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 November 14, 2011 is intended to assist in understanding and assessing our results of operations and financial condition and should be read in conjunction with the consolidated financial statements and related notes. Gold Reserve, an exploration stage company, is engaged in the business of acquiring, exploring and developing mining projects. From 1992 to 2008 we focused substantially all of our management and financial resources on the development of the Brisas gold and copper project located in the Kilometer 88 mining district of the State of Bolivar in south-eastern Venezuela (which we refer to as the “Brisas Project” or “Brisas”). In April 2008 the Venezuelan government revoked our Authorization to Affect for the commencement of construction at the Brisas Project. For the next 12 months we attempted to have the Authorization reinstated and ultimately determined in April 2009 to notify the government of our intent to commence arbitration under the Canada-Venezuela Bilateral Investment Treaty if an amicable resolution was not reached. On October 21, 2009 we filed a Request for Arbitration under the Additional Facility Rules of the International Centre for Settlement of Investment Disputes (“ICSID”). On October 26, 2009, in apparent response to our filing government personnel arrived at the project site, claimed ownership of the Brisas Alluvial Concession, seized assets, expelled our personnel, and took physical possession of the property. Subsequently, on November 4, 2009, Venezuela notified us through the issuance of an Administrative Act, dated October 20, 2009, of its intent to cancel our underlying Unicornio (hard rock) Concession which it formally completed in June 2010. See Part II, Item 1. Legal Proceedings – Arbitration. A determining factor in the Company’s current financial position and continuing results of operations is the substantial operating deficits and project development costs incurred since 1992 and, the issuance of $183 million of convertible notes and common shares and the acquisition of approximately $125 million of equipment subsequent to the March 2007 issuance of the Authorization to Affect all related to the development of the Brisas Project. Due to the Venezuelan government’s seizure of the Brisas Project, we ceased development and wrote-off previously capitalized costs associated with the project development and commenced selling assets purchased for the construction and operation of the project. The Company is well advanced in the arbitration process having filed its last reply including amending its claim prior to the oral hearings scheduled to commence February 6, 2012 in Washington D.C. During 2011, the Company met several times with representatives from the Venezuelan Attorney General’s Office to discuss an amicable resolution to the matter under arbitration that would respect the rights of both parties. Even though the arbitration is well advanced we expect to continue efforts with the appropriate government representatives in the future. Our primary objectives continue to be: (1) obtain a working interest in one or more acceptable mineral exploration properties; (2) diligently pursue the arbitration claim against Venezuela and minimize costs to the extent possible; (3) pursue an amicable settlement with Venezuela that may include a monetary agreement and/or project participation; (4) dispose of remaining assets previously purchased for the Brisas Project, which originally cost approximately $29 million and are recorded on the balance sheet (as property, plant and equipment) at their estimated fair value of $21 million; and (5) evaluate the Company’s options to redeem, restructure or otherwise modify the terms of the 5.50% convertible notes the outcome of which, among other things, is subject to the sale of the Brisas Project assets. Any information contained in this Quarterly Report on Form 10-Q relating to our past development efforts, regulatory processes and reported mineral reserves for the Brisas Project and Choco 5 property are presented only 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. The Company no longer considers historically reported mineralization as “reserves”. We have no commercial production at this time and, as a result, we have no revenue or cash flows from mining operations and continue to experience losses from operations, a trend we expect to continue while we pursue other mining prospects and until the investment dispute regarding Brisas is resolved favorably to the Company. Historically we have financed the Company’s operations through the issuance of common stock, and convertible debt. On going Company expenditures are subject to available cash, sale of equipment originally slated for the Brisas Project and/or future financings, if any. The Company has only one operating segment, the exploration and development of mineral properties. For the fiscal year commencing in 2011, the Company changed its basis of accounting and financial reporting to comply with accounting principles generally accepted in United States. See Note 1 to the consolidated financial statements. 