United States Securities and Exchange Commission Washington, DC 20549 FORM 10-QSB Quarterly Report under Section 13 or 15(d) of the Securities Exchange Act of 1934 For the Nine Months Ended Commission File Number September 30, 2006 0-50218 BEKEM METALS, INC. (Exact name of registrant as specified in its charter) UTAH (State or other jurisdiction of incorporation or organization 87-0669131 (I.R.S. Employer Identification No.) 170 Tchaikovsky Street, 4th Floor, Almaty, Kazakhstan 050000 (Address of principal executive offices) +7 3272 582 386 (Registrant's telephone number, including area code) Securities registered pursuant to Section 12 (b) of the 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 report(s), and (2) has been subject to such filing requirements for the past 90 days. (1) Yes [X] No [ ] Check whether the Issuer is a shell company (as defined by Rule 12b-2 of the Exchange Act) Yes [ ] No [X] As of September 30, 2006, the issuer had 124,088,888 shares of its $0.001 par value common stock outstanding.INDEX Bekem Metals, Inc. Form 10-QSB For The Nine Months Ended September 30, 2006 Part I. Financial Information Page ---- Item 1. Financial Statements Condensed Consolidated Balance Sheets (Unaudited) as of September 30, 2006 and December 31, 2005 2 Condensed Consolidated Statements of Operations (Unaudited) for the Nine Months and Three Months Ended September 30, 2006 and 2005 3 Condensed Consolidated Statements of Cash Flows (Unaudited) for the Nine Months Ended September 30, 2006 and 2005 4 Notes to the Unaudited Condensed Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis 18 Item 3. Controls and Procedures 31 Part II. Other Information Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 32 Item 6. Exhibits 34 Signatures PART I. FINANCIAL INFORMATION Item 1. Financial Statements BEKEM METALS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED) September 30, December 31, 2006 2005 ------------------------------------------------------------------------------------------------------------------------------ ASSETS Current Assets Cash $ 8,496,223 $ 89,366 Trade accounts receivable 11,794 18,657 Prepaid expenses and other current assets 2,826,533 - Related party receivables 14,072 42,393 Inventories 378,360 337,030 VAT recoverable 141,495 61,936 ------------------------------------------------------------------------------------------------------------------------------ Total Current Assets 11,868,477 549,382 ------------------------------------------------------------------------------------------------------------------------------ Long-term deferred expenses 8,101 37,606 Property, plant and equipment (net of accumulated 5,188,951 3,061,290 depreciation of $56,089 and $25,436) Other assets 131,999 1,635 Mineral property rights net 8,243,226 7,877,078 ------------------------------------------------------------------------------------------------------------------------------ Total Assets $ 25,440,754 $ 11,526,991 ============================================================================================================================== LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT) Current Liabilities Accounts payable $ 740,926 $ 424,306 Accrued expenses 489,780 276,291 Due to related party - 5,518 Current portion of long-term notes payable - 3,660,230 ------------------------------------------------------------------------------------------------------------------------------ Total Current Liabilities 1,230,706 4,366,345 Deferred tax liabilities 2,473,823 2,304,285 Notes payable - 797,178 Notes payable - related parties 90,000 4,075,012 Asset retirement obligation 931,656 833,840 ------------------------------------------------------------------------------------------------------------------------------ Total Liabilities 4,726,185 12,376,660 ------------------------------------------------------------------------------------------------------------------------------ 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, 124,088,888 and 100,089,888 shares outstanding 124,089 100,089 Additional paid-in capital 26,893,722 515,879 Accumulated deficit (6,286,730) (1,448,344) Cumulative translation adjustment (16,512) (17,293) ------------------------------------------------------------------------------------------------------------------------------ Total Shareholders' Equity (Deficit) 20,697,210 (849,669) ------------------------------------------------------------------------------------------------------------------------------ Total Liabilities and Shareholders' Equity (Deficit) $ 25,440,754 $ 11,526,991 ============================================================================================================================== The accompanying notes are an integral part of these financial statements. 2 BEKEM METALS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) For the three months ended For the nine months ended September 30, September 30, -------------------------------------------------------------------- 2006 2005 2006 2005 ----------------------------------------------------------------------------------------------------------------- Revenue $ - $ - $ 69,527 $ - ----------------------------------------------------------------------------------------------------------------- Operational Expenses Cost of product sold - - 65,871 - General and administrative expenses 1,287,652 168,575 2,209,740 358,519 Research and development costs - - 391,307 - Exploratory costs 264,688 87,609 382,953 275,175 Accretion expense 18,758 13,915 54,901 41,746 Depreciation expense 12,695 7,629 48,423 23,781 ----------------------------------------------------------------------------------------------------------------- Total Expenses 1,583,793 277,728 3,153,195 699,221 ----------------------------------------------------------------------------------------------------------------- Loss From Operations (1,583,793) (277,728) (3,083,668) (699,221) Other Income (Expense) Other income (37,556) - (109,267) - Interest expense (1,109,062) - (1,474,274) - Translation adjustment 90,045 - (30,269) - Grant expense - - - (3,108) Grant revenue - - - 3,108 Exchange rate gain (loss) (1,031,056) 835 (140,908) 3,920 ----------------------------------------------------------------------------------------------------------------- Net Other Income (2,087,629) 835 (1,754,718) 3,920 ----------------------------------------------------------------------------------------------------------------- Net Loss Before Taxes (3,671,422) (276,893) (4,838,386) (695,301) Deferred tax benefit - - - - ----------------------------------------------------------------------------------------------------------------- Net Loss $ (3,671,422) $ (276,893) $ (4,838,386) $ (695,301) ================================================================================================================= Basic Loss per Common Share $ (0.03) $ (0.01) $ (0.05) $ (0.02) ================================================================================================================= Weighted-Average Shares used in Basic Loss per Common Share 120,436,714 38,543,236 106,946,031 38,387,970 ================================================================================================================= ================================================================================================================= Diluted Loss per Common Share $ (0.03) $ (0.01) $ (0.04) $ (0.02) ================================================================================================================= Weighted-Average Shares used in Diluted Loss per Common Share 129,254,105 38,543,236 109,917,459 38,387,970 ================================================================================================================= The accompanying notes are an integral part of these financial statements. 