |   |   |   |   |   |   |
| Net loss for period                                                                      |   |   |   |   | (4,706,122) | (4,706,122) |
| Cumulative translation adjustment                                                        |   |   |   | (12,923) |   | (12,923) |
| **Comprehensive Loss**                                                                   |   |   |   |   |   | $   (5,636,597) |
|                                                                                     |   |   |   |   |   |   |
| Shares issued for cash, July 14, 2006 -                                                  |   |   |   |   |   |   |
| net of fees of 1,577,614                                                                 | 24,000,000 | 24,000 | 26,398,386 | - | - | 26,422,386 |
| Issue of Stock grants at 1.95 per share on                                               |   |   |   |   |   |   |
| October 20, 2006                                                                         | 1,083,123 | 1,083 | 2,111,007 | - | - | 2,112,090 |
| **Balance, December 31, 2006 - Restated**                                                | 125,172,011 | $125,172 | $     29,025,272 | $       (30,216) | $     (6,222,349) | $    22,897,879 |
|                                                                                     |   |   |   |   |   |   |

 

 

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

 

F-5

 

----

| **BEKEM METALS, INC. AND SUBSIDIARIES**                                       |
|-------------------------------------------------------------------------------|
| **(An Exploration Stage Company)**                                            |
| **CONSOLIDATED STATEMENTS OF CASH FLOWS**                                     |
|                                                                          |   |   |   |   |   |   |   |
|                                                                          |   |   |   | **For the Period****from** |   |
|                                                                          |   |   |   | **March 5, 2004** |   |
|                                                                          |   | **For the Years Ended** |   | **(Date of Inception)** |   |
|                                                                          |   | **December 31,** |   | **through** |   |
|                                                                          |   | **2006** |   | **2005** |   | **December 31, 2006** |   |
|                                                                          |   | **(Restated)** |   | **(Restated)** |   | **(Restated)** |   |
| **Cash Flows from Operating Activities**                                      |   |   |   |   |   |   |   |
| Net loss                                                                      |   | $ (4,706,122) |   | $ (1,271,137) |   | $    (6,222,349) |   |
| Adjustments to reconcile net loss to                                          |   |   |   |   |   |   |   |
| net cash provided by operating activities:                                    |   |   |   |   |   |   |   |
| Depreciation and amortization                                                 |   | 117,502  |   | 48,233  |   | 167,133  |   |
| Accretion expense on asset retirement                            obligations  |   | 72,865  |   | 60,632  |   | 149,566  |   |
| Interest expense from debt discount                                           |   | 855,970  |   | 107,261  |   | 963,231  |   |
| Shares issued on option modification                                          |   | -  |   | 19,426  |   | 19,426  |   |
| Deferred tax benefit                                                          |   | (2,016,909) |   | (917,238) |   | (2,934,147) |   |
| Foreign currency exchange gain and                            translation     |   |   |   |   |   |   |   |
| adjustment                                                                    |   | (142,795) |   | (64,192) |   | (203,251) |   |
| Purchased exploration costs                                                   |   | -  |   | 251,286  |   | 251,286  |   |
| Stock grant compensation expense                                              |   | 151,583  |   | -  |   | 151,583  |   |
| Loss on disposal of property and equipment                                    |   | 58,928  |   | -  |   | 58,928  |   |
| Loss recognized on minority shareholders'                            interest |   | -  |   | (19,426) |   | (141,208) |   |
| Change in operating assets and liabilities:                                   |   |   |   |   |   |   |   |
| Trade accounts receivable                                                     |   | 16,983  |   | (8,015) |   | 8,968  |   |
| Inventories                                                                   |   | 47,985  |   | 30,399  |   | 78,384  |   |
| VAT recoverable                                                               |   | (122,498) |   | -  |   | (122,498) |   |
| Prepaid expenses and other current assets                                     |   | (29,040) |   | 30,181  |   | 80,979  |   |
| Accounts payable                                                              |   | 88,129  |   | 52,381  |   | 221,967  |   |
| Accrued expenses                                                              |   | (9,976) |   | (77,234) |   | (87,210) |   |
| **Net Cash From Operating Activities**                                        |   | (5,617,395) |   | (1,757,443) |   | (7,559,212) |   |
|                                                                          |   |   |   |   |   |   |   |
| **Cash Flows from Investing Activities**                                      |   |   |   |   |   |   |   |
| Purchase of property and equipment                                            |   | (2,577,696) |   | (16,100) |   | (2,618,437) |   |
| Purchase of intangible assets                                                 |   | (57,480) |   | -  |   | (57,480) |   |
| Proceeds from disposal of property and                            equipment   |   | 22,941  |   | -  |   | 22,941  |   |
| Restricted cash                                                               |   | (100,000) |   | -  |   | (100,000) |   |
| Notes receivable                                                              |   | (56,983) |   | -  |   | (56,983) |   |
| Change in related party receivables/payables                                  |   | 46,930  |   | 3,545  |   | 50,475  |   |
| Cash acquired in acquisitions                                                 |   | -  |   | 26,761  |   | (152,180) |   |
| **Net Cash From Investing Activities**                                        |   | (2,722,288) |   | 14,206  |   | (2,911,664) |   |
|                                                                          |   |   |   |   |   |   |   |
| **Cash Flows from Financing Activities**                                      |   |   |   |   |   |   |   |
| Proceeds from notes payable                                                   |   | 1,996,731  |   | 12,618,779  |   | 14,706,914  |   |
| Payments on notes payable                                                     |   | (7,870,993) |   | (14,874,760) |   | (22,745,753) |   |
| Proceeds from notes payable related parties                                   |   | 251,900  |   | 4,075,012  |   | 4,326,912  |   |
| Payments on notes payable - related parties                                   |   | (4,326,912) |   | -  |   | (4,326,912) |   |
| Issuance of shares for cash                                                   |   | 26,422,386  |   | 2,000  |   | 26,728,842  |   |
| **Net Cash From Financing Activities**                                        |   | 16,473,112  |   | 1,821,031  |   | 18,690,003  |   |
|                                                                          |   |   |   |   |   |   |   |
| **Effect of Exchange Rate Changes on                            Cash**        |   | 360,885  |   | 7,382  |   | 364,553  |   |
|                                                                          |   |   |   |   |   |   |   |
| **Net Increase in Cash**                                                      |   | 8,494,314  |   | 85,176  |   | 8,583,680  |   |
| **Cash at Beginning of Period**                                               |   | 89,366  |   | 4,190  |   | -  |   |
| **Cash at End of Period**                                                     |   | $  8,583,680  |   | $        89,366  |   | $     8,583,680  |   |
|                                                                          |   |   |   |   |   |   |   |
|                                                                               |  |  |  |  |  |  |  |  |  |

 

 

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

 

F-6

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

 

**NOTE            1 – BASIS OF PRESENTATION, NATURE OF BUSINESS, AND SIGNIFICANT ACCOUNTING            POLICIES**

 

**Basis of Presentation**

 

The            accompanying consolidated financial statements include the accounts of Bekem Metals,            Inc. (“BMI”) and its wholly owned subsidiaries Kazakh Metals, Inc.            (“KMI”), Kyzyl Kain Mamyt LLP (“KKM”), Condesa Pacific, S.A.            (“Condesa”) and Kaznickel, LLP (“Kaznickel”). Intercompany            accounts and transactions have been eliminated in consolidation. The results of            operations of the previously separate KMI and BMI were combined for all periods prior            to the acquisition (as further explained below), with recognition of the minority            interest in BMI, and the operations of BMI and KMI are consolidated from October 24,            2005.

 

On            October 24, 2005, Bekem Metals, Inc. (“BMI”, “Bekem” or the            “Company”) entered into an Acquisition Agreement with Kazakh Metals, Inc.,            a British Virgin Islands international business company (“KMI”), under            which BMI acquired 100% of the outstanding common shares of KMI in exchange for the            issuance of 61,200,000 common shares.

 

The            KMI shareholders received 61.1% of the BMI common stock outstanding after the            transaction and therefore KMI was considered the acquirer for financial reporting            purposes. Accordingly, the accompanying financial statements include financial            statements of KMI for all periods presented.

 

Brisa Equities Corporation, a British Virgin Islands holding company            (“Brisa”), together with other entities its owners control, is the            controlling shareholder of KMI and was also the controlling shareholder of BMI.            Accordingly, the transaction was considered to be between entities under common control            and did not result in a change in control of BMI. Following the transaction, entities            over which the controlling shareholder maintained voting and investment control held            51,600,000 BMI common shares, which represented 51.5% of the 100,088,888 outstanding            common shares.