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, http://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. 15 Continued Listing of the Company’s Shares on NYSE Amex and the Toronto Stock Exchange (“TSX”) NYSE-Amex In June 2011, the Company was advised by the NYSE Amex LLC (the “Exchange”) that it intended to file a application with the United States Securities and Exchange Commission (the “SEC”) delisting the Company’s common shares. The Staff based this decision on its analysis that subsequent to the seizure of the Brisas Project by the Venezuelan authorities in October 2009, the Company “no longer complies” with the Exchange’s continued listing rules. Specifically, the Exchange noted that the Company was non-compliant with: Section 1002(c) of the NYSE Amex Company Guide (the “Company Guide”) as Gold Reserve has ceased to be an operating company; and Section 1003(c)(i) as Gold Reserve has sold or otherwise disposed of its principal operating assets or has ceased to be an operating company or has discontinued a substantial portion of its operations or business for any reason whatsoever, including without limitation such events as sale, lease, spin-off, distribution, foreclosure, discontinuance, abandonment, destruction, condemnation, seizure or expropriation. The Company appealed the Exchange’s conclusions and subsequently submitted a number of written submissions in addition to several follow-up conversations with the Staff outlining the reasons supporting continued listing on the Exchange. On October 27, 2011, the Company received notice from the Exchange that it had accepted the Company’s plan to regain compliance with the Exchange’s listing standards (the “Plan”) by a targeted completion date of December 20, 2012. The Staff’s acceptance of the Plan marks the completion of the first step in the Company’s process towards compliance with the Exchange’s listing standards. The Staff reiterated that the Company is not in compliance with Company Guide and, with the Exchange’s acceptance of the Plan, the Company’s listing is being continued pursuant to an extension. The Plan provides for an 18 month schedule (starting from the initial date of notice of non-compliance, June 20, 2011) whereby the Company expects to obtain a working interest in one or more acceptable mineral exploration properties with commensurate exploration expenditures made thereon. The Company will continue to provide the Exchange staff with updates relative to the initiatives detailed in the Plan, including the specific milestones to be met by July 31, 2012, and December 20, 2012. There can be no assurance that the Company will be able to achieve compliance within the required time frame, and if the Company is not able to achieve compliance as outlined in the Plan or otherwise show progress consistent with the Plan, the Company will remain subject to delisting procedures as set forth in the Company Guide and may in fact be delisted. Toronto Stock Exchange (“TSX”) In September 2011 the Company received a letter from the Compliance & Disclosure Department of the Toronto Stock Exchange (“TSX”) requesting that the Company provide information regarding its current operating activities as part of a fact gathering process related to meeting the TSX’s continuous listing requirements. The letter stated that if the TSX determines that the Company has discontinued a substantial portion of its business, the Company will be required to meet the original listing requirements (“OLR”) of the TSX. The TSX may provide the Company with up to 120 days from the date of the letter, to meet the OLR. If the Company fails to provide an acceptable plan to the TSX of how it intends to meet the OLR in the short term, the TXS will initiate a delisting review. On October 4, 2011 the Company provided its response and a plan to the TSX and since that date has continued discussions with the Compliance and Disclosure Staff regarding the Company’s efforts to maintain compliance and continue its listing on the TSX. On November 11, 2011 the Company received a letter from the Compliance & Disclosure Department of the Toronto Stock Exchange (“TSX”) advising the Company that while the TSX appreciates the difficult situation that the Company faces, as detailed in its prior submission, the Company’s plans are not sufficiently advanced for TSX to grant the Company 120 days to regain compliance with TSX’s continued listing requirements. As a result, the TSX is reviewing the eligibility for continued listing on TSX of the common shares of the Company pursuant to Part VII of The Toronto Stock Exchange Company Manual, under the Expedited Review Process as described in Section 707(b) of the TSX Company Manual. The Continued Listing Committee of TSX scheduled a meeting on November 21, 2011 to consider whether or not to suspend trading in and delist the common shares of the Company. The Company expects to make a submission regarding this matter at the meeting. There can be no assurance that the Company will be able to achieve compliance within the required time frame, and if the Company is not able to achieve compliance, the Company will remain subject to delisting procedures as set forth in the Company Manual and may in fact be delisted. Management is also evaluating alternative listing options such as the TSX Venture Exchange or NEX. 