3 BEKEM METALS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED) For the nine months ended September 30 2006 2005 --------------------------------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities Net loss $ (4,838,386) $ (695,301) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 37,396 5,938 Accretion expense on asset retirement obligations 54,901 59571 Shares issued on option modification - 19,426 Foreign currency exchange gain 41,682 (7,317) Loss on disposal of property and equipment 40,191 - Change in operating assets and liabilities: Accounts receivable 7,370 - Inventories (24,469) (4,610) Prepaid expenses and other current assets (709,570) 13,994 Accounts payable and accrued liabilities 298,512 234,487 Accrued expenses 206,418 - Deferred grant revenue 2,445 (2,565) --------------------------------------------------------------------------------------------------------------------------- Net Cash From Operating Activities (4,883,510) (376,377) --------------------------------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities Issuance of shares 26,401,842 - Purchase of property and equipment, net (2,079,419) (2,521) Purchase of intangible assets (31,797) - Restricted cash (100,000) Cash acquired in acquisitions 45,393 2,648 Increase in related party payables (2,240,252) - --------------------------------------------------------------------------------------------------------------------------- Net Cash From Investing Activities 21,995,494 127 --------------------------------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities Proceeds from notes payable 869,900 397,472 Payments on notes payable (11,260,644) - Proceeds from notes payable 1,536,044 - Proceeds from accrued liabilities to related parties - 2,374 --------------------------------------------------------------------------------------------------------------------------- Net Cash From Financing Activities (8,854,700) 399,846 --------------------------------------------------------------------------------------------------------------------------- Effect of Exchange Rate Changes on Cash 149,573 2,554 --------------------------------------------------------------------------------------------------------------------------- Net Increase in Cash 8,406,857 26,150 Cash at Beginning of Period 89,366 4,190 --------------------------------------------------------------------------------------------------------------------------- Cash at End of Period $ 8,496,223 $ 30,340 =========================================================================================================================== Supplemental Cash Flow Information =========================================================================================================================== Non Cash Investing and Financing Activities: Fair value of assets acquired $ - $ 4,471 Fair value of shares issued for acquisitions $ - $ 11,706 --------------------------------------------------------------------------------------------------------------------------- Liabilities Assumed $ - $ 16,177 =========================================================================================================================== The accompanying notes are an integral part of these financial statements. 4 NOTE 1 - BASIS OF PRESENTATION AND NATURE OF BUSINESS Interim Financial Information -- The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission. Accordingly, they are condensed and do not include all of the information and notes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments and reclassifications considered necessary for a fair and comparable presentation have been included and are of a normal recurring nature. The accompanying financial statements should be read in conjunction with the Company's most recent audited financial statements included in the Company's annual report on Form 10-KSB filed for the year ended December 31, 2005. Operating results for the nine-month period ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. Basis of Presentation 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 principal 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. The accompanying consolidated financial statements include the accounts of Bekem Metals, Inc. and its wholly owned subsidiaries, Kazakh Metals, Inc., 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 5 were combined for all periods prior to the acquisition, with recognition of the minority interest in BMI, and the operations of BMI and KMI are consolidated from October 24, 2005. Bekem Metals, Inc. - The combined 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. See Note 12. Kazakh Metals, Inc. - The combined 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 BMI. On March 16, 2005, the Company filed an amendment to its Articles of Incorporation to affect the change. 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 a net loss of $4,855,745 and $695,301 for the nine-month periods ended September 30, 2006 and 2005, respectively. Management expects that the Company will need significant additional capital to fund construction of a processing plant in 2006-2008. 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 of up to 6 $10,000,000. 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. Kempirsai Production Stage - The Kempirsai, or KKM, operations are considered to be in the production stage. Gornostai Exploration Stage - The Gornostai, or Kaznickel, operations are considered to be in the exploration stage. Since its inception on March 4, 2004, the Company has devoted a substantial amount of effort in raising capital, acquiring Kaznickel, and exploring the Gornostai deposit under its exploration contract. This mineral property has not yet reached development or production stage and accordingly, no revenues from production have been recorded. Therefore, the Gornostai or Kaznickel operation is considered to be in the development stage. 