 

The            acquisition of the portion of the net liabilities of BMI relating to the common shares            owned by the controlling shareholder was recorded at historical cost of $(161,998). The            acquisition of the common shares of BMI purchased from the minority shareholders of BMI            were recorded at $345,000, which was the estimated fair value of those shares on the            date of acquisition. KMI accounted for the purchase of BMI similar to a            pooling.

 

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

 

***Kazakh Metals, Inc.***– The            consolidated financial statements also include the accounts of KMI and its wholly-owned            subsidiary, KKM, which it acquired on June 1, 2005 in a purchase business            combination.

 

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

 

F-7

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

 

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

 

**Nature of Business**

 

The            Company is engaged in the acquisition, exploration and production of mineral resource            properties. Kaznickel owns the right to the Gornostayevskoye (“Gornostai”)            nickel and cobalt deposit located in the East Kazakhstan Oblast in northeast            Kazakhstan. The license is for exploration and production of cobalt and nickel ores and            is valid through February 26, 2026. KKM holds exploration and production licenses from            the government of Kazakhstan to a 575,756 acre parcel, located approximately 130            kilometers northwest of Aktobe, Kazakhstan. This deposit is referred to as the            Kempirsai deposit. The licenses grant KKM the right to explore for and produce nickel            and cobalt from deposits located within the territory through October 12, 2011, which            may be extended upon agreement between KKM and the Ministry of Energy and Minerals            Resources (MEMR) of the Republic of Kazakhstan. KKM also holds a license to explore for            and produce Mamyt brown coal from a deposit located within 40 kilometers of its cobalt            and nickel deposit. This license expires on December 11, 2018 with further possible            extensions.

 

***Business Condition***– The            Company has no proven mineral reserves that conform to U.S. accounting standards and            has had only limited ore and Mamyt brown coal production from its Kempirsai deposit            since its acquisition on May 31, 2005. The Gornostai deposit has not yet entered the            development stage with respect to its mineral interests and has no production. There            has been only limited revenue from the Kempirsai operations, and the Company has            incurred net losses of ($4,706,122) and ($1,271,137) for the years ended December 31,            2006 and 2005, respectively and ($6,222,349) for the period from March 5, 2004 (date of            inception) through December 31, 2006. Current assets exceeded current liabilities by            $9,040,599 at December 31, 2006, while current liabilities exceeded current assets by            $3,913,939 at December 31, 2005. Management expects that the Company will need            significant additional capital to fund construction of a processing plant in 2007-2008.            The Company anticipates it will need to raise additional capital through the sale of            its equity securities or debt securities. Certain shareholders of the Company have            indicated a willingness to provide the Company a line of credit. The Company has no            formal agreement with said shareholders to provide this line of credit and the            shareholders are under no obligation to enter into any agreement or make available any            funds to the Company.

 

**Exploration Stage Company**

 

The            Company is an exploration stage company. As an exploration stage enterprise, the            Company discloses the deficit accumulated during the exploration stage and the            cumulative statements of operations and cash flows from inception to the current            balance sheet date. The Company will remain in the exploration stage until such time as            proven or probable reserves have been established for either the KKM (Kempirsai) or the            Kaznickel (Gornostai) operations.

 

F-8

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

**Significant Accounting Policies**

 

***Use of Estimates***– The            preparation of the Company’s consolidated financial statements in accordance with            accounting principles generally accepted in the United States of America requires            management to make estimates and assumptions that affect the reported amounts in the            financial statements and accompanying notes. Actual results could differ from those            estimates. The more significant areas requiring the use of management estimates and            assumptions relate to mineral reserves that are the basis for future cash flow            estimates and units-of-production depreciation, depletion and amortization            calculations; environmental, reclamation and closure obligations; asset impairments;            write-down of inventory to net realizable value; valuation allowances for deferred tax            assets; reserves for contingencies and litigation; and the fair value and accounting            treatment of financial instruments. The Company bases its estimates on historical            experience and on various other assumptions that are believed to be reasonable under            the circumstances. Accordingly, actual results may differ significantly from these            estimates under different assumptions or conditions.

 

***Revenue Recognition***– Since            the Company is in the exploration stage, any incidental sales of ore and Mamyt brown            coal are recorded as a reduction of the exploratory costs. Income from such sales is            recognized when persuasive evidence of an arrangement exists, title to product            transfers to the customer, and collectibility is reasonably assured.

 

***Trade Receivables***– In the            normal course of business, the company extends credit to its customers on a short-term            basis. The principal customers are local companies and government agencies. Although            credit risks associated with these customers are considered minimal, the company            routinely reviews its accounts receivable balances and makes provisions for doubtful            accounts.

 

***Related Party Receivables***–            Related party receivables consists of short-term advances to employees. No allowance            has been provided due to the historic short-term nature and recoverability of such            advances.

 

***Inventories***– Inventory            consists of materials and spare parts, miscellaneous goods, fuel and some raw            materials. Spare parts, goods and fuel are recorded at the lower cost or estimated            service value.

 

***Prepaid Expenses***– Prepaid            expenses relate to office rent, subscriptions, insurance and advance drilling costs.            Prepaid expenses are charged to operations in the period the related service or work is            performed.

 

***Impairment of Long-Lived Assets and Long-Lived Assets to be            Disposed***– Long-lived assets are reviewed for            impairment whenever events or changes in circumstances indicate that the carrying            amount of an asset may not be recoverable. Recoverability of assets to be held and used            is measured by comparison of the carrying amount of an asset to future net cash flows            expected to be generated by the asset. If such assets are considered to be impaired,            the impairment to be recognized is measured by the amount that the carrying amount of            the assets exceeds the fair value of the assets. Assets to be disposed of are reported            at the lower of the carrying amount or fair value less costs to sell. During 2006, the            Company realized losses from the impairment and disposal of property, plant and            equipment in the amount of $58,928. At December 31, 2006, the Company reviewed its            long-lived assets as disclosed above and determined no additional impairment was            necessary.

 

***Income Taxes***– Income taxes            are calculated using the liability method of tax accounting. Under this method, future            income tax assets and liabilities are computed based on temporary differences between            the tax basis and carrying amount on the balance sheet for assets and liabilities.            Future income tax assets and liabilities are calculated using tax rates anticipated to            apply in the periods that the temporary differences are expected to reverse.

 

F-9

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

***Depreciation, Depletion and Amortization***– Costs incurred to develop new properties will be capitalized as            incurred, when it has been determined that the property can be economically developed            based on the existence of proven and probable reserves. All such costs will be            amortized using the units-of-production (“UOP”) method over the estimated            life of the ore body based on recoverable minerals to be mined from proven and probable            reserves.

 

Depreciation of equipment used in exploration activities is calculated            using the straight-line method based on the estimated useful lives of the assets and is            charged to Exploratory costs.

 

Expenditures for new facilities or equipment and expenditures not            related to exploration activities and used for administrative and other operation            purposes or that extend the useful lives of existing facilities or equipment are            capitalized and depreciated using the straight-line method at rates sufficient to            depreciate such costs over the estimated future lives of such facilities or equipment.            These lives do not exceed the estimated mine life as the useful lives of these assets            are considered to be limited to the life of the relevant mine.

 

The            expected useful lives used in depreciation, depletion and amortization calculations are            determined based on applicable facts and circumstances, as described above. Significant            judgment is involved in the determination of useful lives, and no assurance can be            given that actual useful lives will not differ significantly from the useful lives            assumed for purpose of depreciation, depletion and amortization            calculations.

 

***Mineral Property Rights***–            Mineral property acquisition costs, site restoration costs and development costs on            mineral properties with proven and probable reserves are capitalized and will be            depleted using the units-of-production method over the estimated life of the reserves.            If there are insufficient reserves to use as a basis for depleting such costs, they are            written off as a mineral property or mineral interest impairment in the period in which            the determination is made. Site restoration costs are depleted over the term of their            expected life. Interest costs are capitalized on mineral properties and mineral            interests in development. The development potential of mining properties is established            by the existence of proven and probable reserves, reasonable assurance that the            property can be permitted as an operating mine and evidence that there are no            metallurgical or other impediments to the production of saleable metals.

