UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q/A

Amendment No. 1

 

(MARK ONE)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
	EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2006.
OR
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM            TO            .

COMMISSION FILE NUMBER 1-13627

APEX SILVER MINES LIMITED

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

(345) 949-0050

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

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

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A LARGE ACCELERATED FILER, AN ACCELERATED FILER, OR A NON-ACCELERATED FILER:

LARGE ACCELERATED FILER o   ACCELERATED FILER x   NON-ACCELERATED FILER o

INDICATE BY CHECK MARK WHETHER THE REGISTRANT IS A SHELL COMPANY (AS DEFINED IN RULE 12B-2 OF THE EXCHANGE ACT):  YES o     NO x

AT NOVEMBER 3, 2006, 58,439,500 ORDINARY SHARES, $0.01 PAR VALUE PER SHARE, WERE ISSUED AND OUTSTANDING.

EXPLANATORY NOTE

Apex Silver Mines Limited (“we,” “us,” or the “Company”) is filing this Amendment No. 1 (this “Amendment”) to its Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2006 to restate its consolidated financial statements and related financial information.

We are restating the consolidated financial statements to correct the liability of our metals derivative positions. We determined that the method used in prior periods to estimate the fair value of our open metals derivative positions was not appropriate. pursuant to Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS No. 133”), we record our open derivative positions at their fair value on our consolidated balance sheet and record the changes in fair value to current earnings at the end of each reporting period.

Our derivative positions mature or expire on various dates over an approximate six-year period commencing in July 2007. Many of the derivative positions mature or expire beyond the periods covered by the major commodities price indices such as LME or COMEX, or expire in future periods covered by those indices with respect to which only limited trading activity has occurred. In instances where only limited market activity existed, we used price projections provided by an independent third party employing statistical analysis and models to estimate the fair value of our open derivative positions. The models used by the independent third party relied on commodities prices indices out to three months and mean reversion statistical estimates beyond the three-month period. Recently, we reassessed the market information reflected in the commodities prices indices out to twenty-seven months and quoted prices from the counterparties holding the derivative positions and concluded that the additional market information is a more reliable indicator of fair value than the independent third party price projections we previously used.

Based on the reassessment, we concluded that we had understated the liability related to the open derivative positions commencing with the quarter ended September 30, 2005. The cumulative liability for our open derivative positions was understated by $300.5 million at September 30, 2006. In addition, correcting the error in the valuation of the open derivative positions impacted the gain and minority interest that we recognized on the sale of the 35% interests in the subsidiaries that own the San Cristobal project. The gain on the sale increased from $119.8 million to $199.6 million and the minority interest decreased from $88.4 million to $18.9 million at September 30, 2006.

As a result, we have concluded that our financial statements for the quarter ended September 30, 2005, the year ended December 31, 2005 and the first three quarters of 2006 should be restated. This Amendment No. 1 to the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2006 also includes the restatements for the Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2005. Use of the additional market information in calculating the fair value of our open derivative positions will likely result in increased volatility in our earnings during the next three years, the period over which most of the derivatives mature or expire. We intend to settle these derivatives with revenues from San Cristobal production over the six-year period commencing in July 2007. Therefore, the cash effect of settling these hedges will be realized as higher or lower revenue over that six-year period and the ultimate losses or gains from these derivatives will be determined based upon market prices at the time of settlement.

The information contained in this Amendment, including the financial statements and the notes thereto, amends only Items 1, 2, 3 and 4 of the original filing, in each case to reflect only the restatement discussed herein. No other information in the original filing is amended hereby. Currently-dated certifications from our Chief Executive Officer and our Chief Financial Officer have been included as exhibits to this Amendment.  As discussed in Item 4, Controls and Procedures (as restated), management identified a control deficiency that relates to the restatement that, under the circumstances, constitutes a material weakness.

The foregoing items have not been updated to reflect other events occurring after the filing date of the original filing or to modify or update those disclosures affected by subsequent events.  Except for the foregoing amended information, this Amendment continues to describe conditions as of the date of the original filing, and we have not updated the disclosures contained herein to reflect events that occurred at a later date.

We do not intend to amend our previously-filed Annual Report on Form 10-K or our Quarterly Reports on Form 10-Q for the periods affected by the restatement described herein that ended prior to January 1, 2006.

APEX SILVER MINES LIMITED
FORM 10-Q
QUARTER ENDED SEPTEMBER 30, 2006

INDEX

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

 

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PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements

APEX SILVER MINES LIMITED
An Exploration and Development Stage Company
CONSOLIDATED BALANCE SHEETS
(Expressed in United States dollars)
(Unaudited)

		September 30,			December 31,
		2006			2005
		Restated
		(in thousands, except share data)
Assets
Current assets
Cash and cash equivalents		$	138,097		$	4,808
Restricted cash		15,172			135,182
Investments		290,743			132,000
Restricted investments		101,133			67,491
Ore inventories		444			—
Materials and supply inventory		4,124			—
Prepaid expenses and other assets		11,444			5,824
Total current assets		561,157			345,305
Property, plant and equipment, net		583,168			379,138
Ore inventories		16,498			—
Deferred financing costs		19,988			21,604
Value added tax recoverable		45,537			20,052
Investments		4,000			—
Restricted investments		—			12,392
Other		2,109			2,020
Total assets		$	1,232,457		$	780,511
Liabilities and Shareholders’ Equity
Current liabilities
Accounts payable and other accrued liabilities		$	66,048		$	74,487
Accrued interest payable		799			3,096
Derivatives at fair value		17,827			5,652
Current portion of long term debt		2,993			2,270
Total current liabilities		87,667			85,505
Long term debt		434,117			320,021
Derivatives at fair value		464,920			145,719
Deferred gain on sale of asset		1,400			—
Asset retirement obligation		5,394			2,003
Total liabilities		993,498			553,248
Minority interest in subsidiaries		18,876			34
Commitments and contingencies (Note 12)
Shareholders’ equity
Ordinary Shares, $.01 par value, 175,000,000 shares authorized; 58,435,200 and 50,444,890 shares issued and outstanding at respective dates		584			504
Accumulated other comprehensive income (loss)		160			(243		)
Additional paid in capital		666,291			486,762
Accumulated deficit during development stage		(446,952		)	(259,794		)
Total shareholders’ equity		220,083			227,229
Total liabilities and shareholders’ equity		$	1,232,457		$	780,511

 

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

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APEX SILVER MINES LIMITED
An Exploration and Development Stage Company
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Expressed in United States dollars)
(Unaudited)

 

