Accounting & Tax

Apex Silver Restates over Derivatives

Inappropriate method for estimating fair value of metals derivative positions leads to $300 million understatement of derivative liability.
Dave Cook and Stephen TaubMay 3, 2007

Apex Silver Mines restated its financials for the quarter ended September 30, 2005, the year ended December 31, 2005, and the first three quarters of 2006 after determining that the method it had used to estimate the fair value of metals derivative positions was not appropriate.

The cumulative understatement of the Apex’s derivative liability is about $300.5 million as of September 30, 2006, in line with the company’s earlier projections.

Correcting the valuation of the derivatives, Apex also noted, affected the gain and minority interest recognized on the sale of a 35 percent interest in the company’s mining subsidiary during the quarter ended September 30, 2006. The gain on sale increased from to $199.6 million, from $119.8 million, and the minority interest decreased to $18.9 million, from $88.4 million, as of September 30.

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To meet the requirements of its project finance facility, Apex explained, during the third quarter of 2005 it entered into certain silver, zinc, and lead derivative contracts — primarily forward sales, but also puts and calls — regarding a portion of the planned production from its San Cristobal project. Under Financial Accounting Standard No. 133, Apex elaborated, it records the derivatives at their fair value on its balance sheet and records the change in fair value to current earnings at the end of each reporting period.

Many of the derivatives mature or expire beyond the periods covered by the major commodities price indexes such as LME or COMEX, or expire in periods for which limited trading activity has occurred, the company explained. In the latter case, Apex added, historically it has used price projections to estimate a forward price curve provided by an independent third party to calculate the fair value of its open derivative positions. The models used by the third party relied on commodities prices indexes out to three months and mean reversion statistical estimates beyond the that period.

Recently, the company elaborated, it reassessed the market information reflected in the commodities prices indexes out to 27 months and quoted prices from the counterparties holding derivative positions. The company concluded that the additional market information is a more reliable indicator of fair value than the third-party price projections it had been using.

Apex also disclosed that “management identified a control deficiency that relates to the restatement that, under the circumstances, constitutes a material weakness” as of September 30, 2006.

In addition, Apex warned, the accounting changes will likely increase volatility in the company’s earnings during the next three years, when most of its derivatives mature or expire.