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. NOTE 2 - ACQUISITIONS Purchase of Minority Interest in Bekem Metals, Inc. - On October 24, 2005 the Company issued 17,888,888 shares of common stock to acquire the minority shareholders' interests of BMI. Acquisition of the minority interests was accounted for under the purchase method. The incremental increase in the assets acquired and liabilities assumed related to the Kaznickel property, and were recorded at their estimated fair values as follows: ------------------------------------------------------------------- Mineral interest rights $ 132,432 Purchased exploration costs 251,286 Deferred tax liability (38,718) ------------------------------------------------------------------- Minority Shareholders' Interests Acquired $ 345,000 =================================================================== The value assigned to the intangible purchased exploration costs was written off and charged to operations on the date of the acquisition as exploration costs. Intangible mineral interest rights assets acquired include the mineral property rights, which are capitalized until the production phase begins, subject to impairment considerations. 7 Acquisition of Kyzyl Kain Mamyt, LLC - On June 1, 2005, Kazakh Metals acquired 100% of the equity interests of Kyzyl Kain Mamyt, LLC for the cash purchase price of $100,000. The former equity holders of KKM were not related parties. KKM operates in the Aktyubinsk region of northwestern Kazakhstan and has 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 in 1938. The height of production occurred in the late 1980's. Limited production has occurred since that time. KKM's primary assets are its rights to exploit unproven 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 the acquisition 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 are included in the Company's consolidated financial statements since the date of the acquisition. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of acquisition. ----------------------------------------------------------------- Current Assets $ 469,379 Unproved mineral property rights 7,034,321 Asset retirement costs of the mineral rights 86,852 Buildings, construction machinery and equipment 3,068,786 ----------------------------------------------------------------- Total assets acquired 10,659,338 ----------------------------------------------------------------- Current 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 assumed 10,559,338 ----------------------------------------------------------------- Net Assets Acquired $ 100,000 ================================================================= 8 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. Acquisition of EMPS Research, Inc. - 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 of KMI and 14,000,000 were issued to minority shareholders in Condesa. EMPS then 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 of KMI that were outstanding prior to the reorganization into 21,000,000 common shares, or a 700-for-1 stock split. The accompanying financial statements have been 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 and intangible assets of $1,823 and current liabilities of $15,077. The operations of Condesa are included for all periods presented and the operations of EMPS are included from the acquisition of EMPS. Purchase of Kaznickel LLP -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 to enable Kaznickel to further develop 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 interest holders 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 9 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. NOTE 3 - MINERAL PROPERTY RIGHTS The government of Kazakhstan retains the title to the property upon which the Company's mineral rights pertain; accordingly, the Company's mineral interests are considered to be intangible assets. The Company capitalized the acquisition costs of its mineral interests upon the purchase business combinations with Kaznickel and with KKM. 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 10 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; accordingly, the Company's mineral interest is considered to be an intangible asset. 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. 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 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. The asset retirement cost is depleted over the life of the contract from the date of acquisition. 11 NOTE 4 - CASH September 30, December 31, 2006 2005 -------------------------------------------------------------------- Current accounts (US Dollars) $ 649,272 $64,136 Current accounts (Tenge) 263,057 25,230 Bank deposit (US Dollars) 7,583,894 - -------------------------------------------------------------------- Cash $8,496,223 $89,366 ==================================================================== Bank deposit accounts are located in a Kazakhstani Bank (Center Credit Bank). Bank deposits earn interest from 3% to 8% annually. Restrictions on the use of these facilities vary with a maximum term of 15 months. Cash of $100,000 restricted in its use over 15 months is shown as other non-current assets. NOTE 5 - PREPAID EXPENSES AND OTHER CURRENT ASSETS Prepaid expenses and other current assets as of September 30, 2006 substantially represent a short term loan made to the Mining Bureau (Kazakhstan) in the amount of $2,070,000. The Company holds a Russian patent to a proprietary ore processing technology. The technology is designed to decrease start-up investment costs and result in more economical operating costs. The Mining Bureau represents the interests of a Russian metallurgy research institute, which developed this ore processing technology in Kazakhstan. Currently, the Company, in conjunction with the Mining Bureau and a Western metallurgy specialist, is performing tests of the ore processing technology in a pilot plant (see Note 6). The payment to the Mining Bureau was made for the purpose of facilitating the joint testing of the ore processing technology and assistance in making an ore reserve valuation and pre-feasibility study. The payment was made under a loan agreement terminating on December 31, 2006 and bears interest at an annual interest rate of 6%. NOTE 6 - PROPERTY, PLANT AND EQUIPMENT, NET Property, plant and equipment net, were as follows: September 30, December 31, 2006 2005 -------------------------------------------------------------------- Buildings $2,174,191 $2,062,865 Machinery and equipment 2,983,200 970,005 Other fixed assets 87,649 53,856 -------------------------------------------------------------------- 5,245,040 3,086,726 Accumulated depreciation (56,089) (25,436) -------------------------------------------------------------------- Net Property and Equipment $5,188,951 $3,061,290 ===================================================================- 12 The increase in property, plant and equipment 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 capitalized since it was placed in service on June 15, 2006. NOTE 7 - 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 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. On January 18, 2006, the Company signed a financial aid agreement with Balmont Trading S.A (see Note 9) which was repaid on July 25, 2006. Because the notes are denominated in Tenge, the balance reported on the financial statements fluctuates based upon ending exchange rates. 