														For the Period from
														December 22, 1994
		Three Months Ended						Nine Months Ended						(inception)
		September 30,						September 30,						through
		2006			2005			2006			2005			Sept. 30, 2006
		Restated			Restated			Restated			Restated			Restated
		(in thousands, except share data)
Operating income and expenses:
Exploration		$	(2,155	)	$	(1,097	)	$	(5,162	)	$	(3,858	)	$	(78,593	)
Administrative		(4,123		)	(4,814		)	(15,122		)	(13,660		)	(84,980		)
Gain (loss) on commodity derivatives		(119,934		)	(79,689		)	(370,895		)	(77,633		)	(521,443		)
Gain (loss) on foreign currency derivatives and transactions		203			474			439			(810		)	1,167
Other operating expense (1)		(134		)	—			(276		)	—			(276		)
Amortization and depreciation		(100		)	(81		)	(296		)	(114		)	(1,692		)
Total operating expenses		(126,243		)	(85,207		)	(391,312		)	(96,075		)	(685,817		)
Other income and expenses:
Interest and other income		4,469			5,700			12,637			12,743			47,309
Gain on sale of interest in subsidiary		199,600			—			199,600			—			199,600
Gain on extinguishment of debt		—			—			2,875			—			9,640
Interest expense and other borrowing costs (2)		—			(2,639		)	(774		)	(6,501		)	(11,696		)
Total other income and expense		204,069			3,061			214,338			6,242			244,853
Income (loss) before minority interest and income taxes		77,826			(82,146		)	(176,974		)	(89,833		)	(440,964		)
Income taxes		(54		)	—			(161		)	—			(540		)
Minority interest in (income) loss of consolidated subsidiaries		(10,016		)	1			(10,023		)	12			(5,448		)
Net income (loss)		$	67,756		$	(82,145	)	$	(187,158	)	$	(89,821	)	$	(446,952	)
Other comprehensive income:
Unrealized gain (loss) on securities		$	(42	)	$	30		$	160		$	(127	)	$	(83	)
Reclassification for loss on securities included in net income		(518		)	—			243			—			243
Other comprehensive income (loss)		(560		)	30			403			(127		)	160
Comprehensive income (loss)		$	67,196		$	(82,115	)	$	(186,755	)	$	(89,948	)	$	(446,792	)
Net Income (loss) per Ordinary Share - basic		$	1.16		$	(1.68	)	$	(3.35	)	$	(1.87	)
Net Income (loss) per Ordinary Share - diluted		$	1.15		$	(1.68	)	$	(3.35	)	$	(1.87	)
Weighted average Ordinary Shares outstanding - basic		58,417,387			48,781,621			55,816,488			48,047,071
Weighted average Ordinary Shares outstanding - diluted		58,989,561			48,781,621			55,816,488			48,047,071

 

(1)          Other operating expense is accretion expense associated with our asset retirement obligation at San Cristobal.

(2)          Interest expense and other borrowing costs are net of $7.7 million and $18.7 million capitalized for the three and nine month periods ended September 30, 2006, respectively and $1.8 million and $4.3 million for the three and nine month periods ended September 30, 2005, respectively and $28.1 million for the inception to date period ended September 30, 2006.

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

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APEX SILVER MINES LIMITED
An Exploration and Development Stage Company
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Expressed in United States dollars)
(Unaudited)

		Nine Months Ended						For the period from December 22, 1994 (inception)
		September 30,						through
		2006			2005			September 30, 2006
		(in thousands)
Cash flows from operating activities:
Net cash used in operating activities		$	(58,417	)	$	(16,491	)	$	(165,294	)
Cash flows from investing activities:
Purchase of available for sale investments		(385,104		)	(404,500		)	(1,578,296		)
Sale of available for sale investments		183,172			521,798			1,247,124
Purchase of held-to-maturity investments		(24,662		)	(17,524		)	(263,869		)
Sale of held-to-maturity investments		8,000			95,770			195,007
Purchase of available for sale restricted investments		(233,200		)	—			(248,150		)
Sale of available for sale restricted investments		246,400			—			246,400
Purchase of held-to-maturity restricted investments		(22,199		)	—			(49,542		)
Sale of held-to-maturity restricted investments		45,882			4,668			60,658
Payment of derivative premiums & settlements, net		(39,519		)	(1,889		)	(39,620		)
Advances for construction of port facility		—			—			(2,000		)
Advances to suppliers and contractors		(1,480		)	(1,296		)	(5,355		)
Released from (transfer to) restricted cash to collateralize credit facility, letters of credit and interest payments, net		120,010			(96,892		)	(18,134		)
Proceeds from the sale of interest in subsidiary		224,000			—			224,000
Capitalized costs and acquisitions of property, plant and equipment		(207,283		)	(101,301		)	(490,213		)
Net cash used in investing activities		(85,983		)	(1,166		)	(721,990		)
Cash flows from financing activities:
Proceeds from issuance of Ordinary Shares (net of offering costs of $4.8 million in 2006)		156,795			16,639			580,358
Proceeds from issuance of convertible notes		—			—			339,987
Payment of debt issuance costs		(671		)	(3,778		)	(24,992		)
Payments of notes payable and long term debt		(1,607		)	(2,142		)	(4,883		)
Proceeds from note to power line contractor		1,407			—			1,407
Borrowings under project finance facility		120,000			—			120,000
Proceeds from exercise of stock options and warrants		1,765			107			13,504
Net cash provided by financing activities		277,689			10,826			1,025,381
Net increase (decrease) in cash and cash equivalents		133,289			(6,831		)	138,097
Cash and cash equivalents - beginning of period		4,808			27,740			—
Cash and cash equivalents - end of period		$	138,097		$	20,909		$	138,097

 

See Note 14 for supplemental cash flow information.

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

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APEX SILVER MINES LIMITED
An Exploration and Development Stage Company

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Expressed in United States dollars)

1.              Basis of Preparation of Financial Statements and Nature of Operations

These unaudited interim consolidated financial statements of Apex Silver Mines Limited (the “Company”) and its subsidiaries have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”).  Such rules and regulations allow the omission of certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles in the United States of America, so long as such omissions do not render the financial statements misleading.  Certain prior period amounts have been reclassified to conform to the current period presentation.

In the opinion of management, these financial statements reflect all adjustments that are necessary for a fair statement of the results for the periods presented.  All adjustments were of a normal recurring nature.  These interim financial statements should be read in conjunction with the annual financial statements of the Company included in its 2005 Annual Report on Form 10-K as amended.

The Company is a mining exploration and development company that holds a portfolio of exploration and development properties primarily in South America and Central America. The Company currently focuses its resources primarily on the development of its San Cristobal Project in Bolivia. At present, none of the Company’s properties are in production and, consequently, the Company does not have current operating income.

2.              Significant Accounting Policies

On September 25, 2006 the Company sold a 35% interest in the subsidiaries holding its San Cristobal Project to Sumitomo Corporation (“Sumitomo”) for $224 million in cash and the retention of certain interests in future silver and zinc production.  Pursuant to the Company’s principles of consolidation under which it consolidates more-than-50%-owned subsidiaries that it controls and entities over which control is achieved through means other than voting rights, the Company fully consolidates the results of operations of its San Cristobal Project and reports Sumitomo’s participation as a minority interest. (See Note 11 for further details of the transaction).

Effective January 1, 2006 the Company adopted Financial Accounting Standards No. 123R, “Share-Based Payment” (“FAS No. 123R”), using the modified prospective approach, which revised Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“FAS No. 123”), and superseded Accounting Principles Board (“APB”) Opinion 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. The Company is currently evaluating whether it will adopt the short-cut method for calculating the pool of windfall tax benefits as allowed by FAS No. 123R-3. The Company had previously adopted FAS No. 123 effective January 1, 2004. FAS No. 123R requires measurement and recording in the financial statements of the costs of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, recognized over the period during which an employee is required to provide services in exchange for the award.  Additionally, FAS No. 123R requires companies that did not previously include the effects of estimated forfeitures in the FAS No. 123 expenses they reported, to record a cumulative adjustment to the income statements presented in the period of adoption of FAS No. 123R in order to reflect the effect of the estimated forfeitures.  The forfeiture rate used by the Company prior and subsequent to the adoption of FAS No. 123R has not changed and, therefore, the Company did not record a cumulative effect adjustment related to prior period estimated forfeitures. The adoption of FAS No. 123R did not have a material impact on the Company’s financial position or results of operations (see Note 10).

During March 2005, a committee of the Emerging Issues Task Force (“EITF”) reached a consensus (EITF Issue No. 04-6) that stripping costs incurred during the production phase of a mine are variable production costs that should be included in the costs of inventory produced during the period that the

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stripping costs are incurred.  The Financial Accounting Standards Board (“FASB”) ratified the EITF consensus.  The EITF consensus is effective for the first reporting period in fiscal years beginning after December 15, 2005.  In January 2006, the EITF issued additional guidance defining the commencement of production as the period when saleable minerals are first extracted in greater than de minimis amounts.  During the first quarter 2006, the Company began mining significant amounts of oxide ore reserves at its San Cristobal project, and placed the ore in stockpiles for future processing.  The quantity and value of the minerals mined were sufficient to declare the start of ore production according to the EITF consensus.  The Company has commenced the mining and stockpiling of significant amounts of ore at its San Cristobal Project and has included the associated costs as ore inventories on its financial statements.

