Formation Metals Inc. May 31, 2011

Transcription

1 Condensed Interim Consolidated Financial Statements For the First Quarter Ending May 31, 2011 (Unaudited Prepared by Management) Suite West Hastings Street Vancouver, BC, Canada V6C 2W2

2 Notice of No Auditor Review of Condensed Interim Consolidated Financial Statements The accompanying unaudited condensed interim consolidated financial statements of the Company have been prepared by management and approved by the Audit Committee and Board of Directors of the Company. The Company s independent auditor has not performed a review of these condensed interim consolidated financial statements in accordance with standards established by the Canadian Institute of Chartered Accountants for a review of by an entity s auditor.

3 Consolidated statements of financial position (Stated in Canadian dollars) May 31 February 28 March $ $ $ Assets Current assets Cash and cash equivalents 62,955,357 2,440, ,484 Restricted cash (Note 6) 1,005,678 1,008,585 - Precious metals inventory (Note 7) 3,633,760 2,703,801 2,893,063 Trade and other receivables 395, ,040 55,350 Prepaid expenses and deposits 2,678,859 59,770 52,253 70,668,995 6,362,451 3,751,150 Deferred financing costs 1,634,439 1,681,112 - Reclamation bond (Note 8) 602, , ,893 Long-term deposits (Note 9) 633, ,341 4,370,527 Property, plant and equipment (Note 9) 13,933,606 12,577,725 9,094,020 Mineral properties (Note 10) 61,477,115 60,848,313 57,437,167 Deferred tax assets 4,290,984 2,701,560 2,204, ,241,363 85,343,932 77,512,754 Liabilities Current liabilities Trade payables 937, ,321 1,524,967 Accrued and other payables 1,543,605 1,756,310 1,238,159 2,481,351 2,258,631 2,763,126 Convertible debenture (Note 11) - 6,775,801 - Deferred tax liabilities 7,482,899 7,042,648 5,899,599 9,964,250 16,077,080 8,662,725 Shareholders Equity Share capital (Note 12) Common shares 149,021,990 84,588,098 81,384,410 Share purchase warrants 20,954,848 9,206,301 8,892,463 Equity portion of convertible debenture - 252,916 - Share-based payments and other 6,535,544 6,266,311 5,279,312 reserves Foreign currency translation reserve (1,050,729) (1,001,190) - Deficit (32,184,540) (30,045,584) (26,706,156) 143,277,113 69,266,852 68,850, ,241,363 85,343,932 77,512,754 Nature of Business (Note 1) Commitments (Note 16) Subsequent Events (Note 19) Approved by the Board (Signed) Mari-Ann Green Mari-Ann Green, Director (Signed) Scott Bending Scott Bending, Director See accompanying notes to the condensed interim consolidated financial statements 1

4 Consolidated statements of operations (Stated in Canadian dollars, except share amounts) (unaudited) Three Months Three Months Ending Ending May 31 May $ $ Revenue - refinery 5,611,462 1,588,333 Cost of revenues (4,584,000) (1,395,552) 1,027, ,781 EXPENSES Accounting and audit 61,302 28,804 Accretion on convertible debenture - 29,952 Administration 85,036 71,778 Advertising and promotion 8,241 6,174 Bank and interest charges 445,001 7,367 Depreciation 37,601 49,574 Foreign exchange (income) loss (79,064) 217,906 Legal fees 59,242 21,843 Listing and filing fees 20,027 14,806 Management fees 10,152 2,403 Office 83,393 95,239 Shareholder information 31,285 32,211 Stock-based compensation 16, , ,057 Loss before undernoted item 248,928 (385,276) Early settlement on debenture (Note 11) (2,333,333) - Other income 235,464 4,093 Loss before income taxes (1,848,940) (402,263) Income taxes (290,016) (228,832) Net loss for the period (2,138,956) (610,015) Basic loss per share (0.02) (0.02) Weighted average number of shares outstanding Basic 84,824,234 34,865,947 See accompanying notes to the condensed interim consolidated financial statements 2