 

Exploration costs incurred on mineral interests, other than acquisition            costs, prior to the establishment of proven and probable reserves are charged to            operations as incurred. Development costs incurred on mineral interests with proven and            probable reserves will be capitalized as mineral properties. We regularly perform            evaluations of our investment in mineral interests to assess the recoverability and /            or the residual value of the investments in these assets. All mineral interests and            mineral properties are reviewed for impairment whenever events or circumstances change            which indicate the carrying amount of an asset may not be recoverable, utilizing            established guidelines based upon undiscounted future net cash flows from the asset or            upon the determination that certain exploration properties do not have sufficient            potential for economic mineralization.

 

Our            estimates of mineral prices, recoverable probable reserves, and operating, capital and            reclamation costs, when available, are subject to certain risks and uncertainties,            which may affect the recoverability of mineral property costs. Although we make our            best estimate of these factors, it is possible that changes could occur in the near            term, which could adversely affect the future net cash flows to be generated from the            properties.

 

***Exploratory Costs***– since the            Company is deemed to be in the Exploration stage, all costs related to operating            activities are classified as Exploratory costs, which mainly consist of cost of            drilling exploration works at the Gornostai deposits, cost of blasting, stripping,            excavation and ore extracting works at the Kempirsai deposits, as well as salaries and            wages, depreciation charges and other expenses directly related to these            works.

 

F-10

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

***Financial Instruments***– The            nature of the Company’s operation exposes the Company to fluctuations in            commodity prices, foreign currency exchange risk and credit risk. The Company            recognizes these risks and manages its operation in a manner such that exposure to            these risks is minimized to the extent practical. The Company is not exposed to            fluctuations in interest rates because certain of its loans are interest free, as a            general requirement under Kazakh law for non-financial institutions.

             

***Basic and Diluted Income (Loss) Per Share***– Basic income (loss) per share is calculated by dividing net            income (loss) by the weighted-average number of shares outstanding. Diluted income per            share is calculated by dividing net income by the weighted-average number of shares and            all dilutive potentially issuable shares, except during loss periods when those            potentially issuable shares are anti-dilutive.

 

The            following data shows the amounts used in computing basic and diluted weighted-average            number of shares outstanding at December 31, 2006 and 2005:

 

| *For the years ended December 31,*                                                | **2006**   |   | **2005**   |
|-----------------------------------------------------------------------------------|------------|--------|------------|
| Basic weighted average common shares                            outstanding       | 95,285,844 |   | 48,645,053 |
| Dilutive effect of outstanding                            options/warrants        | -          |   | -          |
| **Diluted Weighted Average Common Shares                            Outstanding** | 95,285,844 |   | 48,645,053 |

 

***Recent Accounting Pronouncements***– In July 2006, the FASB issued FASB Interpretation (FIN) No.            48,*Accounting for Uncertainty in Income Taxes,*which provides guidance on the accounting for uncertainty in income            taxes recognized in financial statements. FIN 48 is effective for fiscal years            beginning after December 15, 2006, with earlier adoption permitted. The Company is            currently evaluating the impact, if any, the adoption of FIN 48 will have on its            financial reporting and disclosures.

 

In            February 2006, the FASB issued SFAS No. 155,*Accounting for            Certain Hybrid Financial Instruments -- an amendment of FASB Statements No. 133 and            140.*SFAS No. 155 resolves issues addressed in SFAS No. 133            Implementation Issue No. D1,*Application of Statement 133 to            Beneficial Interests in Securitized Financial Assets*. SFAS            No. 155 will become effective for the Company's fiscal year that begins after September            15, 2006. The impact of SFAS No. 155 will depend on the nature and extent of any new            derivative instruments entered into after the effective date.

 

In            September 2006, the FASB issued Statement of Financial Accounting Standards No.            157,*Fair Value Measurements,*which            provides enhanced guidance for using fair value to measure assets and liabilities. SFAS            No. 157 establishes a common definition of fair value, provides a framework for            measuring fair value under generally accepted accounting principles, and expands            disclosure requirements about fair value measurements. SFAS No. 157 is effective for            financial statements issued in fiscal years beginning after November 15, 2007, and for            interim periods within those fiscal years. The Company is currently evaluating the            impact, if any, the adoption of SFAS No. 157 will have on its financial reporting and            disclosures.

 

In            September 2006, the SEC staff published Staff Accounting Bulletin No. 108,            “Considering the Effects of Prior Year Misstatements when Quantifying            Misstatements in Current Year Financial Statements” (“SAB 108”). SAB            108 addresses quantifying the financial statement effects of misstatements,            specifically, how the effects of prior year uncorrected errors must be considered in            quantifying misstatements in the current year financial statements. This statement is            effective for fiscal years ending after November 15, 2006. SAB 108 did not have a            material effect on the Company’s financial reporting and disclosures.

 

F-11

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

**NOTE            2**–**ACQUISITIONS AND            DISPOSAL**

 

***Kaznickel Acquisition by Condesa***

 

On            July 9, 2004 Condesa, which was owned 60% by Brisa holding 8,400,000 of 14,000,000            shares of outstanding common stock, entered into an investment agreement under which            Condesa provided a $300,000 convertible loan to Kaznickel LLP, which was immediately            converted into a new 40 percent equity interests in Kaznickel. On September 22, 2004,            Brisa acquired an interest in Kaznickel by purchasing 60 percent of the equity interest            of the founding partners’ remaining 60 percent interests. As consideration for            the purchase, the original partners obtained a commitment from Brisa to facilitate a            reverse merger with a U.S. public company, and a commitment to obtain funding enabling            Kaznickel to further explore its mineral property rights. The value of the commitment            was estimated to be $270,000 based on the percent of Kaznickel obtained for            Condesa’s original cash investment of $300,000.

 

On            November 19, 2004, Brisa and the remaining Kaznickel partners exchanged their combined            60% interest in Kaznickel for a new 60% interest, equal to 21,000,000 shares of            Condesa, thereby making Kaznickel a wholly-owned subsidiary of Condesa. Brisa received            12,600,000 shares of Condesa in the transaction. The remaining 8,400,000 common shares            issued in the acquisition were recognized as minority shareholders’ interests.            The acquisition of a controlling interest in Kaznickel by Brisa and Condesa was            considered the purchase of Kaznickel with a measurement date of September 22, 2004, the            date Brisa and Condesa obtained control from the original Kaznickel            partners.

 

Condesa accounted for the acquisition of Kaznickel as a purchase            business combination with a purchase price of $304,456. The purchase price was            allocated to the assets acquired and liabilities assumed based on their estimated fair            values. Negative goodwill was not recognized in connection with the acquisition of            Kaznickel. Instead, the excess of the fair value of the net assets over the purchase            price was allocated as a pro rata reduction of the amounts that otherwise would have            been assigned to the long-term assets. The Company is in the process of obtaining an            independent valuation of the net assets acquired. Accordingly the allocation of the            purchase price is subject to refinement. At September 22, 2004, the purchase price was            allocated to the assets acquired and the liabilities assumed as follows:

 

| Current assets                               | $       | 231,674  |
|----------------------------------------------|---------|---------------|
| Mineral property rights                      |    | 267,660  |
| Asset retirement costs of the mineral rights |    | 474,936  |
| Property and equipment                       |    | 21,573   |
| Total assets acquired                        |    | 995,843  |
| Current liabilities                          |    | (25,468)      |
| Asset retirement obligation                  |    | (665,919)     |
| Total liabilities assumed                    |    | (691,387)     |
| Minority Shareholders' interests             |    | (121,782)     |
| **Net Assets Acquired**                      | $  | 182,674  |

 

Intangible assets acquired include the mineral property rights, which            are capitalized until the production phase begins, subject to impairment            considerations. Other intangible assets include the asset retirement costs of the            mineral rights, which have a 20-year estimated life and are subject to amortization at            a planned rate of $24,291 per year, and the asset retirement obligation, which is            accreted over its 20-year life, with a current estimated expense of $43,274 per            year.

 

F-12

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

 

***Condesa Acquisition of EMPS (Bekem)***

 

On            January 28, 2005, EMPS Research, Inc. (“EMPS”) completed a Plan and            Agreement of Reorganization with Condesa, wherein EMPS acquired 100% of the outstanding            capital stock of Condesa in exchange for the issuance of 35,000,000 common shares of            which 21,000,000 were held by the controlling shareholder and 14,000,000 were issued to            minority shareholders in Condesa. EMPS subsequently changed its name to Bekem Metals,            Inc. As a result of that reorganization, the shareholders of Condesa owned 91% of the            outstanding common stock of EMPS at that reorganization date. The combined entities            were referred to after that reorganization as Bekem.