The Company records costs related to production activities as inventory held for sale in the ordinary course of business or work in process for such sale.  Work-in-process inventories include ore produced and stockpiled for which further processing is necessary before a product is ready for sale.  The Company uses the average cost method to assign costs to the units of ore stockpiled during the period.  Inventories are carried at the lower of cost or the current net realizable value.  If costs held in inventory exceed their net realizable value, the excess cost is recognized as a loss in the current period.  Net realizable value reflects the gross realizable value (“estimated selling price”) reduced by estimated costs of completion and disposal as of the balance sheet date.  Gross realizable value reflects the anticipated average realization that the inventory will generate when it is sold.

New Accounting Standards

In March 2006 the EITF reached a tentative consensus (EITF Issue No. 05-1) that the issuance of equity securities to settle an instrument that becomes convertible upon the issuer’s exercise of a call option should be accounted for as a conversion (as opposed to an extinguishment) if, at issuance, the debt instrument contains a substantive conversion feature other than the issuer’s call option.  The EITF concluded that if an instrument is deemed convertible at issuance, then a subsequent conversion of the instrument is in accordance with a “conversion privilege that existed at issuance” and is, therefore, outside the scope of APB Opinion No. 26, “Early Extinguishment of Debt.”  Therefore, the issuance of shares to settle debt pursuant to the original terms of the debt instrument should be afforded conversion treatment.  If the instrument does not contain a substantive conversion feature at issuance, the issuance of equity securities to settle the instrument should be recognized as a debt extinguishment.  EITF Issue No. 05-1 became effective for interim or annual reporting periods beginning after June 28, 2006, following its ratification during June 2006. The Company previously accounted for two transactions involving the buy-back of its convertible debt as an extinguishment under APB Opinion No. 26.  Ratification of EITF Issue No. 05-1 will require similar future transactions be accounted for as conversions.

Financial Accounting Standards No. 154, “Accounting Changes and Error Corrections – a replacement of APB Opinion No. 20 and FASB Statement No. 3” (“FAS No. 154”), is effective for years beginning after December 15, 2005.   FAS No. 154 changes the requirements for the accounting and reporting of a change in accounting principle.  The statement, which applies to voluntary changes as well as changes required by accounting pronouncements that do not otherwise provide specific transition provisions, requires retrospective application to prior period’s financial statements where practical.  FAS No. 154 did not have a material impact on the Company’s financial position or results of operations for the period and is not expected to have a material impact in the future.

In June 2006, the FASB issued Financial Accounting Standards Interpretation No. 48, “Accounting for Uncertainty in Income Taxes,” (“FIN 48”), an interpretation of Financial Accounting Standards Statement No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Interpretation requires that the Company recognize in its financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective beginning January 1, 2007 with the cumulative effect of the change in accounting principle recorded as an adjustment to the opening balance of retained earnings. The Company is currently evaluating the impact of adopting FIN 48 but does not believe it will have a material impact on its financial position or results of operations.

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During September 2006 the FASB issued Financial Accounting Standards No. 157 “Fair Value Measurements” (“FAS No. 157”). FAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. This Standard addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under U.S. GAAP. Accordingly, this Standard does not require any new fair value measurements. FAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company does not expect the adoption of FAS No. 157 to have a material impact on its financial position or results of operations.

During September 2006 the SEC issued Staff Accounting Bulletin No. 108 (“SAB 108”) which establishes an approach to the quantification of unadjusted financial statement errors based on the effects of the error on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a “dual approach” because it essentially requires quantification of unadjusted errors under both the iron-curtain and the roll-over methods.  SAB 108 permits companies to record the cumulative effect of initially applying the “dual approach” in the first year ending after November 15, 2006 by recording the necessary “correcting” adjustments to the carrying values of assets and liabilities as of the beginning of that year with the offsetting adjustment recorded to the opening balance of retained earnings. The Company has no unadjusted errors and therefore does not expect the adoption of SAB 108 to have an impact on its financial position or results of operations.

Correction of an Error Related to the Valuation of Open Derivative positions

Pursuant to the requirements of the lenders of its $225 million project finance facility, the Company was required to provide price protection for a portion of its planned production from the San Cristobal project. In the third quarter 2005, the Company entered into silver, zinc and lead derivative positions utilizing primarily forward sales, but also puts and calls, to comply with this requirement. As discussed above, the Company records its open derivative positions at their estimated fair value on its balance sheet and records the change in estimated fair value in earnings at the end of each reporting period.

The Company’s derivative positions mature or expire on various dates over an approximate six-year period commencing in July 2007. Many of the derivative positions mature or expire beyond the periods covered by the major commodity price indices such as LME or COMEX, or expire in future periods covered by those indices with respect to which only limited trading activity has occurred. In instances where only limited market activity exists, the Company had historically used price projections to estimate a forward price curve provided by an independent third party employing statistical analysis and models to estimate the fair value of its open derivative positions. The models used by the independent third party relied on commodity price indices out to three months and mean reversion statistical estimates beyond the three month period. Recently, the Company reassessed the market information reflected in the commodities prices indices out to twenty-seven months and quoted prices from the counterparties holding our derivative positions and concluded that the additional market information is a more reliable indicator of fair value than the independent third party price projections previously used. Accordingly, the Company concluded the derivative liability related to its open derivative positions was understated at September 30, 2006 by $300.5 million ($5.38 per share) and December 31, 2005 by $95.1 million ($1.96 per share).

Additionally, correcting the error in the valuation of the open derivative positions impacted the gain and minority interest the Company recognized on the sale of the 35% interests in the subsidiary holding its San Cristobal project, the subsidiary that will market the San Cristobal concentrates and the subsidiary that holds the derivative positions required by the project finance facility.  The revised valuation of the derivative positions resulted in the gain on the sale being increased from $119.8 million to $199.6 million.

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The following table summarizes the impact of the restatement on the historical balances reported on the Company’s consolidated balance sheets for the period ended September 30, 2006:

 

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The following table summarizes the impact of the restatement on the historical amounts reported on the Company’s consolidated statement of operations for the three and nine months ended September 30, 2006 and the inception to date period through September 30, 2006:

														For the Period from
														December 22, 1994
		Three Months Ended						Nine Months Ended						(Inception)
		September 30,						September 30,						Through Sept. 30,
		2006			2005			2006			2005			2006
		(amounts in thousands except per share data)
Losses on commodity derivatives
As previously reported		$	(45,432	)	$	(9,640	)	$	(165,487	)	$	(7,584	)	$	(220,937	)
Adjustment		(74,502		)	(70,049		)	(205,408		)	(70,049		)	(300,506		)
As restated		(119,934		)	(79,689		)	(370,895		)	(77,633		)	(521,443		)
Total operating expenses
As previously reported		$	(51,741	)	$	(15,158	)	$	(185,904	)	$	(26,026	)	$	(385,311	)
Adjustment		(74,502		)	(70,049		)	(205,408		)	(70,049		)	(300,506		)
As restated		(126,243		)	(85,207		)	(391,312		)	(96,075		)	(685,817		)
Gain on sale of interest in subsidiary
As previously reported		$	119,800		$	—		$	119,800		$	—		$	119,800
Adjustment		79,800			—			79,800			—			79,800
As restated		199,600			—			199,600			—			199,600
Total other income and expense
As previously reported		$	124,269		$	3,061		$	134,538		$	6,242		$	165,053
Adjustment		79,800			—			79,800			—			79,800
As restated		204,069			3,061			214,338			6,242			244,853
Gain (loss) before minority interest and income taxes
As previously reported		$	72,528		$	(12,097	)	$	(51,366	)	$	(19,784	)	$	(220,258	)
Adjustment		5,298			(70,049		)	(125,608		)	(70,049		)	(220,706		)
As restated		77,826			(82,146		)	(176,974		)	(89,833		)	(440,964		)
Minority interest in loss of consolidated subsidiaries
As previously reported		$	257		$	1		$	250		$	12		$	4,825
Adjustment		(10,273		)	—			(10,273		)	—			(10,273		)
As restated		(10,016		)	1			(10,023		)	12			(5,448		)
Net income (loss)
As previously reported		$	72,731		$	(12,096	)	$	(51,277	)	$	(19,772	)	$	(215,973	)
Adjustment		(4,975		)	(70,049		)	(135,881		)	(70,049		)	(230,979		)
As restated		67,756			(82,145		)	(187,158		)	(89,821		)	(446,952		)
Comprehensive income (loss)
As previously reported		$	72,171		$	(12,066	)	$	(50,874	)	$	(19,899	)	$	(215,813	)
Adjustment		(4,975		)	(70,049		)	(135,881		)	(70,049		)	(230,979		)
As restated		67,196			(82,115		)	(186,755		)	(89,948		)	(446,792		)
Net income (loss) per Ordinary
Share - basic
As previously reported		$	1.25		$	(0.25	)	$	(0.92	)	$	(0.41	)
Adjustment		(0.09		)	(1.43		)	(2.43		)	(1.46		)
As restated		1.16			(1.68		)	(3.35		)	(1.87		)
Net income (loss) per Ordinary
Share - diluted
As previously reported		$	1.23		$	(0.25	)	$	(0.92	)	$	(0.41	)
Adjustment		(0.08		)	(1.43		)	(2.43		)	(1.46		)
As restated		1.15			(1.68		)	(3.35		)	(1.87		)

 

The restatements had no impact on the Company’s cash or investment balances or cash flows.

3.              Investments

The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.  The Company accounts for its investments in auction rate securities in accordance with Statement of Financial Accounting Standards No. 115, “Accounting for Certain Investments in Debt and Equity Securities” such that if the underlying security of an auction rate security has a stated or contractual maturity date in excess of 90 days, regardless of the frequency of the interest rate reset date, the security is classified as a current available-for-sale investment. Short-term investments include investments with maturities greater than three months, but not exceeding twelve months and available for sale auction rate securities.  Long-term investments include investments with maturities greater than twelve months.

The Company determines the appropriate classification of its investments in debt and equity securities at the time of purchase and re-evaluates classifications at each balance sheet date. Debt securities are classified as held to maturity when the Company has the intent and ability to hold the securities to maturity.  Held to maturity debt securities are stated at amortized cost and include government agency and corporate obligations.  Available for sale investments are marked to market at each reporting period with changes in value recorded as a component of other comprehensive income. If declines in value are deemed other than temporary, a charge is made to net loss for the period.

The Company invests only in government and corporate securities rated “investment grade” or better. The following tables, based on quoted market prices, summarize the Company’s investments at September 30, 2006 and December 31, 2005:

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September 30, 2006		Cost			Market			Balance
		(in Thousands)
Investments:
Short-term
Available for sale
Auction rate securities		$	246,080		$	246,094		$	246,094
Corporate notes		4,873			5,000			5,000
Government bonds		6,440			6,442			6,442
Common stock		761			842			842
Total available for sale		258,155			258,378			258,378
Held to maturity
Corporate notes		3,601			3,597			3,601
Government bonds		28,764			28,764			28,764
Total held to maturity		32,365			32,361			32,365
Total short term		$	290,520		$	290,739		$	290,743
Long-term
Available for sale
Corporate notes		2,000			2,000			2,000
Total available for sale		2,000			2,000			2,000
Held to maturity
Government bonds		2,000			2,000			2,000
Total held to maturity		2,000			2,000			2,000
Total long term		$	4,000		$	4,000		$	4,000
Restricted Investments:
Short-term
Available for sale
Auction rate securities		$	75,000		$	75,000		$	75,000
Total available for sale		75,000			75,000			75,000
Held to maturity
Government bonds		26,133			26,039			26,133
Total held to maturity		26,133			26,039			26,133
Total short term		$	101,133		$	101,039		$	101,133

 

December 31, 2005		Cost			Market			Balance
		(in Thousands)
Short-term investments
Available for sale
Common stock		$	434		$	686		$	686
Bond funds		3,381			2,885			2,885
Auction rate securities		127,426			127,426			127,426
Total available for sale		131,241			130,997			130,997
Held to maturity
Corporate notes		1,003			998			1,003
Total held to maturity		1,003			998			1,003
Total short term		$	132,244		$	131,995		$	132,000
Restricted Investments:
Short-term
Available for sale
Auction rate securities		$	14,950		$	14,950		$	14,950
Total available for sale		14,950			14,950			14,950
Held to maturity
Corporate notes		2,003			2,004			2,003
Government bonds		50,538			50,191			50,538
Total held to maturity		52,541			52,195			52,541
Total short term		$	67,491		$	67,145		$	67,491
Long-term
Held to maturity
Government bonds		$	12,392		$	12,173		$	12,392

 

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To fulfill the requirements of the San Cristobal Project finance facility, the Company liquidated prior to their maturity dates approximately $34.0 million of investments in the fourth quarter of 2005 and $12.0 million of investments in the first quarter of 2006, which were previously recorded as held-to-maturity (“HTM”) securities.  The Company recognized a $0.2 million and $0.1 million loss on the liquidation for the fourth quarter of 2005 and first quarter of 2006, respectively.  The liquidation was necessitated by the terms of the project finance facility which required the Company to transfer substantially all of its cash and/or investments to collateral accounts to restrict funds necessary to complete the San Cristobal project. Certain covenants related to the project finance facility restricted the maturity dates of investments held in the collateral accounts to less than one year. A portion of the Company’s HTM portfolio had maturity dates slightly beyond the one year limitation. As a result, prior to transferring the securities to the project finance collateral accounts, those HTM securities with maturities greater than one year were liquidated and reinvested in instruments with maturities less than one year.  During the full year 2005 and for the nine month period ended September 30, 2006, the Company recorded as an investing cash inflow an additional $126.3 million and $41.5 million respectively related to HTM securities that matured on their maturity dates.  The Company believes the project financing requirements which caused the Company to liquidate a portion of its HTM investments prior to their maturity dates represent an isolated, unanticipated event that did not change the Company’s ability or intent to hold its remaining HTM investments until their maturity dates.

4.              Prepaid expenses and other assets

Prepaid expenses and other assets consist of the following:

		September 30, 2006			December 31, 2005
		(in thousands)
Prepaid insurance		$	2,704		$	824
Prepaid bank fees		83			—
Accrued interest receivable		752			758
Prepaid consulting & contractor fees		5,345			3,874
Receivables, travel advances and other		715			118
Prepaid import taxes and duties receivable		1,333			—
Withholding taxes receivable		512			250
		$	11,444		$	5,824

 

The prepaid consulting and contractor fees consist primarily of advance payments made to contractors for work being performed for the San Cristobal Project.

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5.              Value Added Tax Recoverable

The Company has recorded value added tax (“VAT”) paid in Bolivia as a recoverable asset.  Current Bolivian tax law states that VAT paid prior to production is recoverable as a credit against Bolivian taxes arising from production, including income tax. The VAT paid in Bolivia is expected to be recovered through production from the proven and probable reserves at the San Cristobal Project that the Company is developing.  Future changes to Bolivian tax law should they occur, could have an adverse effect on the Company’s ability to recover these taxes.  At September 30, 2006 and December 31, 2005 the recoverable VAT recorded for Bolivia is $45.5 million and $20.1 million, respectively.

In addition, the Company incurred VAT related to various exploration activities outside of the San Cristobal project in Bolivia and in other countries. Because of the uncertainty of the recoverability of these taxes they are charged to expense as incurred.