13 NOTE 8 - NOTES PAYABLE Notes payable consists of the following: September 30, 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 Note payable to a company bearing interest at 0%; due on demand; unsecured; - - Note payable to a company bearing interest at 0%; due on demand; unsecured; (See Note 6) - - ============================================================================================================================ 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 third quarter of 2006 the Company repaid notes payable in the amount of $9,275,724 which also represents additional borrowings made during the nine months 2006. 14 NOTE 9 - NOTES PAYABLE - RELATED PARTIES Long-term debt to related parties consists of the following: September 30, 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; 90,000 2,288,000 Notes payable to related companies bearing interest at 6.29%; due May 2008; unsecured; - 77,000 Notes payable to related companies bearing interest at 0%; due May 2007; unsecured; - - ------------------------------------------------------------------------------------------------------------------ Total Long-term Debt 90,000 4,075,012 Less: Current Portion - - ------------------------------------------------------------------------------------------------------------------ Long-term Debt - Net of Current Portion $90,000 $4,075,012 ------------------------------------------------------------------------------------------------------------------ The above amounts were loaned to the Company per an agreement dated August 8, 2005, between KMI and KKM, for up to $10,000,000 for the purpose of assisting KKM in funding its work requirements, including generation of geological data, under its mineral extraction contract. Funds borrowed under this agreement bear interest at the rate of 6.29% (the August 8, 2005 LIBOR plus 2%) per annum. Terms ranged from three to five years with no prepayment penalties. The notes were not collateralized. At December 31, 2005 $3,998,012 had been borrowed. The former owners of Kazakh Metals, Inc. are funding this agreement. On January 18, 2006, the Company signed a financial aid agreement with Balmont Trading S.A. Under this agreement the Company borrowed $100,000 for the period of 16 months from the date of signing the agreement. The loan was repaid on July 25, 2006. During the quarter ended September 30, 2006, the Company repaid a substantial portion of related party debt in the amount of $3,984,874 which payment also included payment of additional borrowings made during the nine months ended September 30, 2006. Subsequent to September 30, 2006 the Company repaid the remaining $90,000. NOTE 10 - SHAREHOLDERS' EQUITY On July 14, 2006, the Company closed a private placement of 24,000,000 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 15 shares of our 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 they are granted. Also, the Company incurred legal and consulting expenses of $153,487. NOTE 11 - 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, and 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. 16 NOTE 12 -SUBSEQUENT EVENT Stock grants 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 for 1,083,123 shares to certain officers and employees of the Company. The stock grants were valued at $1.95 per share, which represented the closing market price of the Company's stock on October 20, 2006. The stock grants were made under the Company's 2003 Stock Option Plan. Sale of Condesa On October 1, 2006 Bekem sold Condesa to a third party for a nominal value. 17 Item 2. Management's Discussion and Analysis For a complete understanding, this Management's Discussion and Analysis should be read in conjunction with the Financial Statements and Notes to the Financial Statements contained in this Form 10-QSB and our Form 10-KSB for the year ended December 31, 2005, as amended. Forward Looking Information and Cautionary Statement Certain statements in this quarterly report may be deemed to be forward-looking statements. Forward-looking statements regarding economic conditions, effects of corporate initiatives, future profitability, projections, future revenue opportunities, and their impact on us are forward-looking statements and not historical facts. These statements are estimates or projections involving numerous risks or uncertainties, including but not limited to, our ability to locate and exploit commercially viable mineral deposits, demand for nickel, cobalt and brown coal, our ability to prove up our ore processing technology, our ability to control expenses, actions by competitors, changes in market needs and technology, political or regulatory matters, litigation, general economic conditions and changes in management strategy. Actual results or events could differ materially from those discussed in the forward-looking statements. See our annual report on Form 10-KSB as filed with the Securities and Exchange Commission for further information. We disclaim any obligation to publicly update, revise or correct any forward-looking statements, whether as a result of new information, future events or otherwise. The information contained in this analysis should be read in conjunction with the financial statements contained herein and related disclosures. Overview We are engaged in the exploration, extraction, refining and marketing of nickel, cobalt and brown coal in the Republic of Kazakhstan. We incorporated in the state of Utah under the name EMPS Research Corporation on January 30, 2001. 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. 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 a 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 2026, to explore for and engage in test production of nickel, cobalt and other minerals in a 12,232 acre area in northeastern Kazakhstan known as the Gornostai deposit. 18 On October 24, 2005, we entered into an agreement whereby we acquired KMI, and its wholly owned subsidiary KKM in exchange for 61,200,000 of our common shares. As discussed above, KKM holds the exclusive licenses to extract and process nickel and cobalt ore from its Kempirsai deposit and brown coal from its Mamyt deposit in northwestern Kazakhstan. Under the applicable accounting reporting rules, KMI was considered the accounting acquirer.
