GOLD RESERVE LTD 10-Q

ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview This Management’s Discussion and Analysis of Financial Condition and Results of Operations, dated May 13, 2010, is intended to assist in understanding and assessing our results of operations and financial condition. While we pursue our arbitration claim against the Venezuelan government as more fully discussed below, we are attempting to settle our dispute with the Venezuelan government, mitigate our loss through the sale of Brisas Project assets, and are seeking to invest in or acquire other projects. The expense categories shown in the consolidated statements of operations have been revised on a comparative basis to better present the current operations of the Company. The revisions had no effect on previously reported results of operations. Gold Reserve, an exploration stage company, is engaged in the business of acquiring, exploring and developing mining projects. From 1992 to 2009 we focused substantially all of our management and financial resources on the development of the Brisas gold and copper project located in the Kilometre 88 mining district of the State of Bolivar in south-eastern Venezuela (which we refer to as the “Brisas Project” or “Brisas”). The Brisas Project is one of the largest undeveloped gold/copper deposits in the world, containing estimated ore reserves of 10.2 million ounces of gold and 1.4 billion pounds of copper. The Venezuelan Ministry of Mines (“MIBAM”) approved the Brisas operating plan during 2003 and in early 2007 the Venezuelan Ministry of Environment (“MinAmb”) approved the Brisas Environmental and Social Impact Study for the Exploitation and Processing of Gold and Copper Ore (“Estudio de Impacto Ambiental y Sociocultural” or “ESIA”). In March 2007, MinAmb issued the Authorization for the Affectation of Natural Resources for the Construction of Infrastructure and Services Phase of the Brisas Project (the “Authorization to Affect”). In May 2007 we raised (net of expenses) $177.5 million comprised of $103.5 million of 5.50% senior subordinated convertible notes (“convertible notes”) and $74 million of common shares. Thereafter we commenced significant pre-construction efforts including awarding contracts for site preparation and construction camp facilities and placing equipment orders totaling approximately $125.3 million. In April 2008, the MinAmb revoked the March 2007 Authorization to Affect without prior notification. In August 2008, the Company received an unsolicited nonbinding expression of interest from Rusoro Mining Ltd. (“Rusoro”) to complete a 100% business combination by issuing two shares of Rusoro for each share of Gold Reserve. The Board of Directors of the Company reviewed the expression of interest and unanimously determined that it was inadequate and not in the best interests of the Company’s shareholders. On December 15, 2008, Rusoro Mining Ltd. (‘Rusoro”), with the assistance of Endeavour Financial International Corporation (“Endeavour”) launched a hostile takeover attempt of the company. On December 16, 2008, the Company filed an action in the Ontario Superior Court of Justice against Rusoro and Rusoro’s financial advisor Endeavour seeking an injunction restraining Rusoro and Endeavour from proceeding with Rusoro’s unsolicited offer, significant monetary damages, and various other items. Endeavour was the Company’s financial advisor from 2004 until shortly after the commencement of Rusoro’s offer. On February 10, 2009, the Ontario Superior Court of Justice granted an interlocutory injunction restraining Rusoro from proceeding with any hostile takeover bid to acquire the shares of the Company until the conclusion and disposition at trial of the action commenced by the Company. Following the issuance of the interlocutory injunctions, Rusoro withdrew its unsolicited takeover offer. On February 15, 2009, Rusoro and Endeavour both served a motion with the Ontario Superior Court of Justice seeking permission to appeal to the Divisional Court the February 10, 2009 order that was granted against them. On April 6, 2009 the permission to appeal was denied. Rusoro has filed a counterclaim against the Company for, among other things, damages of Cdn $102.5 million allegedly arising from the Company’s successful motion for an interlocutory injunction. Endeavour has filed a $0.5 million counter claim against the Company relating to the lost opportunity to earn a success fee from the successful completion of the Rusoro offer. On April 21, 2009 the Company notified the Venezuelan government of the existence of a dispute under the Agreement between the Government of Canada and the Government of the Republic of Venezuela for the Promotion and Protection of Investments (“Canada – Venezuela