6.              Property, Plant and Equipment

The components of property, plant and equipment were as follows:

		September 30, 2006			December 31, 2005
		(in thousands)
Mineral properties		$	117,319		$	117,103
Construction in progress		425,767			232,288
Buildings		11,493			8,423
Mining equipment and machinery		12,868			10,127
Equipment under capital lease		22,183			14,928
Other furniture and equipment		3,150			1,966
		592,780			384,835
Less: Accumulated depreciation		(9,612		)	(5,697		)
		$	583,168		$	379,138

 

For the nine month periods ended September 30, 2006 and 2005 the Company recorded depreciation expense of $296,000 and $114,000, respectively.  Also, for the nine month periods ended September 30, 2006 and 2005 the Company capitalized depreciation associated with the San Cristobal Project in the amounts of $3.6 million and $1.8 million respectively.

The September 30, 2006 and December 31, 2005 construction in progress balances include $28.1 and $9.4 million of capitalized interest respectively.

7.              Debt

The Company’s debt consists of the following:

		September 30, 2006						December 31, 2005
		Current			Long term			Current			Long term
		(in thousands)
2.875% Convertible Senior Subordinated Notes due 2024		$	—		$	180,000		$	—		$	180,000
4.0% Convertible Senior Subordinated Notes due 2024		—			109,987			—			129,987
Project finance facility		—			120,000			—			—
Note payable to Ingelec		—			1,407			—			—
Note assigned to Sumitomo		—			7,798			—			—
Capital lease obligations		2,993			14,925			2,270			10,034
		$	2,993		$	434,117		$	2,270		$	320,021

 

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In December 2005 the Company closed on a $225 million project finance facility, arranged by BNP Paribas and Barclays Capital, and funded by a group of international financial institutions including banks, export credit agencies and the Andean Development Corporation, a multilateral financial agency that promotes sustainable development in South America.  Borrowings from the facility are being used to complete the development of the Company’s San Cristobal Project. During the nine months ended September 30, 2006 the Company borrowed $120.0 million under the facility. The Company is required to pay a 1.0% annual commitment fee on the undrawn amount of the facility.  Interest on the outstanding amounts drawn under the facility is based on LIBOR plus a credit spread.  Covenants related to the facility require the Company to maintain certain security interests, financial ratios, insurance coverage, minimum sales contracts and metals price protection contracts as well as other requirements.  The first principal payment under the facility is due in December 2008, and the facility must be fully repaid in December 2012.

In connection with the sale to Sumitomo of a 35% interest in the subsidiaries that own our San Cristobal Project, Sumitomo has guaranteed the repayment of 35% of the project finance facility debt. Also, in conjunction with the sale, the project finance facility agreements were amended to provide for the release of $70.0 million of overrun financing previously held in accounts controlled by the lenders and approximately $5.7 million previously escrowed to meet interest payments on our subordinated notes. This $75.7 million is now unrestricted and available for general corporate purposes (see Note 11 for detail of sale of 35% interest in San Cristobal).

During the nine months ended September 30, 2006 the Company placed in service $8.1 million of additional mining equipment to be used in stripping and mine production, and recorded the transaction as a capital lease, resulting in total capital lease obligations of $17.9 million. During the nine months ended September 30, 2006 the Company made payments of $1.7 million related to capital lease obligations and will be required to make additional payments of $0.8 million for the remainder of 2006, $3.0 million during each of 2007 and 2008, $2.4 million during 2009, $1.9 million during 2010 and $6.8 million thereafter.

The Company has loaned funds to the contractor that is building the power line for the San Cristobal Project and holds a note receivable from the contractor in the amount of $22.3 million. The Company expects to receive repayment of the note from the power company in the form of credits against charges for the delivery of power.  In connection with the sale of 35% of the San Cristobal Project to Sumitomo, the Company assigned 35% of the $22.3 million note to Sumitomo. As the Company receives payments from the power company it must pay Sumitomo its 35% share of such payments. As a result, the Company has recorded a note payable to Sumitomo in the amount of $7.8 million.

During the third quarter of 2006 the contractor that is building the power line for the San Cristobal Project borrowed approximately $1.4 million from its parent company to complete the construction of the power line.  Per the guidance of FASB Interpretation No. 46R “Variable Interest Entities” (“FIN 46R”) the Company consolidates the accounts of the contractor and recorded the note payable of $1.4 million on its consolidated books.

During 2006 the Company issued approximately 1.1 million Ordinary Shares valued at $17.1 million and $0.3 million of cash for unpaid interest to complete the purchase of $20.0 million principal amount of the Company’s 4.0% Convertible Senior Subordinated Notes due 2024 in a privately negotiated exchange transaction. The transaction resulted in the recognition of a $2.9 million gain on extinguishment of debt.  The Company canceled the notes purchased in the transaction.

Pursuant to the agreement related to the 4% Notes and certain provisions of the project finance facility, the Company is required to maintain restricted investments to cover the payment of interest on the Notes through 2007.  The amount invested will at maturity equal the interest payments due.  As of September 30, 2006, $5.5 million of restricted investments were designated for this purpose.

8.              Sales Contracts and Derivative Instruments

Certain covenants related to the project finance facility required the Company to provide price protection for a portion of its planned production of metals from San Cristobal.  During the third quarter of 2005, the Company entered into positions utilizing primarily forward sales, but also puts and calls, to comply with the project finance facility covenants. In order to maintain leverage to silver market prices, the Company entered into proportionally

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more zinc and lead positions than silver positions.  Non-cash mark-to-market gains and losses from these outstanding metal derivative positions may fluctuate substantially from period to period based on spot and forward prices and option volatilities.

In addition, the Company made limited investments in shorter duration put and call options and other metals derivatives not required by the project financing facility.  During 2006, the Company made $36.4 million of net cash payments to settle the majority of these discretionary derivative contracts. The remaining liability for these discretionary derivative positions on a mark-to-market basis as of September 30, 2006 was approximately $5.0 million.

The Company marks its open derivative positions to estimated fair value at the end of each accounting period with the related change in estimated fair value recorded to earnings. For the quarter and year to date periods ended September 30, 2006 the Company recorded non-cash mark to market losses of $112.6 million and $334.5 million and realized losses of $7.3 million and $36.4 million compared to a $79.7 million and $77.6 million non-cash mark to market loss and realized gains or losses of $nil and $nil for the quarter and year to date periods ended  September 30, 2005 and a non-cash mark-to-market gain of $0.8 million and realized gains or losses of $nil recorded for the year ended December 31, 2004. The 2006 and 2005 losses are the result of continuing high spot and forward prices for silver, zinc and lead. The actual financial impact of the required project financing facility derivative positions will not be known until the positions are closed on their future settlement dates. The Company does not intend to settle the open derivatives position contracts relating to the project financing facility prior to their settlement dates which begin during the second half of 2007. At the time of final settlement, the gain or loss recorded will exclude previously recognized non-cash mark-to-market gains or losses.

The following table sets forth the Company’s open derivative positions at September 30, 2006.  The contracts with open maturity dates of less than one year represent the discretionary derivatives while those with maturities greater than one year are all related to the requirements of the project financing and will be settled for cash based on monthly average prices for each metal in the period indicated.