 

EMPS            had 3,300,000 shares of common stock outstanding prior to that transaction that            remained outstanding, were classified as minority interests, and were valued at $0. The            transaction resulted in a change of control of EMPS. For financial reporting purposes,            Condesa was considered the acquirer. The acquisition was recognized as a forward stock            split of Condesa’s 30,000 shares of capital stock held by the controlling            shareholder that were outstanding prior to the reorganization into 21,000,000 common            shares, or a 700-for-1 stock split. The financial statements were restated for the            effects of the stock split for all periods presented. Condesa’s assets,            liabilities and minority interests were recorded at their historical cost and the            effect of the stock split was reflected retroactively since the inception of Condesa.            The assets of EMPS were considered to have been acquired by Condesa in exchange for the            assumption of EMPS’s net liabilities. The net assets consisted of cash of $2,648,            intangible assets of $1,823 and current liabilities of $15,077. The operations of            Condesa were included for all periods presented and the operations of EMPS were            included from the acquisition of EMPS.

 

***Kazakh Metals, Inc. Acquisition of Kyzyl Kain Mamyt,            LLC***

 

On            June 1, 2005, Kazakh Metals acquired 100% of the equity interests of Kyzyl Kain Mamyt,            LLC (KKM) for the cash purchase price of $100,000. The management of the Company            understands that at this time KKM was not able to maintain the subsoil use contract            because of financial liquidity problems. The owners of KKM, prior to its acquisition by            Kazakh Metals, had incurred significant debt obligations on the property which they            were unable to service and KKM’s assets were pledged as a guarantee for these            debt obligations. Moreover, at the time of the acquisition of KKM by Kazakh Metals, the            price of nickel was at the level where the processing of nickel ore by known and proven            technologies was not considered economically feasible due to high processing costs.            Therefore, the former owners of KKM sold their interests in KKM to Kazakh Metals at a            price significantly below the estimated fair value to free itself from the debt            obligations associated with the property. The former equity holders of KKM were not            related parties.

 

KKM            operates in the Aktyubinsk region of northwestern Kazakhstan and owns licenses to            explore for, and is engaged in the production and sale of nickel and cobalt ore and            Mamyt brown coal. KKM has been actively involved in mining cobalt and nickel ore since            its inception and has been operating in the Soviet Union since 1938. The height of            production occurred in the late 1980’s. Production, although limited, has            occurred since that time. KKM’s primary assets are its rights to exploit unproved            reserves and its infrastructure of buildings, machinery and equipment, including a rail            spur.

 

Kazakh Metals accounted for the acquisition of KKM as a purchase            business combination with a purchase price of $100,000. The purchase price was            allocated to the assets acquired and liabilities assumed based on their estimated fair            values. The Company has estimated a fair value of $40,000,000 for the mineral interests            and obtained an independent appraisal of the buildings and equipment of $17,693,795 on            the acquisition date, and is in the process of obtaining third-party valuations of the            mineral assets; accordingly, the allocation of the purchase price is subject to            refinement. Negative goodwill was not recognized in connection with theacquisition of KKM. Instead, the excess of the fair value of the net            assets over the purchase price was allocated as a pro rata reduction of the amounts            that otherwise would have been assigned to the long-term assets. Notes payable assumed            in the acquisition with a stated value of $7,445,197 are due to third parties generally            within three years, including $4,432,290 to a bank, and were recorded based upon their            fair values on the acquisition date, resulting in a discount to the notes that will be            recognized as interest expense through maturity. The operations and cash flows of KKM            were included in the Company’s consolidated financial statements since the date            of the acquisition.

 

F-13

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

The            following table summarizes the estimated fair values of the assets acquired and            liabilities assumed at the date of acquisition.

 

| **Acquisition of Kaznickel LLP**                                                               |    |             |
|------------------------------------------------------------------------------------------------|---------|------------------|
|                                                                                           |    |             |
| Current assets                                                                                 | $       | 231,674     |
| Mineral property rights                                                                        |    | 267,660     |
| Asset retirement costs of the mineral rights                                                   |    | 474,936     |
| Property and equipment                                                                         |    | 21,573      |
| Total assets acquired                                                                          |    | 995,843     |
| Current liabilities                                                                            |    | (25,468)         |
| Asset retirement obligation                                                                    |    | (665,919)        |
| Total liabilities assumed                                                                      |    | (691,387)        |
| Minority Shareholders' interests                                                               |    | (121,782)        |
| **Net Assets Acquired**                                                                        | $       | 182,674     |
|                                                                                           |    |             |
| **Acquisition of Minority Shareholders' Interests of                            Bekem Metals** |
|                                                                                           |    |             |
| Unproved mineral property rights                                                               | $  | 132,432     |
| Purchased exploration costs                                                                    |    | 251,286     |
| Deferred tax liability                                                                         |    | (38,718)         |
| **Minority Shareholders' Interests                            Acquired**                       | $  | 345,000     |
|                                                                                           |    |             |
| **Acquisition of KKM**                                                                         |    |             |
|                                                                                           |    |             |
| Current Assets                                                                                 | $  | 469,379     |
| Unproved mineral property rights                                                               |    | 7,034,321   |
| Asset retirement costs of the mineral rights                                                   |    | 86,852      |
| Buildings, constructions machinery and                            equipment                    |    | 3,068,786   |
| Total assets acquired                                                                          |    | 10,659,338  |
| Current liabilities                                                                            |    | (717,527)        |
| Asset retirement obligation                                                                    |    | (97,223)         |
| Notes Payable, net of discount of $917,737                                                     |    | (6,541,670)      |
| Deferred tax liability                                                                         |    | (3,202,918)      |
| Total liabilities assumed                                                                      |    | (10,559,338)     |
| **Net Assets Acquired**                                                                        | $       | 100,000     |

 

Intangible assets acquired include the mineral property rights, which            are capitalized and amortized on a units-of-production method, subject to impairment            considerations. Other intangible assets include the asset retirement costs of the            mineral rights, which have a 20-year estimated life and are subject to amortization at            a planned rate of $4,311 per year, and the asset retirement obligation, which is            accreted over its 20-year life, with a current estimated expense of $7,680 per            year.

 

F-14

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

 

***Bekem Acquisition of Kazakh Metals***

 

On            October 24, 2005, Kazakh Metals, Inc. (KMI) was acquired by Bekem Metals, Inc. in a            purchase business combination under which Bekem acquired 100% of the outstanding common            shares of KMI in exchange for the issuance of 61,200,000 common shares. The primary            asset of KMI is its wholly owned subsidiary, KKM.

 

The            principal shareholder of Bekem was also the principal shareholder of KMI. Accordingly,            the transaction was considered to be between entities under common control and did not            result in a change in control of Bekem. Following the transaction, entities over which            this shareholder maintains voting and investment control hold 51,600,000 Bekem common            shares, which represented 51.5% of the 100,088,888 outstanding common shares. The            acquisition of the portion of KMI owned by the principal shareholder will be recorded            at historical cost. The portion of KMI purchased from the minority shareholders of KMI            was recorded at fair value.

 

***Disposal of Condesa***

 

On            July 24, 2006, Condesa transferred its interest in Kaznickel to Bekem, making Kaznickel            a wholly-owned subsidiary of Bekem. On September 30, 2006 Bekem sold Condesa to a third            party for a nominal value. Condesa generated no sales and had no income. The disposals            of Condesa had no material effect on the financial position and the income statement of            Bekem.

 

**NOTE            3 – CASH**

 

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

 

Cash            consists of the following:

 

| *December 31,*           |   | **2006**  |      |   | **2005** |
|--------------------------|--------|-----------|-----------|--------|----------|
| Current accounts (USD)   | $      | 479,947   |      | $      | 64,136   |
| Current accounts (Tenge) |   | 38,379    |      |   | 25,230   |
| Bank deposit (USD)       |   | 8,065,354 |      |   | -        |
| **Total**                |   | $         | 8,583,680 |   | $   | 89,366 |
|                          |        |           |           |        |          |  |

 

Bank            deposit accounts are located in a Kazakhstani Bank (Center Credit Bank). Bank deposits            earn interest from 3% to 8% annually based on the length of time the funds are left on            deposit. Of the total bank deposits, only $100,000 is restricted. The $100,000 is            restricted for a term of 15 months. This amount is shown as other non-current assets.            The balances of the bank deposits are immediately available to the Company.