Treaty”) after months of continuous efforts to meet with representatives of the Venezuelan government to resolve the issues related to the May 2008 revocation of the Authorization to Affect. In May 2009 the Venezuelan government denied the extension of the Brisas Alluvial Concession which contains 3% of the gold and no copper mineralization and the El Pauji Concession (used for Brisas project infrastructure purposes). Pursuant to Article 25 of the Venezuelan mining law the Company applied for extensions of the Brisas Alluvial Concession in October 2007 and the El Pauji Concession in January 2008. MIBAM did not respond to our request for the extensions during the requisite 6 month time period. Accordingly, the extensions were automatically granted pursuant to the mining law. After six months of unsuccessful attempts to meet with government officials to resolve the investment dispute, on October 21, 2009 the Company filed a Request for Arbitration under the Additional Facility Rules of ICSID, against the Bolivarian Republic of Venezuela. In evident retaliation, Venezuelan government personnel arrived at the Brisas Project camp site on October 26, 2009, claimed ownership of the Brisas Alluvial Concession, seized assets, expelled our personnel and took physical possession of the property. Subsequently, on November 4, 2009, the Venezuelan government notified the Company through the issuance of an Administrative Act, dated October 20, 2009, of its intent to cancel the Company’s underlying Brisas hard rock concession which contains 97% of the gold and 100% of the copper mineralization. As a result of the expropriation of the Brisas Project by the Venezuelan government, in 2009 we recorded a $150.7 million non-cash write-off of the carrying value of the expropriated assets including an adjustment for the estimated net realizable value of certain processing and related equipment purchased for the Brisas Project of approximately $14.5 million. Also, we no longer report mineral reserves for Brisas, and we have discontinued our activities relating to the Brisas and Choco 5 properties. In November 2009 our Request for Arbitration was registered by ICSID (Gold Reserve Inc. v. Bolivarian Republic of Venezuela (ICSID Case No. ARB(AF)/09/1)). The Company is seeking compensation in the arbitration for all of the loss and damage resulting from Venezuela’s wrongful conduct which includes the full market value of the legal rights to develop the Brisas Project. Our current arbitration efforts consist of engaging and assisting technical, legal, and financial experts, and developing and filing our initial pleadings, the filing of which is expected to occur in September 2010. Since acquiring the Brisas Alluvial Concession in 1992, we have spent close to $300 million on the project (including equipment recorded in the Consolidated Balance Sheet and financial, legal and engineering costs incurred in support of our Venezuelan operations and the write-down of previously capitalized costs associated with our Venezuelan operations recorded in the Consolidated Statement of Operations). The information contained in this Quarterly Report on Form 10-Q relating to Brisas and Choco 5 is presented for informational and historical purposes and should not be construed as an indication of our expectations regarding the future development and operation of these properties or the outcome of the arbitration proceedings. We have no commercial production at this time and, as a result, we have not recorded revenue or cash flows from mining operations and continue to experience losses from operations, a trend we expect to continue unless and until the investment dispute regarding Brisas is resolved favorably to the Company and/or we acquire directly or indirectly other mining projects. Historically we have financed the Company’s operations through the issuance of common stock, other equity securities and convertible debt. The Company has only one operating segment, the exploration and development of mineral properties. We prepare our consolidated financial statements in U.S. dollars in accordance with accounting principles generally accepted in Canada (see Note 19 to the Consolidated Financial Statements- Differences Between Canadian and U.S. GAAP). The Company’s historical results of operations and current financial position are a result of the Company’s efforts, since 1992, to develop the Brisas Project into an operating mine and more specifically, our decision, subsequent to the issuance of the Authorization to Affect (the authorization to begin construction of the Brisas Project), to raise $ 177.5 million through the issuance of convertible notes and common shares, place orders to acquire approximately $125 million of equipment, and to continue the development