		Current Maturity Date
		Year 1			Years 2 and 3			Years 4 and 5			Thereafter			Total
Forward Contracts
Silver (000 ounces)		—			230			185			200			615
Average price (per ounce)		$	—		$	7.27		$	7.21		$	7.13		$	7.21
Zinc (000 pounds)		9,177			411,431			335,348			19,841			775,797
Average price (per pound)		$	0.59		$	0.48		$	0.48		$	0.48		$	0.48
Lead (000 pounds)		17,085			241,511			64,374			—			322,970
Average price (per pound)		$	0.30		$	0.30		$	0.29		$	—		$	0.30
Put Option Contracts Owned
Silver (000 ounces)		100			1,325			3,102			4,573			9,100
Average price (per ounce)		$	5.25		$	5.49		$	5.71		$	5.91		$	5.78
Zinc (000 pounds)		24,251			—			—			—			24,251
Average price (per pound)		$	0.57		$	—		$	—		$	—		$	0.57
Call Option Contracts Written
Silver (000 ounces)		1,885			6,200			3,255			345			11,685
Average price (per ounce)		$	15.24		$	8.25		$	8.37		$	9.14		$	9.44
Zinc (000 pounds)		57,871			12,126			1,653			—			71,650
Average price (per pound)		$	1.06		$	0.57		$	0.57		$	—		$	0.97
Lead (000 pounds)		4,409			24,251			3,307			—			31,967
Average price (per pound)		$	0.70		$	0.39		$	0.39		$	—		$	0.43
Call Option Contracts Owned
Silver (000 ounces)		1,240			—			—			—			1,240
Average price (per ounce)		$	13.55		$	—		$	—		$	—		$	13.55
Zinc (000 pounds)		57,871			—			—			—			57,871
Average price (per pound)		$	1.23		$	—		$	—		$	—		$	1.23

 

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The following table sets forth the fair value of the Company’s open derivative positions based on indices such as the LME and COMEX and valuations from counterparties holding the Company’s derivative positions at September 30, 2006 and December 31, 2005 and the change for the nine months ended September 30, 2006.

		Amount To Be Realized In
Period Ended		Less Than 1 Year			2 to 3 Years			4 to 5 Years			Thereafter			Total
		(in thousands)
12/31/2005		$	5,652		$	62,268		$	77,584		$	5,867		$	151,371
9/30/2006 Restated		$	17,827		$	327,953		$	134,642		$	2,325		$	482,747
2006 Change		$	12,175		$	265,685		$	57,058		$	(3,542	)	$	331,376

 

During 2005, the Company recognized a $0.9 million mark-to-market loss on a foreign currency collar transaction utilizing puts and calls that were put in place during 2004 to hedge currency fluctuations related to payments required on certain long-lead equipment purchased for the San Cristobal project that was denominated in Euros. The transaction resulted in a realized gain of $0.5 million during the two years it was in place. No such gains or losses were recognized during the nine months ended September 30, 2006 and the Company did not have any foreign currency derivative positions.

The Company’s 2.875% and 4.0% Convertible Senior Subordinated Notes Due 2024 have several embedded derivatives that have been determined to have no value.

Credit Risk and Risks Relating to the Use of Derivatives

Credit risk is the risk that a third party might fail to fulfill its performance obligations under the terms of a financial instrument. For derivatives, when the fair value of a derivative is negative, as in the Company’s case at September 30, 2006, we assume no credit risk. However, should the Company’s derivative positions become positive, the Company would become exposed to credit risk. All of the Company’s derivative positions at September 30, 2006 are required by the project finance facility and per the terms of the facility are concentrated with two counterparties. The two counterparties are of high credit-quality and the Company monitors their financial condition at regular intervals. Under the terms of the derivative agreements, the counterparties cannot require the Company to immediately settle outstanding derivatives, except upon the occurrence of customary events of default such as covenant breaches, including financial covenants, insolvency or bankruptcy.

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9.              Asset Retirement Obligations

The Company has developed an asset retirement plan for its San Cristobal Project which is currently under construction and is expected to begin producing in the third quarter of 2007. The plan includes estimated reclamation, remediation and closure requirements based on Bolivian government requirements, World Bank financing requirements and the Company’s policies.  Beginning in the third quarter of 2005 the Company has been conducting activities at its San Cristobal Project including earthworks, plant construction and mining activities that fall within the scope of the asset retirement plan and as such will require future reclamation and closure expenditures.

Per the guidance of Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (“FAS No. 143”), the fair value of the asset retirement obligation (“ARO”) associated with the San Cristobal Project is calculated by first estimating the cash flows required to settle an estimated $28.5 million ARO obligation in future periods using an inflation rate of 1.6 percent and then discounting the future cash flows using the Company’s credit-adjusted risk-free rate of 9.8 percent.

The following table reconciles the beginning and ending balance for the Company’s asset retirement obligations (in thousands):

 

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10.       Shareholders’ Equity

The following table sets forth the changes in shareholders’ equity during the first nine months of 2006:

													Accumulated
							Additional						Other			Total
		Common Stock					Paid-in			Accumulated			Comprehensive			Shareholders’
		Shares		Amount			Capital			Deficit			income			Equity
		(in thousands except share data)
Balance, December 31, 2005		50,444,890		$	504.4		$	486,762		$	(259,794	)	$	(243	)	$	227,229
Stock to finance construction of the power line ($15.09 per share)		369,033		3.7			5,724			—			—			5,728
Shares issued to retire debt, ($15.77 per share)		1,086,653		10.9			17,114			—			—			17,125
Stock to consultants ($15.90 per share)		1,699		—			27			—			—			27
Stock compensation accrued		—		—			3,897			—			—			3,897
Stock options exercised ($12.52 per share)		140,925		1.4			1,764			—			—			1,765
Stock granted as compensation ($19.30 per share)		17,000		0.2			—			—			—			—
Sale of Ordinary Shares, net ($23.70 per share)		6,375,000		63.8			151,003			—			—			151,067
Unrealized gain on marketable equity securities		—		—			—			—			403			403
Net loss Restated		—		—			—			(187,158		)	—			(187,158		)
Balance, September 30, 2006 Restated		58,435,200		$	584.4		$	666,291		$	(446,952	)	$	160		$	220,083

 

Ordinary Share Issuances – During January 2006, the Company issued 369,033 of its Ordinary Shares, valued at $5.7 million, as the last of four agreed upon advances to SC TESA for the construction of the power line to the San Cristobal project. The Company had previously issued 1,134,799 of its Ordinary Shares, valued at $16.6 million, during 2005, as the first three advances to SC TESA. Proceeds in excess of construction costs of approximately $0.1 million received by SC TESA from the sale of the shares will be added to the advances to be repaid to the Company with interest through credits against charges for future delivery of power.

In January and February 2006 the Company issued approximately 1.1 million Ordinary Shares valued at $17.1 million and paid $0.3 million for interest to complete the purchase of $20.0 million principal amount of the Company’s 4.0% Convertible Senior Subordinated Notes due 2024 in a privately negotiated exchange transaction. The Company canceled the notes purchased in the transaction.

During the second quarter of 2006, the Company completed the public offering of 6,375,000 of its Ordinary Shares at $24.45 per share ($23.70 per share net of commissions) registered under its shelf registration statement.  The Company intends to use the net proceeds of approximately $151.1 million to continue further evaluation, exploration, advancement and expansion of its portfolio of exploration properties and for other general corporate purposes.

Stock Option Plans – The Company established a plan to issue share options and other share awards for officers, employees, consultants and agents of the Company and its subsidiaries (the “Plan”). Option awards are granted with an exercise price equal to the market price of the Company’s stock at the date of grant. Options typically vest ratably over periods of up to four years with the first tranche vesting on the date of grant or the first anniversary of the date of grant. Unexercised options expire typically ten years after the date of grant.  The options and other awards provide for accelerated vesting if there is a change in control as defined in the Plan.

The Company also established a share option plan for its non-employee directors (the “Director Plan”).  Options granted under the Director Plan vest on the date of the grant and expire ten years after the date of the grant or three years after the date that a non-employee director ceases to be a director of the Company.  Options granted under the Director Plan are transferable only in limited circumstances.