 

F-15

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

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

             

Property, plant and mineral interests consist of the            following:

 

| *December 31,*                   |    | **2006**         |   |   | **2005**         |
|----------------------------------|---------|------------------|--------|--------|------------------|
| Buildings                        | $  | 2,156,326   |   | $      | 2,062,865   |
| Machinery and equipment          |    | 3,474,858   |   |   | 970,005     |
| Other fixed assets               |    | 69,665      |   |   | 53,856      |
| Unproved mineral property rights |    | 8,313,744   |   |   | 7,909,351   |
|                             |    | 14,014,593  |   |   | 10,996,077  |
| Accumulated depreciation         |    | (144,030)        |   |   | (57,709)         |
| **Net Property and Equipment**   | $       | 13,870,563  |   | $      | 10,938,368  |

 

The            increase in property, plant and mineral interests is principally related to the            purchase of equipment by the Company in May 2006 from a third party for $2,000,000,            which is used in KKM’s pilot plant. The equipment was placed in service and            capitalized in October, 2006. The $2,000,000 capitalized assets represents only            tangible equipment that have alternative uses either in other research and development            projects or for other nickel ore processing technologies such a pyrometallurgical            technologies or hydrometallurgical technologies.

 

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

 

***Gornostai Deposit***

 

Kaznickel acquired its interest in the Contract on Exploration and            Development of Gornostai Cobalt and Nickel Deposit (the “Contract”) issued            by the Ministry of Energy and Mineral Resources of the Republic of Kazakhstan            (“MEMR”) dated February 26, 2004. By virtue of the Contract, Kaznickel            acquired the right to exploit the mineral property including the right to explore,            develop and produce the cobalt and nickel mineral resources on the Deposit through            February 26, 2026. The Company has the right to re-negotiate the contract at that time            for an additional 30 years. The government of Kazakhstan retains the title to the            property; however, the Company’s mineral interests are considered to be tangible            assets. The Company capitalized the acquisition costs of its mineral interest upon the            purchase business combination with Kaznickel. The allocated purchase price included a            capitalized amount of an acquired asset retirement obligation. While the property is            not in production, the asset retirement cost is depleted over the life of the contract            from the date of acquisition.

 

The            Contract provides the Company certain rights and also imposes certain obligations and            commitments. The rights include exploration through February 2008, and development and            production of minerals through February 26, 2026. The Company may transfer its right to            third parties in accordance with Kazakh laws and regulations and has a right to            renegotiate an extension of the Contract. Significant rights and obligations and            commitments of the Contract include monetary commitments for exploration of $1,105,100            in 2006 and $1,576,480 in 2007, and expenditures to support social projects amounting            to $300,000 during the production stage. In addition, the Company was required to pay a            fee of $2,000 upon award of the Contract, and a fee for the use of Kazakh owned            technical data of $735,400 of which $4,179 was paid on award of the Contract and            $731,221 will be due upon a finding of commercial deposits. Royalties of 0.5% of ores            extracted and sold will be required. The Contract subjects the Company to pay regular            income tax of 30 percent and requires an excess profits tax of 15 to 60 percent if its            net profits exceed 20 percent of gross profit. Obligations also include the            establishment and funding of a reclamation fund that includes the cost of removing            buildings and equipment used in the Deposit area. The Company is also required to            comply with Kazakh environmental laws and regulations.

 

F-16

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

 

***Kempirsai Deposit***

 

Bekem acquired two contracts to explore for and extract minerals in            connection with the purchase of KKM. One contract is for the exploration and extraction            of nickel and cobalt ore from deposits located in an approximately 575,756 acre site in            the northwest area of the Republic of Kazakhstan approximately 130 kilometers northwest            of the city of Aktobe, Kazakhstan, near the town of Badamsha, referred to as the            “Kempirsai” deposit through October 12, 2011. The other contract is for the            exploration and extraction of Mamyt brown coal at a site located within 40 kilometers            of the Kempirsai deposit through December 11, 2018. The contracts may be extended upon            agreement between KKM and the Geology and Minerals Resources Committee of the Ministry            of Energy and Minerals Resources of the Republic of Kazakhstan. The Kempirsai contract            requires the Company to pay royalty payments equal to 2.21% of gross ore sales. The            Mamyt brown coal contract requires a royalty payment equal to nine tenths of one            percent (0.9%) of gross coal sales. Both contracts require the Company to pay an excess            profits tax ranging from 4 to 30 percent based upon the reaching of an internal rate of            return (as defined in the contracts) ranging from 22 to 30 percent. The allocated            purchase price of the mineral interest included a capitalized amount of an acquired            asset retirement obligation.

 

| **NOTE 5 – INCOME TAXES** |
|---------------------------------|

             

In            accordance with the laws and regulations of the Republic of Kazakhstan income taxes are            calculated at the statutory rate of 30 percent. Net operating losses for development            companies in the exploration and development may be carried forward for the seven            subsequent years from the date the losses are incurred. Therefore, the Company has            deferred tax assets due to the savings of income tax in future periods. However, the            Company assessed the recoverability of these deferred tax assets and created a            provision against them until it has more evidence of its recoverability in the future            periods.

 

Deferred tax assets and liabilities were as follows:

 

| *December 31,*                   |    | **2006**        |   |    | **2005**      |
|----------------------------------|---------|-----------------|--------|---------|---------------|
|                             |    |            |   |    |          |
| Tax loss carryforward            | $       | 2,590,511  |   | $  | 747,485  |
| Property and equipment           |    | (704,645)       |   |    | (803,003)     |
| Asset retirement obligation      |    | 308,263    |   |    | 250,152  |
| Unproved mineral property rights |    | (2,503,728)     |   |    | (2,080,040)   |
| Asset retirement cost            |    | (169,521)       |   |    | (149,837)     |
| Grant compensation expense       |    | 45,475     |   |    | -        |
| Long-term debt and discount      |    | -          |   |    | (239,949)     |
| **Net Deferred Tax Liabilities** | $  | (433,645)       |   | $  | (2,275,192)   |
|                             |    |            |   |    |          |

 

The            following is a reconciliation of the amount of tax that would result from applying the            federal rate to pretax income with the provision for income taxes at December 31, 2006            and 2005:

 

F-17

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

| *For the Years Ended December 31,*     |    | **2006**    |   |   | **2005**  |
|----------------------------------------|---------|-------------|--------|--------|-----------|
|                                   |    |        |   |   |      |
| Tax at US Federal statutory rate (34%) | $       | (2,016,909) |   | $      | (656,513) |
| Change in valuation allowance          |    | -      |   |   | (107,721) |
| Effect of higher effective tax rates   |    | -      |   |   | (153,004) |
| **Deferred Tax Benefit**               | $  | (2,016,909) |   | $      | (917,238) |

 

 

**NOTE            6 – RELATED PARTY TRANSACTIONS**

 

On            December 2, 2004, the Company borrowed $92,308 from CJSC Kazmorgeophysica, a Kazakh            company related by virtue of several common shareholders. The short-term loan is            denominated in Kazakh Tenge, interest free and was due on its original terms by            December 31, 2004. During March 2005, the Company borrowed an additional $99,798 from            CJSC Kazmorgeophysica, as a Kazakh Tenge denominated, interest-free, due on demand            note. In addition, during 2005 the Company received advances in the amount of $26,866            from certain owners, which are short-term in nature and payable upon demand. The note            was paid off in 2005.

 

During 2005 and 2006, the Company borrowed $3,998,874 from KMI per an            agreement dated August 8, 2005, between KMI and KKM, for the purpose of assisting KKM            in funding its work requirements, including generation of geological data, under its            mineral extraction contract. The former owners of Kazakh Metals, Inc. were funding this            agreement.

 

Also, during 2005 and 2006 the Company borrowed $329,000 from            shareholders to fund the U.S. administrative operations. The notes were due on demand            and accrued interest at 3 percent. The notes were paid off in 2006.