of Brisas. Likewise our October 2009 Request for Arbitration under the Additional Facility Rules of ICSID and the write-off of the costs associated with our Venezuelan operations will shape the future financial position and results of operations of the Company. We expect the arbitration process to last approximately three years, consume substantial management time and cost an estimated $5 million to $8 million, excluding the time and funds necessary to collect on any award. Our primary objective is to manage the arbitration effort in cooperation with arbitration counsel and various experts, to minimize costs and accelerate its completion, to the extent possible. Substantially all of the key management personnel have been employed by the Company for over 15 years with a single focus of developing the Brisas Project. These individuals possess valuable historical knowledge related to the Brisas Project which is important to the successful execution of our arbitration efforts. In addition to the management of our arbitration claim we will continue to explore opportunities to: (1) settle our dispute with Venezuela; (2) sell Brisas Project assets; (3) redeem, restructure or otherwise modify the terms of the 5.50% subordinated notes; and (4) continue evaluating other mining opportunities for a direct or indirect participation. The successful execution of these objectives will be facilitated by the Company’s senior management team which has considerable technical, financial and administrative experience related to the mining industry. The timing of our involvement in any new mining opportunity if any, and the amounts that may be required cannot be determined at this time and are subject to available cash, sale of equipment originally slated for the Brisas Project and/or future financings, if any. Investors are urged to read our filings with U.S. and Canadian securities regulatory agencies, which can be viewed on-line at www.sec.gov, www.sedar.com or at the Company’s website, www.goldreserveinc.com which also includes the Company’s corporate governance policies. Additionally, you can request a copy of any of these documents directly from us. Financial Overview Cautionary Statement Regarding Forward-Looking Statements The information presented or incorporated by reference in this Quarterly Report on Form 10-Q contains both historical information and forward-looking statements (within the meaning of Section 27A of the Securities Act, Section 21E of the Exchange Act and the Securities Act (Ontario)) that may state our intentions, hopes, beliefs, expectations or predictions for the future. In this report, forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by us at this time, are inherently subject to significant business, economic and competitive uncertainties and contingencies. We caution that such forward-looking statements involve known and unknown risks, uncertainties and other risks that may cause our actual financial results, performance, or achievements of the Company to be materially different from our estimated future results, performance, or achievements expressed or implied by those forward-looking statements. These forward-looking statements involve risks and uncertainties, as well as assumptions that may never materialize, prove incorrect or materialize other than as currently contemplated which could cause our results to differ materially from those expressed or implied by such forward-looking statements. The words “believe,” “anticipate,” “expect,” “intend,” “estimate,” “plan,” “may,” “could” and other similar expressions that are predictions of or indicate future events and future trends which do not relate to historical matters, identify forward-looking statements. Any such forward-looking statements are not intended to give any assurances as to future results. Numerous factors could cause actual results to differ materially from those in the forward-looking statements. Due to risks and uncertainties, including the risks and uncertainties identified in our Annual Report on Form 10-K- “Part I- Item 1A. Risk Factors”, actual results may differ materially from current expectations. Numerous factors could cause actual results to differ materially from those in the forward-looking statements, including without limitation: · the outcome of our arbitration under the Additional Facility Rules of the International Centre for Settlement of Investment Disputes of the World Bank, in Washington D.C. to determine compensation claimed by us resulting from our claims against the Venezuelan government and its agents and agencies; · corruption and uncertain legal enforcement; · political and social instability; · requests for improper payments; · competition with companies that are not subject to or do not follow