Results of Operations Since inception we have generated only limited revenue from operations. We do not anticipate generating cash flow from operations until 2008. We anticipate we will expend millions of dollars before reaching commercial production stage. Because we are not currently, and do not expect to generate cash flow from operations until some time in 2008, we will be completely dependent on investment funds to support our operations until such time as production generates sufficient revenues to cover our operating expenses. We do not expect to begin production until the fourth quarter 2008, and we do not anticipate generating sufficient revenue to cover operating expenses until at least 2009. In July 2006 we raised $28,000,000 through a private placement of our equity securities. These funds are being used in the further development of our properties and technology, for repayment of loans, to make acquisitions and 19as working capital. The funds raised in July, however, represent only a portion of the funds we will need to begin commercial production. We anticipate the need to seek significant additional funding in the future. There is no assurance that we will be able to obtain additional funding in the future on favorable terms, or at all. As you read this Results of Operations section it is important to keep in mind that in October 2005 we acquired KMI and its operating subsidiary KKM. KMI acquired KKM on May 31, 2005. As a result of common ownership between Bekem and KMI prior to the October 2005 acquisition, the operations of KKM have been included in our financial statements from the time KKM was acquired by KMI on May 31, 2005. While KKM has not engaged in significant operations in recent years, it has engaged in significantly greater operations than Bekem or Kaznickel. 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 revenue and expenses during the three and nine months ended September 30, 2006 compared to the three and nine months ended September 30, 2005 is the result of acquisition of KKM and not the result of increased operations of Bekem or Kaznickel. Three months ended September 30, 2006 compared to the three months ended September 30, 2005 General and Administrative Expenses With the acquisition of KKM, our general and administrative expenses during the three months ended September 30, 2006 increased to $1,287,652 from $168,575 during the third quarter 2005. This significant increase in general and administrative expenses in the third quarter 2006 is attributable to the significant increase in employees and employee-related costs due to the acquisition of KKM, as well as, costs associated with having operations in both northeastern and northwestern Kazakhstan, including increased office rents and travel expenses. During the remainder of the 2006 fiscal year we expect general and administrative expenses will continue to increase at about the same or a more accelerated rate as we continue our efforts to ramp up mining and processing operations. Accretion Expense As a result of our acquisition of KKM and the Kempirsai deposit in the current fiscal year, during the three months ended September 30, 2006 accretion expense increased 35% compared to the three months ended September 30, 2005 when we recognized accretion expense related only to the Gornostai deposit. We believe accretion expense will continue at rates consistent with those realized during the quarter ended September 30, 2006 through the balance of the current fiscal year. Depreciation Expense During the third quarter 2006 we realized depreciation expense of $12,695 compared to $7,629 during the third quarter 2005. With the acquisition of KKM, we also acquired the assets of KKM, which includes equipment, buildings, 20 machinery, etc. that we did not own during the third quarter 2005. We expect increases in depreciation expense during the fourth quarter of fiscal 2006 to remain at levels more or less consistent with the increase experienced during the third quarter 2006. Total Expenses For the reasons discussed in the preceding paragraphs, our total expenses increased from $277,728 during the three months ended September 30, 2005 to $1,583,793 during the three months ended September 30, 2006. We expect total expenses during the rest of 2006 to increase at even greater rates as we ramp up our business. Loss from Operations During the three months ended September 30, 2006 we experienced a loss from operations of $1,583,793 compared to a loss of $277,728 during the three months ended September 30, 2005. This dramatic increase in loss from operations during the third quarter 2006 is the result of our acquisition of KKM and its active operations. By comparison, during the third quarter 2005 we engaged in limited operations and incurred few expenses. We expect we will continue to generate losses from operations until such time as we begin significant ore production. Net Loss For the foregoing reasons, during the three months ended September 30, 2006 we experienced a net loss of $3,671,422 compared to a net loss of $276,893 during the three months ended September 30, 2005. This increase in net loss also resulted from retiring notes payable prior to their due dates and the full recognition of the debt discount of $1,075,065. We anticipate we will continue to experience increasing net losses until we are able to engage in significant nickel and cobalt ore extraction, processing and sales. We do not expect to be engaged in significant ore extraction and processing prior to the 2008 fiscal year. Nine months ended September 30, 2006 compared to the nine months ended September 30, 2005 Revenue During the nine month period ended September 30, 2006, we earned revenue of $69,527 primarily from the sale of brown coal and providing various services with our existing machinery and equipment. By comparison, in the first three quarters of 2005 we realized no revenue. During the nine-month period ended September 30, 2005 we acquired the Gornostai deposit. Our operations during the period were limited to exploratory drilling. The KKM operations were limited immediately after our acquisition on May 31, 2005 and no revenue was produced until later in 2005. By the end of the 2006 fiscal year we expect revenue to be lower as compared to the 2005 fiscal year because we do not expect to sell any significant quantities of ore or coal in 2006. 21 Cost of Product Sold We realized cost of product sold of $65,871 during the nine months ended September 30, 2006 and no cost of product sold during the comparable 2005 period. This increase in cost of product sold is the direct result of our acquisition of KKM and its active operations. As discussed above, during the first nine months of 2005 we engaged in very limited mining operations. We expect by the end of the 2006 fiscal year that cost of product sold will be lower when compared to the 2005 fiscal year because we do not expect to sell any significant quantities of ore or coal during the 2006 fiscal year. General and Administrative Expenses General and administrative expenses during the nine month period ended September 30, 2006 increased to $2,209,740 from $358,519 during the nine month period ended September 30, 2005. This dramatic increase in general and administrative expense is attributable to a significant increase in employees and employee-related costs as a result of the acquisition of KKM, as well as, costs associated with having operations in both northeastern and northwestern Kazakhstan, increased office rents and travel expenses. During the remainder of the 2006 fiscal year we expect general and administrative expense will continue to increase at about the same or a more accelerated rate as we continue our efforts to ramp up mining and processing operations. Accretion Expense Accretion expense increased 32% during the nine months ended September 30, 2006 compared to the nine months ended September 30, 2005. As discussed above, this