5 Consolidated statements of shareholders equity and comprehensive loss For the three months ended May 31, 2011 and 2010 (Stated in Canadian dollars, except share amounts) (unaudited) Share-based Foreign Common shares without Share Equity portion payments currency Total par value purchase of convertible and other translation shareholders' Shares Amount warrants debenture reserves reserve Deficit equity $ $ $ $ $ $ Balance, February 28, ,503,617 81,384,410 8,892,463-5,279,312 - (26,706,156) 68,850,029 Issuance of common shares and warrants for cash, net of share issue costs 1,333,375 1,698, , ,012,300 Equity portion of debenture , ,238 Net loss and comprehensive loss for the period (90,043) (602,527) (692,570) Balance, May 31, ,836,992 83,082,872 9,206, ,238 5,279,312 (90,043) (27,308,683) 70,477,997 Issuance of common shares on conversion of convertible debenture 666,666 1,000,000 - (55,322) ,678 Issuance of common shares on conversion of debenture interest 429, , ,946 Issuance of common shares on exercise of stock option 15,441 21, (21,281) Stock-based compensation ,008, ,008,280 Net loss and comprehensive loss for the period (911,147) (2,736,901) (3,648,048) Balance, February 28, ,948,871 84,588,099 9,206, ,916 6,266,311 (1,001,190) (30,045,584) 69,266,853 Issuance of common shares and warrants for cash, net of share issue costs 53,333,333 63,933,891 11,748, ,682,438 Issuance of common shares on conversion of debenture interest 400, ,000 - (252,916) 252, ,000 Stock-based compensation , ,317 Net loss and comprehensive loss for the period (49,539) (2,138,956) (2,188,495) Balance, May 31, ,682, ,021,990 20,954,848-6,535,544 (1,050,729) (32,184,540) 143,277,113 See accompanying notes to the condensed interim consolidated financial statements 3

6 Consolidated statements of cash flows (Stated in Canadian dollars) (unaudited) Three Months Ending Three Months Ending May 31 May $ $ Operating Activities Net loss for the period (2,138,956) (610,015) Items not involving cash Depreciation 37,601 49,574 Accretion on convertible debenture - 29,952 Non-cash loss on debenture settlement 724,199 - Deferred income tax expense 289, ,732 Stock-based compensation 16,317 - Unrealized foreign exchange loss (676,982) 217,906 Change in non-cash operating working capital items Trade and other receivables (245,301) 10,666 Prepaid expenses and deposits (2,619,089) (10,208) Precious metals inventory (929,959) 8,645 Trade payables, accrued and other payables 222,720 (935,900) (6,078,220) (1,003,648) Investing Activities Deposit for property, plant and equipment (66,833) (158,749) Mineral property expenditures (628,802) (808,892) Purchase of property, plant and equipment, net of deposits (1,393,051) (92,192) (2,088,686) (1,059,833) Financing Activities Issuance of common shares and warrants for cash 80,000,000 2,000,063 Convertible debenture (7,000,000) 8,000,000 Share issue costs (4,317,561) (183,560) 68,682,439 9,816,503 Effects of exchange rate changes on the balance of cash held in foreign currencies (431) (1,914) Net cash inflow 60,515,102 7,751,108 Cash and cash equivalents, beginning of period 2,440, ,484 Cash and cash equivalents, end of period 62,955,357 8,501,592 Cash and cash equivalents are comprised of: Cash 2,911, ,394 Short-term investments 60,044,197 8,249,198 62,955,357 8,501,592 Supplementary information (Note 15) See accompanying notes to the condensed interim consolidated financial statements 4