Canadian and U.S. laws and regulations; · regulatory, political and economic risks associated with Venezuela including changes in laws and legal regimes; · the result or outcome of the litigation regarding the enjoined hostile takeover bid for us; · impact of currency, metal prices and metal production volatility; · our dependence upon the abilities and continued participation of certain key employees; · the value of our 5.50% senior subordinated convertible notes due on June 15, 2022 and potential volatility of our Class A common shares (also referred to herein as “Common Shares”), including potential dilution as a result of the conversion of the convertible notes into our common shares by either us or the holder; · the prospects for exploration and development of other mining projects by us; · and risks normally incident to the exploration, development and operation of mining properties. Investors are cautioned not to put undue reliance on forward-looking statements, and investors should not infer that there has been no change in our affairs since the date of this report that would warrant any modification of any forward-looking statement made in this document, other documents filed periodically with securities regulators or documents presented on our website. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this notice. We disclaim any intent or obligation to update publicly or otherwise revise any forward-looking statements or the foregoing list of assumptions or factors, whether as a result of new information, future events or otherwise, subject to our disclosure obligations under applicable rules promulgated by the U.S. Securities and Exchange Commission (the “SEC”). Liquidity and Capital Resources At March 31, 2010 our total financial resources, which included cash and cash equivalents, restricted cash and marketable securities, were approximately $80.7 million compared to $81.2 million at December 31, 2009. The Company’s cash and investments are held primarily in US dollar denominated accounts. March 31, 2010 December 31, 2009 Cash and cash equivalents $ 60,983,350 $ 60,962,813 Restricted cash 8,995,701 9,489,777 Marketable securities 10,760,530 10,773,845 Total $ 80,739,581 $ 81,226,435 Overall financial resources decreased approximately $0.5 million from December 31, 2009. This decrease was primarily due to approximately $4.1 million used by operations more fully described below in results of operations, purchases of property, plant and equipment of approximately $0.5 million relating to our purchase commitments for the Brisas Project, partially offset by net proceeds from the disposition of marketable securities of approximately $0.2 million and approximately $3.9 million from the disposition of equipment. As of May 13, 2010 we held approximately $82 million in cash (including restricted cash of approximately $9.0 million held pursuant to a letter of credit for certain equipment purchase commitments) and marketable securities. The primary future obligation of the Company is the 5.50% senior subordinated notes which may be settled in cash or common shares in the event the holder chooses the one-time option to put the notes back to the Company for repurchase on June 15, 2012 (see Note 17 to the consolidated financial statements). As a result, in the near-term we believe that cash and investment balances and funds available from potential future equipment sales will be sufficient to enable us to fund our activities through 2011. The timing and extent of additional funding, if any, depends on a number of important factors, including, but not limited to the timing and outcome of our investment dispute with the Venezuelan government, the timing and the amount of proceeds, if any, from the sale of Brisas Project assets, the extent of future acquisitions or investments, if any, status of the financial markets and our share price. Operating Activities Cash flow used by operating activities for the three month period ended March 31, 2010 was approximately $4.1 million, which was a decrease over the same period in 2009 of approximately $2.2 million. Investing Activities 2010 2009 Change Purchase of property, plant and equipment $ (498,440) $ (2,904,650) $ 2,406,210 Net proceeds from marketable securities 188,057 - 188,057 Proceeds from sale of equipment 3,865,641 - 3,865,641 Decrease (increase) in restricted cash 494,076 - 494,076 Other - (31,365) 31,365 $ 4,049,334 $ (2,936,015) $ 6,985,349 Investing activities during the three months ended March 31, 2010 and 2009 included net investment in property, plant and equipment of approximately $0.5 million compared to $2.9 million, respectively. These payments primarily relate to obligations related to the 2007 equipment orders for Brisas. Management continues