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. 16 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 ICSID against the Bolivarian Republic of Venezuela; · the actual value realized from the disposition of the remaining Brisas Project related assets; · the result or outcome of the litigation regarding the enjoined hostile takeover bid for us; · the potential equity dilution in the event the convertible notes are converted in part or in whole to common shares; · our ability to maintain continued listing on the Exchange and/or the Toronto Stock Exchange; · 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; · impact of currency, metal prices and metal production volatility; · our dependence upon the abilities and continued participation of certain key employees; · 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 relevant securities regulators. Liquidity and Capital Resources At September 30, 2011 the Company had cash and cash equivalents of approximately $62.4 million which represents an increase from December 31, 2010 of approximately $4.3 million. The increase was primarily due to proceeds from sales of equipment of $16.5 million and net proceeds from marketable securities transactions of $0.9 million offset by cash used by operations of $13.0 million. The components of changes in cash are more fully described in the “Operating,” “Investing” and “Financing” Activities section below. 2011 2010 Change Cash and cash equivalents $ 62,449,366 $ 58,186,478 $ 4,262,888 As of September 30, 2011, our total financial resources, which include cash and cash equivalents and marketable securities, totaled approximately $63.3 million. In addition to cash and cash equivalents and investments, the Company holds Brisas Project related equipment that it intends to dispose of in 2011. This equipment is carried on the balance sheet (as property, plant and equipment and assets held for sale) at its estimated fair value of approximately $21 million (historical cost of approximately $29 million). The primary future obligation of the Company is the $103.5 million 5.50% convertible 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 12 to the consolidated financial statements and Contractual Obligations below. With the ability to settle any request for redemption of the convertible notes with common shares, 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 2012. As of November 14, 2011 we had approximately $62 million in cash and investments which are held primarily in US dollar denominated accounts. 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 Venezuela, the timing and the amount of proceeds, if any, from the sale of Brisas Project related equipment, the extent of future acquisitions or investments, if any, status of the financial markets and our share price. 17 Operating Activities Cash flow used by operating activities for the three and nine months ended September 30, 2011 was approximately $6.5 million and $13.0 million, respectively, compared to approximately $3.9 million and $14.2 million for the comparative periods in 2010. Cash flow used by operating activities consists of net operating losses (the components of which are more fully discussed below) adjusted for certain non-cash income and expense items primarily related to gains on sale of equipment and marketable securities, accretion of convertible notes, stock options and common shares issued in lieu of cash compensation and certain non-cash changes in working capital. Cash flow used by operating activities during the third quarter of 2011 increased from the prior comparable period primarily due to: a net decrease in accounts payable primarily related to the timing of payments to counsel and experts connected with the arbitration. Investing Activities During the three and nine months ended September 30, 2011, net cash provided by investing activities increased approximately $8.0 million, and $8.6 million for the comparable periods in 2010. Investing activities in the comparable periods primarily consisted of the sale of Brisas Project related equipment and to a lesser extent transactions in marketable securities. As of September 30, 2011, the Company held approximately $21.2 million of Brisas project related equipment intended for future sale. 3 months 9 months 2011 2010 Change 2011 2010 Change Proceeds (net of purchases) of