 

F-18

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

**NOTE 7 – LONG-TERM NOTES PAYABLE, NET OF            DISCOUNT**

 

Long-term notes payable, net of discount, consists of the            following:

 

| *December 31,*                                                                |   | **2006**                                                                                     |            | **2005**                                                 |
|-------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------|-----------------|----------------------------------------------------------|
| Note payable to a company bearing interest at                            0%;  |   |                                                                                         |            |
| imputed interest of 22%; denominated in U.S.                                  |   |                                                                                         |            |
| dollars; due April 2009; unsecured;                                           |   | $               - |            | $       497,818  |
| Note payable to a company bearing interest at                            3%;  |   |                                                                                         |            |
| imputed interest of 22%; denominated in U.S.                                  |   |                                                                                         |            |
| dollars; due April 2010; unsecured;                                           |   | -                                                                                            |            | 550,000                                             |
| Note payable to a company bearing interest at                            0%;  |   |                                                                                         |            |
| imputed interest of 22%; denominated in U.S.                                  |   |                                                                                         |            |
| dollars; due August 2008; unsecured;                                          |   | -                                                                                            |            | 485,951                                             |
| Note payable to a company bearing interest at                                 |   |                                                                                         |            |                                                     |
| LIBOR plus 2% (6.39% at December 31, 2005);                                   |   |                                                                                         |            |
| imputed interest of 22%; denominated in U.S.                                  |   |                                                                                         |            |
| dollars; due March 2010; unsecured;                                           |   | -                                                                                            |            | 60,000                                              |
| Notes payable to companies bearing interest at                            0%; |   |                                                                                         |            |
| imputed interest of 22%; due on demand;                            unsecured; | -      |                                                                                         | 3,018,032  |
| Note payable to a company bearing interest at                            14%; |   |                                                                                         |            |
| due on demand; unsecured;                                                     |   | -                                                                                            |            | 29,709                                              |
| Note payable to a company bearing interest at                            16%; |   |                                                                                         |            |
| due on demand; unsecured;                                                     |   | -                                                                                            |            | 52,286                                              |
| Note payable to a company bearing interest at                            5%;  |   |                                                                                         |            |
| due on demand; unsecured;                                                     |   | -                                                                                            |            | 560,203                                             |
| Total Long-term Debt                                                          |   | -                                                                                            |            | 5,253,999                                           |
| Less: Current Portion                                                         |   | -                                                                                            |            | (3,660,230)                                              |
| Less: Debt discount                                                           |   | -                                                                                            |            | (796,591)                                                |
| **Long-term Debt - Net of Current                            Portion**        |   | $               - |            | $       797,178  |

 

During 2006, the Company repaid its notes payable in the amount of            $7,870,993, which includes additional borrowings made during 2006, and interest of            $416,394.

 

F-19

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

**NOTE 8 – LONG-TERM NOTES PAYABLE – RELATED            PARTIES**

 

Long-term notes payable to related parties consists of the            following:

 

| *December 31,*                                                                 |   | **2006**                                                                                     |   | **2005**                     |
|--------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------|--------|------------------------------|
| Notes payable to related companies bearing                            interest |   |                                                                                         |   |
| at 6.29%; due August 2008; unsecured;                                          |   | $               - |   | $   1,710,012 |
| Note payable to related company bearing                            interest    |   |                                                                                         |   |
| at 6.29%; due August 2010; unsecured;                                          |   | -                                                                                            |   | 2,288,000                    |
| Notes payable to related companies bearing                            interest |   |                                                                                         |   |
| at 6.29%; due May 2008; unsecured;                                             |   | -                                                                                            |   | 77,000                       |
| Total Long-term Debt                                                           |   | -                                                                                            |   | 4,075,012                    |
| Less: Current Portion                                                          |   | -                                                                                            |   | -                            |
| **Long-term Debt - Net of Current                            Portion**         |   | $               - |   | $   4,075,012 |

 

During 2005 and 2006, the Company borrowed $3,998,874 from KMI per an            agreement dated August 8, 2005, between KMI and KKM, for the purpose of assisting KKM            in funding its work requirements, including generation of geological data, under its            mineral extraction contract. The former owners of Kazakh Metals, Inc. were funding this            agreement.

 

Funds borrowed from shareholders and former owners of KMI bear interest            at the rate of 3% per annum, as amended in October 2006. During 2006, the Company            repaid all related party debts amounting to $4,326,912 and interest of            $112,702.

 

**NOTE            9 – ASSET RETIREMENT OBLIGATION**

 

Upon            the purchase of Kaznickel on September 22, 2004 and KKM on June 1, 2005, the Company            recorded the effects of asset retirement obligations in accordance with SFAS            No. 143, “Accounting for Asset Retirement Obligations,” and related            interpretations, which requires entities to record the fair value of a liability for an            asset retirement obligation when it is incurred. The Company is required under the            contracts with the Geology and Minerals Resources Committee of the Ministry of Energy            and Minerals Resources (MEMR) of the Republic of Kazakhstan, to remediate the            properties from the effects of the open pit mining processes. The standard applies to            legal obligations associated with the retirement of long-lived assets that result from            the acquisition, construction, development or normal use of the asset. The            Company’s asset retirement obligations relate primarily to the obligation to fill            mining pits and restore surface conditions at the conclusion of the term of the            Contracts.

 

SFAS            No. 143 requires that the fair value of a liability for an asset retirement            obligation be recognized in the period in which it is incurred, if a reasonable            estimate of fair value can be made. When the liability is initially recorded, the            related cost is capitalized by increasing the carrying amount of the related mineral            interest rights. Over time, the liability is accreted upward for the change in its            present value each period until the obligation is settled. The initial capitalized cost            is amortized as a component of mineral rights interests as described in Note            4.

 

F-20

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

The            reconciliation of the asset retirement obligation is as follows:

 

| *December 31,*                    |   | **2006** |   |    | **2005** |
|-----------------------------------|--------|----------|--------|---------|----------|
| Balance at beginning of year      | $      | 833,840  |   | $       | 675,460  |
| Liabilities incurred              |   | 44,650   |   |    | 97,748   |
| Accretion expense during the year |   | 72,865   |   |    | 60,632   |
| **Asset Retirement Obligation**   | $      | 951,355  |   | $  | 833,840  |

 

 

**NOTE            10 – SHAREHOLDERS’ EQUITY**

 

***Shares Issued for Cash***– On            August 8, 2005 the Company issued 61,200,000 shares of common stock for cash proceeds            of $100,000, or $0.02 per share.

 

On            July 14, 2006, the Company closed a private placement of 8,000,000 units at $3.50 per            unit, each unit consisting of three shares of restricted common stock and one warrant            to purchase one share of common stock for two dollars. The private placement resulted            in the issuance of 24,000,000 restricted common shares and warrants to purchase            8,000,000 common shares to two non-U.S. investors for $28,000,000. These issuances did            not result in a change in control of the Company.

 

From            the total proceeds, the Company paid the placement agent, Aton Securities, Inc., a cash            fee totaling 5% of the total proceeds raised, or $1,400,000. The Company also issued to            the placement agent a warrant to purchase up to 2,400,000 shares of restricted common            stock. The exercise price of this warrant is $1.17 per share. The warrant is            immediately exercisable and will expire eighteen months from the date            granted.

 

Also, the Company incurred legal and consulting expenses of            $153,487.

 

The            following summarizes warrant activity for the year ended December 31, 2006:

 

|                             |   |         |   |   | **Weighted-**      |
|----------------------------------|--------|--------------|--------|--------|--------------------|
|                             |   |         |   |   | **Average**        |
|                             |   | **Warrants** |   |   | **Exercise Price** |
| Outstanding at beginning of year | $      | -            |   | $      | -                  |
| Issued                           |   | 10,400,000   |   |   | 1.81               |
| Expired                          |   | -            |   |   | -                  |
| Exercised                        |   | -            |   |   | -                  |
| **Outstanding at End of Year**   | $      | 10,400,000   |   | $      | 1.81               |

 

F-21

 

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

The            following table summarizes information about warrants outstanding at December 31,            2006:

 

|               |   |            |   | **Weighted**     |   |         |
|--------------------|--------|-----------------|--------|------------------|--------|--------------|
|               |   |            |   | **Average**      |   | **Weighted** |
|               |   |            |   | **Remaining**    |   | **Average**  |
| **Range of**       |   | **Number**      |   | **Contractual**  |   | **Exercise** |
| **Exercise Price** |   | **Outstanding** |   | **Life (Years)** |   | **Price**    |
| $ 1.17             |   | 2,400,000       |   | 1.01             |   | $ 1.17       |
| $ 2.00             |   | 8,000,000       |   | 1.51             |   | $ 2.00       |

 

***Shares Issued for Acquisition of the Minority            Interests***– On August 23, 2005, and prior to its            combination with the Company, BMI issued 588,888 shares of common stock in exchange for            the cancellation of 2,000,000 options to purchase common stock at $0.10 per share. BMI            treated the cancellation, for accounting purposes, as a modification of 588,888 of the            options to options with an exercise price of zero, and the cancellation of the            remaining options. The modification resulted in a charge to operations of $19,426, the            difference between the fair value of the options before and after the modification. The            issued shares were included in the 17,888,888 shares considered issued for the            acquisition of the minority shareholders’ interests in BMI on October 24,            2005.