increase in accretion expense is attributable to our acquisition of the Kempirsai deposit. We acquired the Kempirsai deposit during the fourth quarter of 2005 and therefore did not recognize accretion expense for this deposit during the third quarter of 2005. We believe accretion expense will continue at rates consistent with those realized during the nine months ended September 30, 2006 throughout the balance of the current fiscal year. Depreciation Expense During the nine months ended September 30, 2006 we realized depreciation expense of $48,423 compared to $23,781 during the nine months ended September 30, 2005. With the acquisition of KKM, we also acquired the assets of KKM, which included equipment, buildings, machinery, etc. that we did not own during the first quarter 2005. We expect increases in depreciation expense during the remainder of the year to remain at levels more or less consistent with the increase experienced during the first nine months of the year. 22 Research and Development Costs We realized research and development costs of $391,307 related to the development of our pilot processing plant compared to $0 during the nine months ended September 30, 2005. We expect our research and development costs will increase by more than $400,000 by the end of current fiscal year as we start testing our pilot processing plant. Total Expenses As a result of our acquisition of KKM our total expenses increased from $699,221 during the nine months ended September 30, 2005 to $3,153,195 during nine months ended September 30, 2006. We expect our total expenses during the rest of 2006 will continue to increase at even greater rates as we ramp up our business. Loss from Operations During the nine months ended September 30, 2006 we experienced a loss from operations of $3,083,668 compared to a loss of $699,221 during the nine months ended September 30, 2005. This dramatic increase in loss from operations during the nine months ended September 30, 2006 is the result of our acquisition of KKM and its active operations during the fourth quarter 2005. By comparison, during the nine months ended June 30, 2005 we engaged in limited operations and incurred fewer expenses. We expect we will continue to generate losses from operations until such time as we engage in significant ore production. Net Loss For the foregoing reasons, during the nine months ended September 30, 2006 we experienced a net loss of $4,838,386 compared to a net loss of $695,301 during the nine months ended September 30, 2005. The increase in net loss also resulted from retiring notes payable prior to their due dates and the full recognition of the debt discount of $1,075,065. We anticipate we will continue to experience increasing net losses until we are able to engage in significant nickel and cobalt ore extraction, processing and sales. We do not expect to be engaged in significant ore extraction and processing prior to the 2008 fiscal year. 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 September 30, 2006, we have about $8,500,000 of the approximately $26,000,000 in net proceeds we realized from the private placement. We used the money raised in the private offering to reduce debt, acquire equipment, continue exploration and 23 fund operations. We anticipate the need for substantial additional capital resources, which will likewise consist primarily of funds raised in financing activities and debt. During the nine months ended September 30, 2006 and September 30, 2005, cash was primarily used to fund operations and repay notes payable. See below for additional discussion and analysis of cash flow. Nine months ended Nine months ended September 30, 2006 September 30, 2005 ------------------------------- --------------------------- Net cash used in operating activities $ (4,883,510) $(376,377) Net cash provided by investing activities 21,995,494 127 Net cash provided by/used in) financing activities (8,854,700) 399,846 Effect of exchange rate changes on cash 149,573 2,554 ------------ --------- NET INCREASE IN CASH $ 8,406,857 $ 26,150 ============ ========= During the nine months ended September 30, 2006 net cash used in operating activities was $4,883,510 compared to net cash used in operating activities of $376,377 during the nine months ended September 30, 2005. This increase in net cash used in operating activities is primarily attributable to increases in general and administrative expenses and research and development costs, which were largely the result of our acquisition of KMI and its operating subsidiary KKM. During the nine months ended September 30, 2006 we received $21,995,494 from investing activities, most of which is related to cash received through the private placement of our equity securities. By comparison, during the nine months ended September 30, 2005 we realized net cash from investing activities of $127. Net cash used in financing activities during the nine months ended September 30, 2006 was $8,854,700 compared to net cash provided by financing activities of $399,846 during the nine months ended September 30, 2005. During the nine months ended September 30, 2006 the Company repaid a substantial portion of notes payable and related party debts. Plan of Operations Operations Drilling We plan to drill approximately 34,500 meters of the east and west banks of the Gornostai deposit. Estimated drilling costs is $3,500,000 which include 24 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. Core Analysis We anticipate spending approximately $250,000 for core analysis. Design and Engineering We anticipate spending approximately $3,500,000 for pre-feasibility and feasibility studies and to develop a commercial processing plant design for ore processing at the Kempirsai deposit. We will also perform an independent resource and reserves estimate and valuation. Independent Resource and Reserve Estimate We will allocate $1,000,000 to hire an independent mining consulting firm to provide us with a resource and reserve reclassification and estimate for the Gornostai deposit and the Kempirsai deposits. Feasibility Study We anticipate spending approximately $1,000,000 for the preparation of pre-feasibility and feasibility studies. Detailed Design Detailed design costs of $1,500,000 represent the prospective costs of detailed engineering and design contract for construction of a commercial processing plant at the Kempirsai deposit. This includes flow sheet design and its pilot testing. This is a rough estimate, which will be subject to future revision following completion of feasibility studies. Professional Fees We expect to incur approximately $300,000 during the current fiscal year in expenses to our financial auditors and securities attorneys. Administrative Expenses We have allocated approximately $3,000,000 for administrative expenses for the current fiscal year, which includes expenses of maintaining offices in the United States and Kazakhstan, for salaries and for taxes. 