marketable securities $ 300,856 $ 35,778 $ 265,078 $862,763 $ (186,606) $1,049,369 Purchase of property, plant and equipment (6,451) (2,552) (3,899) (39,395) (500,992) 461,597 Proceeds from sale of equipment 7,817,146 50,506 7,766,640 16,457,541 8,901,590 7,555,951 Decrease in restricted cash - - - - 494,076 (494,076) $ 8,111,551 $ 83,732 $ 8,027,819 $ 17,280,909 $ 8,708,068 $ 8,572,841 Financing Activities The Company had no financing activities in the third quarter of 2011 and 2010. Net proceeds from the issuance of commons shares relate to the exercise of employee stock options and totaled $15,778 and $41,084 during the nine months ended 2011 and 2010, respectively. Contractual Obligations The following table sets forth information on the Company’s material contractual obligation payments for the periods indicated as of September 30, 2011: Payments due by Period Total Less than 1 Year 1-3 Years 4-5 Years More Than 5 Years Convertible Notes (1) $102,349,000 – – – $102,349,000 Interest 61,921,145 $5,629,195 $11,258,390 $11,258,390 33,775,170 $164,270,145 $5,629,195 $11,258,390 $11,258,390 $136,124,170 1 In May 2007, the Company issued $103,500,000 aggregate principal amount of its 5.50% convertible notes. As of September 30, 2011, $102,349,000 remains outstanding. The notes pay interest semi-annually and are due on June 15, 2022. The notes are recorded on the balance sheet at amortized cost of approximately $101 million. 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 Convertible Note Indenture provides that the Company may elect to satisfy its obligation to pay the repurchase price, in whole or in part, by delivering Common Shares. If in the future we elect to repurchase the notes with common shares, we would be required to issue shares based on the then current market value. The amounts shown above include the interest and principal payments due if the notes were to reach their contractual maturity date of June 15, 2022. 18 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. The convertible notes are trading in the gray market often at a significant (15% to 25%) discount to face value. The terms of the indenture provide that the Company may repurchase the convertible notes in open market purchases or negotiated transactions. As of September 30, 2011, $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 covenants contained in the 5.50% convertible 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. 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 with cash or Common Shares unless there has occurred and is continuing certain events of default under the Company’s indenture. Results of Operations Summary Results of Operations Consolidated net loss for the three months ended September 30, 2011 was approximately $5.1 million representing a decrease of approximately $1.5 million over the comparable period in 2010. For the nine months ended September 30, 2011 the consolidated net loss of $17.1 million represented an increase of approximately $1.9 million over 2010. 3 months 9 months 2011 2010 Change 2011 2010 Change Other Income $ 1,214,530 $ 85,242 $1,129,288 $ 2,338,132 $ 834,660 $1,503,472 Total expenses (6,276,146) (6,660,726) 384,580 (19,436,781) (16,057,058) (3,379,723) Net Loss $ (5,061,616) $ (6,575,484) $ 1,513,868 $(17,098,649) $(15,222,398) $ (1,876,251) Other Income We have no commercial production at this time and as a result, other income is often variable from period to period due to one-time or otherwise variable sources of income. As noted below, the increase in other income in the three and nine month comparable periods was primarily due to increases in gain on sale of equipment and gain on disposition of marketable securities, partially offset by decreases in interest income. 3 months 9 months 2011 2010 Change 2011 2010 Change Interest $ 25,598 $ 62,748 $ (37,150) $ 112,399 $191,285 $ (78,886) Gain on disposition of marketable securities 243,565 42,042 201,523 755,233 148,593 606,640 Gain on sale of equipment 913,732 36,633 877,099 1,460,727 406,677 1,054,050 Foreign currency gain (loss) 31,635 (56,181) 87,816 9,773 88,105 (78,332) $ 1,214,530 $ 85,242 $ 1,129,288 $ 2,338,132 $ 834,660 $ 1,503,472 Expenses Total expenses for the three and nine months ended September 30, 2011 decreased by $0.4 million and increased $3.4 million, respectively, over the comparable periods in 2010. The decrease in the 3 month comparable period was primarily due to a reduction in arbitration costs and expenses associated with our Venezuelan operations partially off-set by a non-cash increase in compensation costs associated with the issuance of stock options and restricted shares. The increase in the 9 month comparable period was primarily due to non-cash increases in costs associated with the issuance of stock options and restricted shares (primarily in the first quarter) as well an increase in equipment holding costs partially offset by decreases in costs associated with our Venezuelan operation. Substantially all of the increase in corporate general and administrative and corporate communications expense is due to non-cash costs associated with the issuance of stock options and to a lesser degree restricted shares. Costs associated with our Venezuelan operations decreased as a result of a reduction of deposits, advances and other which was netted against expenditures related to our Venezuelan operations. 