with its efforts to dispose of certain assets originally acquired for the Brisas Project. In the third quarter ended March 31, 2010, the Company recovered approximately $3.9 million through the disposal of these assets. During the three months ended March 31, 2010 and 2009, net proceeds from disposition of marketable securities totaled approximately $0.2 million compared to nil, respectively. In connection with a portion of the 2007 equipment orders for Brisas, we opened an irrevocable standby letter of credit with a Canadian chartered bank providing security on the performance of our obligations, secured by cash. As of March 31, 2010 and 2009, the Company had restricted cash of approximately $9.0 million and $9.5 million, respectively as required by this letter of credit. The $0.5 million reduction of restricted cash during the three months ended March 31, 2010 was due to payments related to the 2007 equipment orders. Financing Activities 2010 2009 Change Net proceeds from issuance of common shares $ 32,384 - $ 32,384 Extinguishment of convertible notes - $ (415,254) 415,254 $ 32,384 $ (415,254) $ 447,638 The convertible notes are trading in the gray market often at a significant discount to face value. As the terms of the indenture provide that the Company may repurchase the convertible notes in open market purchases or negotiated transactions, in 2009 we re-purchased approximately $1.1 million (face value) of convertible notes for approximately $0.5 million. Management continues to explore broader efforts to redeem all or a portion of the outstanding convertible notes. These efforts could include a public offer to reacquire all or a portion of the notes or a more limited “Dutch auction” or individual private transactions. The time and extent of any plan will be influenced by, among other things, terms of the indenture, regulatory issues, market conditions and available cash. The covenants contained in the 5.50% subordinated note indenture are limited to administrative issues such as payments of interest, maintenance of office or agency location, delivery of reports and other related issues. Likewise, events of default are defined as failure to pay interest and principal amounts when due, default in the performance of covenants, failure to convert notes upon holder’s exercise of conversion rights and similar provisions or the Company’s failure to give notice of a fundamental change which is generally defined as events related to a change of control in the Company. Contractual Obligations The following table sets forth information on the Company’s material contractual obligation payments for the periods indicated as of March 31, 2010: Payments due by Period Contractual Obligations Total Less than 1 Year 1-3 Years More Than 5 Years Convertible Notes (1) $116,421,988 $5,629,195 $110,792,793 – Equipment Contracts (2) 9,024,135 9,024,135 – – Total $125,446,123 $14,653,330 $110,792,793 – 1 In May 2007, the Company issued $103,500,000 aggregate principal amount of its 5.50% convertible notes. The notes pay interest semi-annually and are due on June 15, 2022. Subject to certain conditions, the notes may be converted into Class A common shares of the Company, redeemed or repurchased. The note holders have the option to require the Company to repurchase the notes on June 15, 2012, at a price equal to 100% of the principal amount of the notes plus accrued but unpaid interest. The Company may elect to satisfy its obligation to pay the repurchase price, in whole or in part, by delivering Common Shares. In the event of a change of control of the Company, the Company will be required to offer to repurchase the notes at a purchase price equal to 100% of the principal amount of the notes plus accrued but unpaid interest unless there has occurred and is continuing certain events of default under the Company’s indenture. At any time on or after June 16, 2010, and until June 15, 2012, the Company may redeem the notes, in whole or in part, for cash at a redemption price equal to 100% of the principal amount being redeemed plus accrued and unpaid interest if the closing sale price of the Common Shares is equal to or greater than 150% of the conversion price then in effect and the closing price for the Company’s Common Shares has remained above that price for at least 20 trading days in the period of 30 trading days preceding the Company’s notice of redemption. Beginning on June 16, 2012, the Company may, at its option, redeem all or part of the notes for cash at a redemption price equal to 100% of the principal amount being redeemed plus accrued and unpaid interest. As of March 31, 2010, $1,151,000 face value of convertible notes have been settled in cash or repurchased by the Company at a total cost of $451,000. The amounts shown above include the interest and principal payments due based on the estimate that the term of the notes will end on June 15, 2012. If the notes were to reach their contractual maturity date of June 15, 2022, additional interest payments would amount to $56.3 million over the additional ten year term of the notes. 