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The fair value of each option award is estimated on the date of grant using the Black-Scholes option-pricing model that uses the assumptions noted in the following table.  Expected volatilities are based on historical volatility of the entity’s stock.  The Company uses historical data to estimate option exercise and employee termination within the Black-Scholes model.  The expected term of options granted represents the period of time that options granted are expected to be outstanding, based on past experience and future estimates and includes data from both the Plan and the Directors Plan.  The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

For purposes of calculating the fair value of options, volatility for the periods presented is based on the historical volatility of the Company’s Ordinary Shares.  The Company currently does not foresee the payment of dividends in the near term. The fair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following assumptions:

		Nine Months Ended September 30,
		2006		2005
Expected volatility		43.8% - 45.4%		42.6% - 43.8%
Weighted average volatility		44.9	%	43.3	%
Expected dividend yield		—		—
Expected term (in years)		3.06		3.78
Risk-free rate		4.89	%	3.72	%

 

A summary of the Company’s stock options at September 30, 2006 and changes during the nine months then ended is presented in the following table:

Options		Number of Shares		Weighted Average Exercise Price Per Share			Weighted Average Remaining Contractual Life		Aggregate Intrinsic Value
Outstanding at beginning of period		2,859,781		$	14.42		6.4 Years		$	6,664,178
Granted during period		123,888		$	15.97		9.6 Years		$	—
Forfeited or expired during period		(47,901	)	$	16.64				$	289,983
Exercised during period		(140,925	)	$	12.53				$	1,145,515
Outstanding at end of period		2,794,843		$	14.54		5.8 Years		$	7,460,540
Exercisable at end of period		1,938,293		$	13.33		4.7 Years		$	7,027,492
Expected to vest at the end of the period		856,550		$	17.28		8.3 Years		$	433,047

 

During the nine months ended September 30, 2006 and September 30, 2005, the Company granted equity awards with weighted average grant date fair values of $0.7 million and $0.8 million, respectively; options were exercised with total intrinsic values of $1.1 million and $0.1 million, respectively; and the total fair value of shares vested during the nine months was $1.7 million and $0.4 million, respectively.

As of September 30, 2006, total unrecognized compensation cost related to the non-vested stock options granted pursuant to the Plan was $1.8 million which the Company expects will be recognized over a weighted average period of 1.0 year.

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A summary of the status of the Company’s non-vested restricted stock grants at September 30, 2006 and changes during the nine months then ended is presented in the following table:

Non-vested Shares		Number of Shares		Weighted Average Grant Date Fair Value Per Share
Non-vested at beginning of period		170,700		$	18.41
Granted during period		25,000		$	13.75
Vested during period		(14,500	)	$	17.70
Forfeited during period		(3,000	)	$	16.03
Nonvested at end of period		178,200		$	17.85

 

As of September 30, 2006, total unrecognized compensation cost related to the non-vested restricted shares granted pursuant to the Plan was $1.9 million.  The Company expects that the total unrecognized cost will be recognized over a weighted average period of 1.5 years.

During 2005 the Company granted stock-based performance bonuses under the Plan, related to certain cost and completion date targets for the San Cristobal Project.  The following table summarizes the stock-based performance bonus plan at September 30, 2006 and changes during the first nine months of 2006:

Non-vested Shares		Number of Shares		Weighted Average Grant Date Fair Value Per Share
Non-vested at beginning of period		32,000		$	15.41
Granted during period		—		$	—
Vested during period		—		$	—
Forfeited during period		(6,000	)	$	16.25
Nonvested at end of period		26,000		$	15.21

 

As of September 30, 2006, total unrecognized compensation cost related to the non-vested performance bonuses granted pursuant to the Plan was $0.1 million.  The Company expects that the total unrecognized cost will be recognized over a weighted average period of 0.7 years.

Total compensation costs recognized for all stock-based employee compensation awards, including amounts capitalized, were $3.6 million and $2.0 million for the nine months ended September 30, 2006 and 2005, respectively.

11.       Minority Interest

On September 25, 2006, pursuant to a Purchase and Sale Agreement among the Company, certain of its wholly owned subsidiaries and Sumitomo Corporation (“Sumitomo”), the Company sold to Sumitomo a 35% interest in three subsidiaries that own its San Cristobal Project, market Project concentrates and hold the metals hedge positions required by the Project lenders, in exchange for $224 million in cash and certain deferred payments based on silver and zinc production from the Project.  The Company continues to own 65% of these three subsidiaries.  The Company also agreed to assign Sumitomo a 35% interest in the $22.3 million note receivable the Company holds from the Project power line construction and transmission contractor.

Pursuant to the Purchase and Sale Agreement, the Company agreed to indemnify Sumitomo generally for breaches of representations and warranties discovered within one year of closing resulting in damages to Sumitomo exceeding $3 million, up to a cap of $40 million, provided that for breaches related to title to shares of the acquired companies, subordinated debt, certain transferred agreements and real and personal property required for the San Cristobal Project discovered within six years of closing, the cap is $224 million.

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Sumitomo agreed to indemnify the Company generally for breaches of representations and warranties that are discovered within one year of closing, resulting in damages to the Company exceeding $3 million, up to a cap of $40 million.

Pursuant to a Deferred Payments Agreement dated September 25, 2006 Sumitomo will make the following deferred payments to the Company in respect of production from the San Cristobal Project and future expansions:  (i) quarterly payments equal to 22.86% of Sumitomo’s share of payable silver production from the San Cristobal Project, or approximately 8% of total payable silver production, payable in cash or silver at Sumitomo’s option, and (ii) quarterly cash payments equal to 20% of Sumitomo’s share of payable zinc production from the San Cristobal Project, or approximately 7% of total payable zinc production, multiplied by the zinc price in excess of $1,800 per tonne.

The Minera San Cristobal (“MSC”) Shareholders Agreement dated September 25, 2006 provides that the majority shareholder will control the MSC Board and appoint the Board Chairman.  MSC is the subsidiary that owns and operates the San Cristobal Project.  As long as the minority shareholder holds more than 25% of MSC, certain significant matters require the approval of the minority shareholder director including approval of annual programs and budgets, increases of 15% or more over budgeted capital expenditures or operating expenses (with customary exceptions for emergencies and compliance), merger or liquidation, permanent cessation or suspension for more than 180 days of mining at or abandonment of the San Cristobal Project.  If a deadlock with respect to adoption or amendment in excess of 15% of a program and budget continues for 180 days, the majority shareholder’s directors are then entitled to approve the program and budget.

Under the MSC Shareholder Agreement, the Company and Sumitomo are required to provide their respective proportionate shares of shareholder debt or equity funding required for MSC to achieve commercial operations, or be diluted on a two for one basis.  Following commercial operations, the Company and Sumitomo may choose to provide their proportionate share of required external funding or dilute on a one for one basis.  Dilution by the Company or Sumitomo of its ownership interest in MSC will result in transfers of shares in the other two subsidiaries, so that the parties’ ownership interests in the three companies remain identical.  If Sumitomo were to dilute below 25% solely as a result of its failure to provide future funding, and were to refuse to approve a program and budget proposed by the Company for more than 180 days, Sumitomo would have the right to sell to the Company all (but not less than all) of its remaining interest in MSC for $224 million, reduced pro rata by the percentage of year-end 2005 reserves produced from the San Cristobal Project.

Each of the Company and Sumitomo has a right of first refusal to acquire any interests in MSC that the other wishes to sell or, if the party wishing to sell has less than a 25% interest in MSC, a right of first offer.  In the event of a change of control of the Company, Sumitomo would be relieved of its right of first refusal and first offer obligations for two years.  Any party that acquires an interest in MSC must acquire a pro rata interest in the other two subsidiaries.

The MSC Shareholders Agreement provides that available cash will be distributed quarterly, first to pay the $5.4 million annual management fee due from MSC to the Company, then to shareholders that have advanced loans on behalf of a non-funding shareholder, then to shareholders who have advanced shareholder loans pro rata to their ownership interests, and then as cash dividends. An additional aggregate $0.3 million annual management fee is jointly payable to the Company by the other two jointly owned subsidiaries.