25 Working Capital We plan to allocate $2,800,000 for working capital for the next twelve months. This will be used to finance our operations at the Kempirsai and Gornostai deposits. Summary of Material Contractual Commitments The following table lists our significant commitments as of September 30, 2006: Payments Due by Fiscal Year ------------------------------------------------ Less than 1 1-3 years Thereafter Contractual Commitments Total year ----------------------------------------- ---------------- ---------------- ---------------- -------------- Monetary commitments for exploration $ 2,441,580 865,100 1,576,480 -0- ----------------------------------------- ---------------- ---------------- ---------------- -------------- Notes Payable - Related Party $ 90,000 90,000 -0- -0- ----------------------------------------- ---------------- ---------------- ---------------- -------------- Due to the Government of Republic of Kazakhstan(1) $ 731,221 -0- 731,221 -0- ----------------------------------------- ---------------- ---------------- ---------------- -------------- Training $ 42,000 -0- $42,000 -0- ----------------------------------------- ---------------- ---------------- ---------------- -------------- Social projects $ 117,906 -0- -0- 117,906 ----------------------------------------- ---------------- ---------------- ---------------- -------------- Operating Leases $ 211,058 54,539 156,519 -0- ----------------------------------------- ---------------- ---------------- ---------------- -------------- Total $ 3,633,765 1,009,639 2,506,220 117,906 ----------------------------------------- ---------------- ---------------- ---------------- -------------- (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. For us to maintain our rights under the exploration license held by Kaznickel and the production license held by KKM, we must satisfy the work program requirements of the MEMR. Each year we must submit a proposed annual work program under each license to the MEMR. This annual work program must be reviewed and approved by the MEMR. If we fail to meet the minimum work program requirements, we could lose our licenses. Under the current work program for Kaznickel, we must drill at least 17,498 meters in 2006. The current work program under the KKM licenses calls for KKM to extract the following amounts of ore for processing and brown coal through 2011. 26 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 To date, we have met the minimum obligations under the minimum work programs of our subsidiaries. Should we fail to complete the minimum work program in some year, the MEMR could review the work program, request an update and amendment to the work program or even recall our license. We are confident of our ability to satisfy the obligations of the minimum work programs of our subsidiaries in the future. Off-Balance Sheet Financing Arrangements As of September 30, 2006 we had no off-balance sheet financing arrangements. Critical Accounting Policies The preparation of financial statements in accordance with accounting standards generally accepted in the United States requires management to make estimates and assumptions that affect both the recorded values of assets and liabilities at the date of the financial statements and the revenues recognized and expenses incurred during the reporting period. Our estimates and assumptions affect our recognition of deferred expenses, bad debts, income taxes, the carrying value of our long-lived assets and our provision for certain contingencies. We evaluate the reasonableness of these estimates and assumptions continually based on a combination of historical information and other information that comes to our attention that may vary our outlook for the future. Actual results may differ from these estimates under different assumptions. We suggest that our Summary of Significant Accounting Policies, as described in Note 1 of Notes to Consolidated Financial Statements on Form 10-KSB for December 31, 2005, be read in conjunction with this Management's Discussion and Analysis of Financial Condition and Results of Operations. We believe the critical accounting policies that most impact our consolidated financial statements are described below. Use of Estimates - The preparation of 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 27 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. 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. Revenue Recognition - For its operating mine, revenues currently arise from the limited sale of ore and Mamyt brown coal. Revenue is recorded when persuasive evidence of an arrangement exists, title to product transfers to the customer, and collectibility is reasonably assured. Produced, but unsold minerals or ore are recorded as inventory until sold. 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. Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of -- 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. At December 31, 2005, we reviewed our long-lived assets as disclosed above and determined no impairment was necessary. 28 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. Depreciation, Depletion and Amortization - Expenditures for new facilities or equipment and expenditures 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 based on proven and probable reserves as the useful lives of these assets are considered to be limited to the life of the relevant mine. Costs incurred to develop new properties are capitalized as incurred, where it has been determined that the property can be economically developed based on the existence of proven and probable reserves. At our surface mines, these costs include costs to further delineate the ore body and remove overburden to initially expose the ore body. All such costs are 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. Major development costs incurred after the commencement of production are amortized using the UOP method based on estimated recoverable minerals to be mined from proven and probable reserves. Depending upon whether the development is expected to benefit the entire remaining ore body, or specific ore blocks or areas only, the UOP basis is either the life of the entire ore body, or the life of the specific ore block or area. The calculation of the UOP rate of amortization, and therefore the annual amortization charge to operations, could be materially impacted to the extent that actual production in the future is different from current forecasts of production based on proven and probable reserves. This would generally occur to the extent that there were significant changes in any of the factors or assumptions used in determining reserves. These factors could include: (i) an expansion of proven and probable reserves through exploration activities; (ii) differences between estimated and actual cash costs of mining, due to differences in grade, mineral recovery rates and foreign currency exchange rates; and (iii) differences between actual commodity prices and commodity price assumptions used in the estimation of reserves. Such changes in reserves could similarly impact the useful lives of assets depreciated on a straight-line basis, where those lives are limited to the life of the mine, which in turn is limited to the life of the proven and probable reserves. 