 

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

 

As            of December 31, 2006, there was $2,034,355 of total unrecognized compensation cost. The            cost is expected to be recognized over a period of 3 years. No shares were vested as of            December 31, 2006. The Company recognized $77,735 of compensation expense for the year            ended December 31, 2006.

 

F-22

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

**NOTE            11 – SUPPLEMENTAL CASH FLOW DISCLOSURES**

 

| **Supplemental Disclosure of Cash Flow                            Information:** | **December 31,**                                                                             |
|----------------------------------------------------------------------------------|----------------------------------------------------------------------------------------------|
|                                                                             | **2006**                                                                                     |   | **2005** |
| Cash paid for interest                                                           | $       529,096                                           |   | $       149,256  |
| Cash paid for income taxes                                                       | -                                                                                            |   | -  |
|                                                                             |                                                                                         |   |   |
| **Non-cash Investing and Financing                            Activities:**      | **December 31,**                                                                             |
|                                                                             | **2006**                                                                                     |   | **2005** |
| Fair value of the assets acquired                                                | $               - |   | $    3,640,160  |
| Fair value of intangible mineral interest                            rights      | -                                                                                            |   | 7,198,372  |
| Cash paid for equity interests                                                   | -                                                                                            |   | (100,419) |
| Liabilities assumed                                                              | -                                                                                            |   | (10,656,105) |
| Fair value of shares issued for acquisitions                                     | -                                                                                            |   | (333,294) |
| Share-based compensation arrangements                                            | 2,112,090                                                                                    |   | -  |

 

 

**NOTE            12 – COMMITMENTS AND CONTINGENCIES**

 

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

 

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

 

***Tax Matters***– The local and            national tax environment in the Republic of Kazakhstan is subject to change and            inconsistent application, interpretation and enforcement. Non-compliance with            Kazakhstan laws and regulations, as interpreted by the Kazakh authorities, can lead to            the imposition of fines, penalties and interest.

 

***Environmental Matters***–            Extensive national, regional and local environmental laws and regulations in Kazakhstan            affect the Company’s operations. These laws and regulations set various standards            regulating certain aspects of health and environmental quality provide for user fees,            penalties and other liabilities for the violation of these standards and establish, in            some circumstances, obligations to remediate current and former facilities and off-site            locations. The Company believes it is currently in compliance with all existing            Republic of Kazakhstan environmental laws and regulations. However, as new            environmental laws and legislation are enacted and the old laws are repealed,            interpretation, application and enforcement of the laws may become inconsistent.            Compliance in the future could require significant expenditures, which may adversely            affect the Company’s operations.

 

F-23

----

**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

 

***Due to the Government of the Republic of Kazakhstan            –***In connection with the Company’s            acquisition of the exploration contract covering the Gornostai deposit, it is required            to repay the Republic of Kazakhstan for historical costs incurred in undertaking            geological and geophysical studies and infrastructure improvements. The repayment terms            of this obligation will not be determined until the Company applies for and is granted            a contract by the Republic of Kazakhstan to engage in commercial production. That            amount is expected to be $731,221 and has not been recorded as a liability. Under the            current contract, once the Company determines the property contains commercially            producible reserves, and desires to commence commercial production, it must apply for            such right prior to the expiration of its exploration and development rights in            February 2026. The Company anticipates it will apply for a commercial production            contract within the next 1-3 years. Of course, there is no guarantee when or if the            Company will discover commercially producible reserves within the Gornostai deposit.            Should the Company decide not to pursue a commercial production contract, then it can            relinquish the Gornostai deposit to the Republic of Kazakhstan in satisfaction of this            obligation.

 

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

 

***Operating Leases***– Bekem            leases approximately 400 square feet of office space located at 324 South 400 West,            Suite 225, Salt Lake City, Utah 84101 for its administrative and registered office in            the United States. The Company pays annual rents of approximately $7,800 for this space            pursuant to a lease agreement that expires December 31, 2007 with an option to extend            the lease for an additional year.

 

The            Company also maintains a representative office in Almaty, Kazakhstan, where it leases            approximately 1,575 square feet of office space. The lease agreement expires on            December 31, 2007. The monthly lease payment is $5,250. Under the terms of the lease            agreement, the owner of the space could terminate the lease at any time and require the            Company to vacate the premises.

 

Kaznickel LLP rents an office (approximately 1,840 square feet) in            Semei, Kazakhstan, for approximately $4,000 per month. Semei is the closest city to the            Gornostai deposit. This lease agreement expires in May 2007. Kaznickel also rents            approximately 4,450 square feet of warehouse space in Semei for $4,000 per month.            Kaznickel uses this space to store test ore. Also, Kaznickel LLP rents an office            (approximately 350 square feet) in Astana, Kazakhstan, for approximately $1,600 per            month. This space is leased on a year-to-year basis. If at any time the owner of this            space decides they need or want the space for other purposes, Kaznickel has no right to            continue to occupy the space and could be forced to move.

 

KKM            rents approximately 1,260 square feet of office space in Aktobe, Kazakhstan. KKM pays            approximately $4,000 per month for this space under a one-year lease agreement. This            space is leased on a year-to-year basis.

 

Rent            expense for the years ended December 31, 2006 and 2005 was $194,854 and $103,160,            respectively. All leases are due within the next year.

 

**NOTE            13 – RESTATEMENT OF FINANCIAL STATEMENTS**

 

Subsequent to the issuance of the December 31, 2006 and 2005 financial            statements, the Company realized that its financial statements needed to be restated to            correct the reporting of mining transactions to be consistent with SEC Industry Guide            7,*Description of Property by Issuers Engaged or to Be Engaged            in Significant Mining Operations*that defines a production            stage enterprise as one that has reserves that are proven or probable as evidenced by            an acceptable reserve report. The Company has not yet received its reserve report,            therefore, under Industry Guide 7 it is an exploration stage enterprise. The Company            had not considered itself a development or exploration stage company due to the history            of production of the sites under mining licenses during the 1980s and 1990s and using            the reports evidencing commercial ore bodies that were developed during the Soviet era            under different methods than those currently used to support the definition of            “reserves” under Industry Guide 7. The Company’s licenses granted by            the MEMR for the Kempirsai and Mamyt deposits are production licenses and require the            Company to extract certain quantities of nickel, cobalt and coal in order to retain the            licenses, which were previously reported as production activity. The Company expects to            obtain acceptable reserve reports early in 2008.

 

F-24

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**BEKEM METALS, INC. AND SUBSIDIARIES**

**(An Exploration Stage Company)**

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**DECEMBER 31, 2006 AND 2005**

 

In            order to comply with the reporting under Industry Guide 7 for the years 2006 and 2005,            a column for transactions from “inception to date” has been added to the            statements of operations and cash flows, stripping costs have been expensed rather than            capitalized, and revenues and costs of products sold have been reclassified to offset            certain direct mining expenses which are included in exploratory costs, depreciation            and amortization expenses were also reclassified as exploratory costs. Also, the other            income (expense) as originally filed included disposals of inventory, which were            reclassified as exploratory costs and revenue from services were reclassified as other            income.

 

In            addition, the reporting of deferred compensation costs has been corrected to properly            allocate the costs to the appropriate years. The change in the deferred compensation,            as well as the changes to the net loss caused the deferred tax liabilities to decrease.            Also, the number of weighted-average shares outstanding at December 31, 2006, was            corrected.