The Company and Sumitomo have also entered into a two year Option Agreement dated September 25, 2006, pursuant to which Sumitomo may acquire a 20 percent to 35 percent interest in each of certain active exploration properties at historical cost, and in each of certain of the Company’s inactive exploration properties at historical cost once the Company has spent $200,000 in exploration costs on the property.  Sumitomo must exercise its option on each active property within 60 days of receiving complete information regarding the property and on each inactive property within 60 days of the Company spending $200,000 on the property.  At September 30, 2006 Sumitomo had not exercised its options to acquire any exploration properties.

The Company also amended the San Cristobal project finance facility in connection with the sale to Sumitomo, as follows:  (i) the Company and Sumitomo provide severally pro rata to their respective 65%

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and 35% ownership interests in MSC, and not jointly, San Cristobal Project completion and cost overrun support; (ii) the Company and Sumitomo guarantee severally pro rata to their MSC ownership interests, and not jointly, the performance of the metals hedge positions; (iii) the Company is permitted to withdraw from accounts controlled by the lenders $70 million of contingent overrun financing previously required by the Project lenders; (iv) Sumitomo guarantees up to $45.5 million of overrun funding by the Company; (v) the Company was permitted to remove from escrow approximately $5.7 million previously deposited to meet interest payments on its subordinated notes, and is no longer required to escrow an additional $10.4 million; and (vi) additional cure periods for certain representation and covenant defaults and certain defaults related to completion of the Project are permitted, as is the substitution of a replacement sponsor in the event of certain defaults, bankruptcy or expropriation events.

The Company recorded a minority interest in the assets and liabilities sold of $8.8 million and recognized a gain of $199.6 million related to the transaction.  The gain is net of approximately $6.4 million of selling costs incurred by the Company related to the transaction.  The $199.6 million gain is calculated as the difference between the cash proceeds (net of selling costs) and the book value of the interests sold. The book value includes the mark-to-market liability on the open metals hedge positions required by the project finance facility, excludes pre-feasibility exploration and other costs previously expensed, and was reduced by the book value allocated to the retained interests in future silver and zinc production. The payments related to the retained interests in future production will be recorded as a reduction of minority interest as they become receivable by the Company.

The Company may be required to pay up to an estimated $4.0 million bonus to the Project construction management contractor contingent upon certain project completion parameters. Sumitomo is deemed to have already paid its 35% share of the bonus as part of the initial cash payment. Therefore, Apex Silver has agreed to reimburse Sumitomo its $1.4 million share of the bonus if it is paid. Apex Silver will defer $1.4 million of the gain until such time as the payment is made or determined not to be payable.

The Company recognized a $0.3 million minority interest benefit related to Sumitomo’s share of certain losses incurred subsequent to the close of the transaction. The losses were primarily related to the mark-to-market losses on the open hedge positions required by the project finance facility that were incurred from the date of the Sumitomo transaction through the end of the period.

12.       Commitments and Contingencies

Letters of Credit – At September 30, 2006, the Company had outstanding irrevocable standby letters of credit related to the San Cristobal Project in the aggregate amount of $7.6 million. The letters of credit include $4.5 million associated with the rail contract to transport metal concentrates to the port facilities, $2.0 million associated with the construction management contract and $1.1 million associated with the power line construction contract.  At September 30, 2006 the Company had deposited $7.6 million to collateralize the letters of credit and has recorded $0.5 million to restricted cash and $7.1 million to restricted investments.  Per the terms of the letters of credit the required amounts may be reduced from time to time under certain circumstances.

Escrow and Other Restricted Amounts – At September 30, 2006, $4.1 million remained in an escrow account to provide for certain requirements related to the development of the port facility for the San Cristobal Project. At September 30, 2006 the amount was recorded to restricted cash.

Project Financing – Per the terms and conditions of the San Cristobal Project finance facility the Company was required to deposit cash and investments in an account the use of which is restricted to the development of the San Cristobal Project. At September 30, 2006 the remaining balance in the account was $99.1 million of which $10.6 million was recorded to restricted cash and $88.5 million recorded to restricted investments.

Capital Commitments – The Company entered into agreements with certain service providers and placed orders for certain long-lead equipment and construction materials for its San Cristobal project resulting in open commitments totaling approximately $77.6 million at September 30, 2006.  If the Company had cancelled all of these agreements or orders at September 30, 2006, it would have incurred cancellation fees totaling approximately $18.6 million.

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Taxes – The Company is receiving certain tax and duty benefits on a portion of the equipment it is importing for its San Cristobal Project. The benefits are contingent upon fulfilling certain expenditure commitments within a specified period of time and returning certain equipment off shore within a specified period of time. Failing to comply with these commitments would obligate the Company to refund all or a portion of the benefits received.

Performance Bonus – The Company may be required to pay up to an estimated $4.0 million bonus to the San Cristobal Project construction management contractor contingent upon certain project completion parameters.  Based on the current project status the company does not consider the payment probable and at September 30, 2006 no amounts have been accrued.

Other Contingencies – The Company reported in its 10-K filing for the period ended December 31, 2005 that it had concluded an internal investigation regarding impermissible payments made to government officials by several senior employees of one of its South American subsidiaries during 2003 and 2004.  The Company reported at that time that the SEC had commenced an investigation with respect to these matters including possible violations of the Foreign Corrupt Practices Act. The Company is cooperating fully with the SEC investigation and will cooperate with any investigation by the U. S. Department of Justice.  The Company cannot predict with any certainty at this time the final outcome of any investigations that may take place including any fines or penalties that may be imposed.

The Company continues to monitor the political uncertainties in Bolivia resulting from the Bolivian government's renegotiation of agreements with oil and gas producers and statements regarding possible changes in current policies affecting the mining industry.  If the San Cristobal Project were nationalized, or if taxes were substantially increased or significant royalty payments imposed, the Company might be unable to recover its investment in the Project and could have substantial liabilities for the derivative positions required by the Project lenders. In addition, changes in Bolivian law may have an adverse effect on the Company’s ability to recover VAT receivable (See Note 5).

13.       Foreign Currency

Gains and losses on foreign currency derivatives and translation consist of the following:

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
		2006			2005			2006			2005
		(in thousands)						(in thousands)
Loss on Euro derivatives		$	—		$	—		$	—		$	(872	)
Gain (loss) on re-measurement of monetary assets denominated in other than US dollars		$	203		$	474		$	439		$	62
Total		$	203		$	474		$	439		$	(810	)

 

The re-measurement of monetary assets is related to certain taxes receivable and other accounts denominated in Bolivia’s local currency.

The loss on the Euro derivatives during 2005 is related to the marking to market of open Euro derivative positions held by the Company related to certain capital equipment purchased for San Cristobal for which the price was denominated in Euros.  The Company held no such derivative positions during 2006.

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14.       Supplemental cash flow information

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

		Nine Months Ended
		September 30,
		2006			2005
		Restated			Restated
		(in thousands)
Supplemental disclosure:
Interest paid, net of amounts capitalized		$	774		$	6,387
Supplemental disclosure of non-cash transactions:
Depreciation expense capitalized		$	3,618		$	1,776
Accrued interest capitalized		$	799		$	228
Stock issued as compensation to consultants		$	27		$	126
Mark-to-market gain (loss) on derivatives		$	334,544		$	(77,633	)
Accrued property plant & equipment		$	(13,008	)	$	55,807
Capitalized leases		$	8,123		$	15,222
Stock issued as compensation including amounts capitalized		$	3,608		$	2,016
Stock issued to purchase debt		$	17,125		$	6,103

 

15.       Subsequent Events

During October 2006 the Company borrowed an additional $20 million against the $225 million San Cristobal project finance facility, bringing to $140 million the total borrowings against the facility. The funds are restricted to the development of the San Cristobal Project.

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