19 A total of approximately 2.6 million share purchase options expired in 2010 or will expire by the end of 2011 and be returned to the option plans. During the first quarter of 2011, the Company granted approximately 2.8 million options which generally vest over three years and in the second quarter of 2011, the Company issued 950,000 options from the Venezuelan Plan (from which no additional shares can be issued until re-approval by shareholders) which vest upon a settlement or an award related to the arbitration against Venezuela. For the nine months ended September 30, 2011 and 2010, new options totaling 3,793,000 and 0, respectively were granted. The Company recorded non-cash compensation expense during the nine months ended September 30, 2011 and 2010 of $2.3 million and $0.1 million, respectively, for stock options granted in 2011 and prior periods. Compensation expense for the nine months ended September 30, 2011 includes $1.5 million related to options granted in the first quarter 2011. The options granted in the second quarter had an estimated fair market value of $0.7 million at the date of grant however the Company does not currently record an expense for these options and will only record an expense in the event it becomes probable the options will vest. As of September 30, 2011, compensation expense of $2.1 million related to unvested options remains to be recognized over the remaining vesting period. Pursuant to generally accepted accounting principles, the Company records a non-cash expense associated with the issuance of options using the fair value method of accounting which is computed using the Black-Scholes method and expensed over the vesting period of the option (see Note 9, Stock Based Compensation). Accounting rules do not provide for the recovery of previously expensed amounts associated with expired share purchase options. 3 months 9 months 2011 2010 Change 2011 2010 Change Corporate general and administrative $ 1,199,949 $ 729,920 $ 470,029 $5,525,691 $ 2,511,437 $ 3,014,254 Venezuelan expenses 145,037 327,830 (182,793) 893,794 1,204,481 (310,687) Corporate communications 131,661 101,124 30,537 511,635 363,415 148,220 Legal and accounting 124,750 81,148 43,602 427,689 372,810 54,879 1,601,397 1,240,022 361,375 7,358,809 4,452,143 2,906,666 Arbitration 2,649,335 3,437,287 (787,952) 5,795,180 5,861,225 (66,045) Equipment holding costs 330,497 305,979 24,518 1,269,058 784,968 484,090 Interest expense 1,694,917 1,674,762 20,155 5,013,734 4,960,222 53,512 Income tax expense (benefit) - 2,676 (2,676) - (1,500) 1,500 Total Expenses for the Period $ 6,276,146 $ 6,660,726 $ (384,580) $ 19,436,781 $ 16,057,058 $ 3,379,723 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. Adoption of US GAAP in 2011 For the fiscal year commencing in 2011, the Company changed its basis of accounting and financial reporting to comply with US GAAP. The Company has accounted for this change in presentation on a retroactive basis. The balance sheet amounts as of December 31, 2010 and the comparative operating results for the three and nine months ended September 30, 2010 were restated accordingly. A reconciliation of Canadian GAAP and US GAAP is included in Note 19 of the Company’s financial statements as of December 31, 2010 and for the year then ended. 20 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. On December 15, 2010, the non-affiliated shareholders of MGC Ventures approved the redemption of all of the shares of MGC Ventures common stock held by Gold Reserve. Gold Reserve received $0.9 million and recorded a gain on sale of subsidiary of $0.2 million. Prior to the redemption, Gold Reserve owned 12,062,953 common shares of MGC Ventures which represented 44% of its outstanding shares. MGC Ventures owned 258,083 common shares of the Company at September 30, 2011 and December 31, 2010. 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. On December 15, 2010, the non-affiliated shareholders of Great Basin approved the redemption of all of the shares of Great Basin common stock held by Gold Reserve. Gold Reserve received $1.2 million and recorded a gain on sale of subsidiary of $0.3 million. Prior to the redemption, Gold Reserve owned 15,661,595 common shares of Great Basin which represented 45% of its outstanding shares. Great Basin owned 491,192 common shares of the Company at September 30, 2011 and December 31, 2010. During the last three years, the Company sublet a portion of its office space to Great Basin for $6,000 per year.