7 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Nature of business Formation Metals Inc. ( the Company ) was incorporated on June 13, 1988 under the Company Act of British Columbia and commenced operations on that date. The Company, directly and through joint exploration ventures, is in the process of exploring its mineral properties and has determined, through a National Instrument Technical Report, that certain of these properties contain ore reserves which are economically recoverable. None of the Company s operations are conducted through joint venture entities. The Company also owns a hydrometallurgical facility in Northern Idaho. This facility was originally purchased by the Company in order to process the cobalt concentrate from its U.S. operations. It will have to be refurbished to process the cobalt concentrate. The facility also contains a precious metals refinery, which the Company has refurbished to process third party precious metals material. Material is refined into high purity silver and gold bullion. During the period ended May 31, 2011 and 2010, this facility processed high grade silver material. The Company s registered office is Suite West Hastings Street, Vancouver, B.C. V6E 3T5. 2. Basis of presentation and adoption of International Financial Reporting Standards ( IFRS ) The Company prepares its financial statements in accordance with Canadian generally accepted accounting principles as set out in the Handbook of the Canadian Institute of Chartered Accountants ( CICA Handbook ). In 2010, the CICA Handbook was revised to incorporate International Financial Reporting Standards ( IFRS ), and require publicly accountable enterprises to apply such standards effective for years beginning on or after January 1, Accordingly, the Company has commenced reporting on this basis in these condensed interim consolidated financial statements. In these condensed interim consolidated financial statements, the term Canadian GAAP refers to Canadian GAAP before the adoption of IFRS. These condensed interim consolidated financial statements have been prepared in accordance with International Accounting Standard 34, Interim Financial Reporting ( IAS 34 ) using accounting policies consistent with IFRS. Subject to certain transition elections disclosed in note 18, the Company has consistently applied the same accounting policies in its opening IFRS statement of financial position at March 1, 2010 and throughout all periods presented, as if these policies had always been in effect. The policies applied in these condensed interim consolidated financial statements are based on IFRS issued and outstanding as of July 15, 2011, the date the Board of Directors approved the statements. Any subsequent changes to IFRS that are given effect in the Company s annual consolidated financial statements for the year ending February 28, 2012 could result in restatement of these annual consolidated financial statements, including transition adjustments recognized on change-over to IFRS. The condensed interim consolidated financial statements should be read in conjunction with the Company s Canadian GAAP annual consolidated financial statements for the year ended February 28, Note 18 disclose IFRS information for the year ended February 28, 2011 that is not provided in those annual financial statements. 5

8 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Significant Accounting Policies (a) Basis of measurement The condensed interim consolidated financial statements have been prepared on the historical cost convention. (b) Consolidation These condensed consolidated financial statements included in the Formation group of companies include the accounts of the Formation Metals Inc. and either directly or indirectly its wholly-owned subsidiaries: Formation Capital Corporation, U.S., a Nevada corporation, Essential Metals Corporation, an Idaho corporation, Coronation Mines Limited ( Coronation ), a Saskatchewan company, Minera Terranova S.A. de C.V., a Mexican company, Formations Holdings US, Inc., an Idaho corporation, US Cobalt, Inc. an Idaho corporation and Formations Holdings Corp, a British Columbia corporation. The Company consolidates those entities which are controlled by the Company. All intercompany transactions and balances have been eliminated. (c) Foreign currency translation (i) Functional and presentation currency Items included in the condensed interim consolidated financial statements of each consolidated entity in Formation Metals Inc. s group of companies are measured using the currency of the primary economic environment in which the entities operate (the functional currency ). The consolidated financial statements are presented in Canadian dollars, which is Formation Metals Inc. s functional currency. The financial statements of entities that have a functional currency different from that of Formation Metals Inc. ( foreign operations ) are translated into Canadian dollars as follows: assets and liabilities at the closing rate at the date of the statement of financial position, and income and expenses at the average rate of the period. All resulting changes are recognized in other comprehensive income as cumulative translation adjustments. (ii) Transactions and balances Foreign currency transactions are translated into the functional currency using the exchange rates prevailing at the dates of the transactions. Generally, foreign exchange gains and losses resulting from the settlement of foreign currency transactions and from the translation at year-end exchange rates of monetary assets and liabilities denominated in currencies other than an operation s functional currency are recognized in the statement of income. (d) Use of estimates The preparation of financial statements in conformity with IAS 34 requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. 6