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. 29 Stripping Costs - In general, mining costs are allocated to production costs, stockpiles, and inventories, and are charged to costs applicable to sales when minerals are sold. However, the mining industry, generally, defers and amortizes certain mining costs on a units-of-production basis over the life of the mine. These mining costs, which are commonly referred to as "deferred stripping" costs, are incurred in mining activities that are normally associated with the removal of waste rock. The deferred stripping accounting method is generally accepted in the mining industry where mining operations have diverse grades and waste-to-ore ratios; however, industry practice does vary. Deferred stripping matches the costs of production with the sale of minerals, where this procedure is employed, by assigning each quantity of mineral with an equivalent amount of waste removal cost. When stripping costs are expensed as incurred, there might be greater volatility in a company's period-to-period results of operations. We did not acquire any deferred stripping costs in the acquisition of KKM. In March 2005, the FASB ratified Emerging Issues Task Force Issue No. 04-6, "Accounting for Stripping Costs Incurred during Production in the Mining Industry," (EITF 04-6) which addresses the accounting for stripping costs incurred during the production phase of a mine and refers to these costs as variable production costs that should be included as a component of inventory to be recognized in costs applicable to sales in the same period as the revenue from the sale of inventory. As a result, capitalization of stripping costs is appropriate only to the extent product inventory exists at the end of a reporting period and the carrying value is less than the net realizable value. We adopted the provisions of EITF 04-6 on January 1, 2006. We have had very limited production activity in the recent period, so the full effect of this adoption will be felt as production increases in the future periods. 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 its 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. 30 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 have made 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. Item 3. Controls and Procedures Evaluation of Disclosure Controls and Procedures Our principal executive officer and our principal financial officer (the "Certifying Officers") are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e). Such officers have concluded (based upon their evaluations of these controls and procedures as of the end of the period covered by this report) that our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in this report is accumulated and communicated to management, including the Certifying Officers as appropriate, to allow timely decisions regarding required disclosure. Based on this evaluation, our Certifying Officers have concluded that our disclosure controls and procedures are effective as of September 30, 2006. Changes in Internal Control over Financial Reporting There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2006 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. PART II - OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds On July 14, 2006, we closed a private placement of 8,000,000 Units of our securities to two non-U.S. investors for $28,000,000. Each Unit consists of three shares of restricted common stock and one warrant to purchase an additional share of common stock for two years from the closing at a price of $2.00 per share. The warrants are immediately exercisable. The price per Unit was $3.50. In connection with this private placement we issued a total of 24,000,000 common shares and warrants to purchase 8,000,000 common shares. These issuances did not result in a change in control of the Company. From the total proceeds, we compensated the placement agent, Aton Securities, Inc., a cash fee totaling 5% of the total proceeds raised, or $1,400,000. We also issued to Aton Securities warrants to purchase up to 2,400,000 shares of our restricted common stock. The exercise price of the 31 warrants is $1.17 per share. The warrants will be immediately exercisable and will expire eighteen months from the date they are granted. The placement agent is not an officer, director or greater than 10% shareholder of the Company. None of the fees to be paid or warrants to be granted to the placement agent will either directly or indirectly be paid to any officer, director or greater than 10% shareholder of the Company. Investors in this offering were granted the right to request the Company file a registration statement on their behalf registering for resale the shares they purchased in this private placement. The Registration Rights Agreement requires that at least 51% of the shares purchased in this private placement request registration before we must undertake efforts to register the shares for resale. The investors in this private placement may not request registration for at least 90 days from the closing of the private placement. As set forth above, the securities were issued without registration under the Securities Act of 1933 in reliance upon exemptions from registration pursuant to Regulation S of the rules and regulations promulgated by the Securities and Exchange Commission under the Securities Act of 1933. Sales Pursuant to Regulation S All offers and sales were made to non-U.S. persons in offshore transactions. No directed selling efforts were made in the United States by the issuer, placement agent or any person acting on their behalf. The shares sold are subject to the offering restrictions set forth in Rule 903(b)(3), including a one-year distribution compliance period. 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. 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. 32 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. 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 meet 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. These stock grants were made without registration under the Securities Act of 1933 in reliance upon exemptions from registration pursuant to Regulation S of the rules and regulations promulgated by the Securities and Exchange Commission under the Securities Act of 1933. Item 6. Exhibits Exhibits. The following exhibits are included as part of this report: Exhibit No. Exhibit Exhibit 31.1 Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 31.2 Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 Exhibit 32.1 Certification of Principal Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2 Certification of Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 33 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. BEKEM METALS, INC. November 14, 2006 By: /s/ Marat Cherdabayev ------------------------------ Marat Cherdabayev, Principal Executive Officer November 14, 2006 By: /s/ Yermek Kudabayev ------------------------------ Yermek Kudabayev, Principal Financial Officer 34