 

The            effects of the restatements are as follows:

 

| **Balance Sheets**                |   |                                         |   |            |   |                                         |
|-----------------------------------|--------|----------------------------------------------|--------|-----------------|--------|----------------------------------------------|
|                              |   | **As Previously**                            |   | **Effect of**   |   |                                         |
|                              |   | **Reported**                                 |   | **Restatement** |   | **As Restated**                              |
| **December 31, 2006**             |   |                                         |   |            |   |                                         |
|                              |   |                                         |   |            |   |                                         |
| Inventories                       |   | $     377,018  |   | $(191,955)      |   | $     185,063  |
| Deferred compensation             |   | 450,267                                 |   | 307,653    |   | 757,920                                 |
| Non-current deferred compensation |   | 1,584,088                               |   | (381,501)       |   | 1,202,587                               |
| Deferred tax liabilities          |   | 513,385                                 |   | (79,740)        |   | 433,645                                 |
| Accumulated deficit               |   | $(6,036,286)                                 |   | $(186,063)      |   | $(6,222,349)                                 |
|                              |   |                                         |   |            |   |                                         |
|                              |   | **As Previously**                            |   | **Effect of**   |   |                                         |
|                              |   | **Reported**                                 |   | **Restatement** |   | **As Restated**                              |
| **December 31, 2005**             |   |                                         |   |            |   |                                         |
|                              |   |                                         |   |            |   |                                         |
| Inventories                       |   | $     337,030  |   | $(96,976)       |   | $     240,054  |
| Deferred tax liabilities          |   | 2,304,285                               |   | (29,093)        |   | 2,275,192                               |
| Accumulated deficit               |   | $(1,448,344)                                 |   | $(67,883)       |   | $(1,516,227)                                 |
|                              |   |                                         |   |            |   |                                         |

 

 

----

| **Statements of Operations**                |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
|---------------------------------------------|--------|---------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------|
|                                        |   | **As Previously**                                                               |   | **Effect of**                                                                                                              |   |                                                                                                                 |
|                                        |   | **Reported**                                                                    |   | **Restatement**                                                                                                            |   | **As Restated**                                                                                                      |
| **For the Year Ended December 31, 2006**    |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Revenue                                     |   | $        105,304                   |   | $        (105,304)                                                                 |   | $               -                    |
| Cost of product sold                        |   | 58,980                                                                     |   | (58,980)                                                                                                                   |   | -                                                                                                               |
| Exploratory costs                           |   | 1,118,115                                                                  |   | 352,132                                                                                                               |   | 1,470,247                                                                                                       |
| Depreciation and amortization               |   | 108,125                                                                    |   | (108,125)                                                                                                                  |   | -                                                                                                               |
| Grant compensation expense                  |   | 77,735                                                                     |   | 73,848                                                                                                                |   | 151,583                                                                                                         |
| Interest income                             |   | -                                                                          |   | 85,337                                                                                                                |   | 85,337                                                                                                          |
| Other income (expense)                      |   | (107,644)                                                                       |   | 110,015                                                                                                               |   | 2,371                                                                                                           |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Net Loss Before Minority Interest and Taxes |   | (6,554,203)                                                                     |   | (168,828)                                                                                                                  |   | (6,723,031)                                                                                                          |
| Deferred tax benefit                        |   | 1,966,261                                                                  |   | 50,648                                                                                                                |   | 2,016,909                                                                                                       |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Net Loss                                    |   | $    (4,587,942)                                            |   | $        (118,180)                                                                 |   | $(4,706,122)                                                                                                         |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Basic Loss per Common Share                 |   | $            (0.04) |   | $                   -  |   | $        (0.04)                                                              |
| Weighted-Average Shares used in             |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Basic Loss per Common Share                 |   | 111,266,970                                                                |   | 213,657                                                                                                               |   | 111,480,627                                                                                                     |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
|                                        |   | **As Previously**                                                               |   | **Effect of**                                                                                                              |   |                                                                                                                 |
|                                        |   | **Reported**                                                                    |   | **Restatement**                                                                                                            |   | **As Restated**                                                                                                      |
| **For the Year Ended December 31, 2005**    |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Revenue                                     |   | $        148,549                   |   | $        (148,549)                                                                 |   | $                  -  |
| Cost of product sold                        |   | 74,205                                                                     |   | (74,205)                                                                                                                   |   |                                                                                                                 |
| General and administrative expenses         |   | 1,018,633                                                                  |   | (485)                                                                                                                      |   | 1,018,148                                                                                                       |
| Exploratory costs                           |   | 623,446                                                                    |   | 74,050                                                                                                                |   | 697,496                                                                                                         |
| Depreciation and amortization               |   | 48,233                                                                     |   | (48,233)                                                                                                                   |   |                                                                                                                 |
| Other income                                |   | 16,790                                                                     |   | 2,700                                                                                                                 |   | 19,490                                                                                                          |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Net Loss Before Minority Interest and Taxes |   | (2,110,825)                                                                     |   | (96,976)                                                                                                                   |   | (2,207,801)                                                                                                          |
| Deferred tax benefit                        |   | 888,145                                                                    |   | 29,093                                                                                                                |   | 917,238                                                                                                         |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Net Loss                                    |   | $     (1,203,254)                                      |   | $           (67,883)                                                |   | $   (1,271,137)                                                                                       |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Basic Loss per Common Share                 |   | $            (0.02) |   | $             (0.01)                                      |   | $            (0.03)                                      |
| Weighted-Average Shares used in             |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
| Basic Loss per Common Share                 |   | 48,645,053                                                                 |   | -                                                                                                                          |   | 48,645,053                                                                                                      |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |
|                                        |   |                                                                            |   |                                                                                                                       |   |                                                                                                                 |

 

 

----

| **Statements of Cash Flows**                |   |              |   |                                                                                               |   |            |
|---------------------------------------------|--------|-------------------|--------|----------------------------------------------------------------------------------------------------|--------|-----------------|
|                                        |   | **As Previously** |   | **Effect of**                                                                                      |   |            |
|                                        |   | **Reported**      |   | **Restatement**                                                                                    |   | **As Restated** |
| **For the Year Ended December 31, 2006**    |   |              |   |                                                                                               |   |            |
|                                        |   |              |   |                                                                                               |   |            |
| Net loss                                    |   | $(4,587,942)      |   | $   (118,180)                                                                       |   | $(4,706,122)    |
| Adjustments to reconcile net loss to        |   |              |   |                                                                                               |   |            |
| net cash provided by operating activities:  |   |              |   |                                                                                               |   |            |
| Depreciation and amortization               |   | 108,125      |   | 9,377                                                                                         |   | 117,502    |
| Deferred tax benefit                        |   | (1,966,261)       |   | (50,648)                                                                                           |   | (2,016,909)     |
| Stock grant compensation expense            |   | 77,735       |   | 73,848                                                                                        |   | 151,583    |
| Loss on disposal of property and equipment  |   | 68,305       |   | (9,377)                                                                                            |   | 58,928     |
| Change in operating assets and liabilities: |   |              |   |                                                                                               |   |            |
| Inventories                                 |   | (21,886)          |   | 69,871                                                                                        |   | 47,985     |
| Prepaid expenses and other current assets   |   | (54,149)          |   | 25,109                                                                                        |   | (29,040)        |
| Net Cash From Operating Activities          |   | $(5,617,395)      |   | $               -  |   | $(5,617,395)    |
|                                        |   |              |   |                                                                                               |   |            |
|                                        |   | **As Previously** |   | **Effect of**                                                                                      |   |            |
|                                        |   | **Reported**      |   | **Restatement**                                                                                    |   | **As Restated** |
| **For the Year Ended December 31, 2005**    |   |              |   |                                                                                               |   |            |
|                                        |   |              |   |                                                                                               |   |            |
| Net loss                                    |   | $(1,203,254)      |   | $     (67,883)                                                            |   | $(1,271,137)    |
| Adjustments to reconcile net loss to        |   |              |   |                                                                                               |   |            |
| net cash provided by operating activities:  |   |              |   |                                                                                               |   |            |
| Deferred tax benefit                        |   | (888,145)         |   | (29,093)                                                                                           |   | (917,238)       |
| Change in operating assets and liabilities: |   |              |   |                                                                                               |   |            |
| Inventories                                 |   | (67,062)          |   | 97,461                                                                                        |   | 30,399     |
| Accounts payable                            |   | (24,368)          |   | 76,749                                                                                        |   | 52,381     |
| Accrued expenses                            |   | -            |   | (77,234)                                                                                           |   | (77,234)        |
| Net Cash From Operating Activities          |   | $(1,757,443)      |   | $               -  |   | $(1,757,443)    |
|                                        |   |              |   |                                                                                               |   |            |

 

**Note            14 – SUBSEQUENT EVENT (UNAUDITED)**

             

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

 

 

F-27

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