2 The Company originally placed orders totaling $125.3 million for the fabrication of processing equipment, mobile equipment and other mining equipment and related engineering. As of March 31, 2010, the Company had equipment orders totaling $61.7 million and has made payments on these orders of $52.7 million. Results of Operations 2010 2009 Change Summary Results of Operations Other Income $ 309,188 $ 659,928 $ (350,740) Total expenses (5,299,025) (4,371,134) (927,891) Net Loss $ (4,989,837) $ (3,711,206) $ (1,278,631) Consolidated net loss for the three months ended March 31, 2010 was approximately $5.0 million, an increase of approximately $1.3 million from 2009. The change in net loss was due to a decrease in other income of approximately $0.3 million and an increase in expenses of approximately $1 million. Other Income Interest $ 64,519 $ 79,942 $ (15,423) Gain on extinguishment of debt - 601,936 (601,936) Gain (loss) on disposition of marketable securities 106,551 - 106,551 Gain on sale of equipment 55,874 - 55,874 Foreign currency gain (loss) 82,244 (21,950) 104,194 $ 309,188 $ 659,928 $ (350,740) The reduction in other income is primarily attributed to a reduction in gain on extinguishment of debt of approximately $0.6 million, due to the absence of any re-purchases of the Company’s convertible notes, partially offset by gains on the disposition of marketable securities of approximately $0.1 million and on sale of equipment of approximately $0.1 million. Expenses Corporate general and administrative $ (978,693) $ (1,185,662) $ 206,969 Venezuelan expenses (450,117) (782,470) 332,353 Equipment holding costs (340,754) (35,458) (305,296) Corporate communications (130,114) (194,269) 64,155 Legal and accounting (127,151) (787,069) 659,918 (2,026,829) (2,984,928) 958,099 Arbitration (1,079,269) - (1,079,269) Takeover defense - (1,453,655) 1,453,655 Minority interest 5,256 (2,681) 7,937 Interest expense (2,199,877) - (2,199,877) Income tax benefit 1,694 70,130 (68,436) $ (5,299,025) $ (4,371,134) $ (927,891) Operating costs decreased by approximately $1.0 million primarily as a result of reductions related to both the number of personnel and compensation related items, fees associated with consultants and litigation costs. Cost reductions were partially offset by costs associated with the storage, maintenance and insuring the remaining equipment originally purchased for the Brisas Project. The change in legal and accounting is primarily attributable to the 2009 litigation related to the unsolicited takeover offer launched in December 2008. These decreases have been supplemented by a decline in takeover defense costs of approximately $1.5 million, but offset by an increase of approximately $1.1 million in costs associated with the arbitration process and an increase in interest expense of approximately $2.2 million as a result of no longer capitalizing interest expense subsequent to the date Brisas was expropriated and we filed for arbitration with ICSID. Off-Balance Sheet Arrangements The Company is not a party to any off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. Transactions with Related Parties MGC Ventures . The Chief Executive Officer, President, Vice President-Finance and Vice President-Administration of the Company are also officers and/or directors and shareholders of MGC Ventures. The Company owned 12,062,953 common shares of MGC Ventures at March 31, 2010 and December 31, 2009 which represented 44% of its outstanding shares. MGC Ventures owned 258,083 common shares of the Company at March 31, 2010 and December 31, 2009. In addition, MGC Ventures owned 280,000 common shares of Great Basin at March 31, 2010 and December 31, 2009. During the last three years, the Company sublet a portion of its office space to MGC Ventures for $6,000 per year. Great Basin . The Chief Executive Officer, President, Vice President-Finance and Vice President-Administration of the Company are also officers and/or directors and shareholders of Great Basin. The Company owned 15,661,595 common shares of Great Basin at March 31, 2010 and December 31, 2009, which represented 45% of its outstanding shares. Great Basin owned 491,192 common shares of the Company at March 31, 2010 and December 31, 2009. Great Basin also owned 170,800 common shares of MGC Ventures at March 31, 2010 and December 31, 2009. During the last three years, the Company sublet a portion of its office space to Great Basin for $6,000 per year.