9 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Significant accounting policies (continued) The most significant areas where management judgment is applied among others, the expected economic lives and the future operating results and net cash flows expected to result from exploitation of resource properties and related assets, the amount of proven and probable mineral reserves and income tax provisions. Significant items that require estimates as the basis for determining the stated amounts include precious metals inventory, amounts receivable, mineral properties, property, plant and equipment, revenue recognition, equity and liability components of convertible debentures and stockbased compensation. Actual results may differ from those estimates. (e) Cash and cash equivalents Cash and cash equivalents consists of cash on hand, deposits in banks and highly liquid short-term investments with an original maturity of three months or less. The Company does not believe it is exposed to significant credit or interest rate risk although cash and cash equivalents are held in excess of federally insured limits with major financial institutions. (f) Precious metals inventory Inventories of precious metals are stated at the lower of cost and net realizable value. Net realizable value is calculated as the estimated price at the time of sale based on prevailing and long-term metal prices less estimated future costs to convert the inventories into saleable form and costs necessary to make the sale. Inventories consist primarily of silver and gold metals and includes cost of materials and direct processing costs. (g) Mineral properties Acquisition costs of mineral properties together with direct exploration and development expenditures thereon are capitalized in the accounts. These costs will be amortized using the unit-of-production method based on proven and probable reserves on the commencement of commercial production or written-off as the properties are sold, allowed to lapse or are abandoned. Mineral property costs not directly attributable to specific properties are expensed during the year. (h) Property, plant and equipment Property, plant and equipment are recorded at cost less accumulated depreciation, depletion and impairment charges. Where an item of plant and equipment comprises major components with different useful lives, the components are accounted for as separate items of plant and equipment. Expenditures incurred to replace a component of an item of property, plant and equipment that is accounted for separately, including major inspection and overhaul expenditures, are capitalized. Directly attributable expenses incurred for major capital projects and site preparation are capitalized until the asset is brought to a working condition for its intended use. These costs include dismantling and site restoration costs to the extent these are recognized as a provision. 7

10 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Significant accounting policies (continued) Property, plant and equipment are depreciated to estimated residual value using the declining balance method. Management reviews the estimated useful lives, residual values and depreciation methods of the Company s property plant and equipment at the end of each reporting period and when events and circumstances indicate that such a review should be made. Changes to estimated useful lives, residual values or depreciation methods resulting from such review are accounted for prospectively. Assets under constructions or undergoing refurbishment are depreciated when they are complete and available for their intended use, over their estimated useful lives. The significant classes of plant and equipment and their rate of depreciation are as follows: Land Not depreciated Buildings 5% Equipment 30% Office furniture and fixtures 30% (i) Impairment of non-financial assets The Company reviews and evaluates its property, plant and equipment and mineral property for indicators of impairment when events or changes in circumstances indicate that the related carrying amounts may not be recoverable or at least at the end of each reporting period. If an indication of impairment exists, the asset s recoverable amount is estimated. An impairment loss is recognized when the carrying amount of an asset exceeds its recoverable amount. For an asset that does not generate largely independent cash inflows, the recoverable amount is determined for the cash-generating unit to which the asset belongs. A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. Future cash flows are estimated based on expected future production, commodity prices, operating costs and capital costs. The recoverable amount is the greater of the asset s fair value less costs to sell and value in use. In assessing value in use, the estimated future cash flows are discounted to their present value using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. Impairment losses are recognized in profit or loss. An impairment loss is reversed if there is an indication that there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation, if no impairment loss had been recognized. 8

11 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Significant accounting policies (continued) (j) Income taxes Current tax Current tax for each taxable entity in the Company is based on the local taxable income at the local statutory tax rate enacted or substantively enacted at the balance sheet date, and includes adjustments to tax payable or recoverable in respect of previous periods. Deferred tax Deferred tax is accounted for using the balance sheet liability method, providing for the tax effect of temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and their respective tax bases. Deferred income tax liabilities are recognized for all taxable temporary differences except where the deferred income tax liability arises from the initial recognition of goodwill, or the initial recognition of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting profit or loss nor taxable profit or loss. Deferred income tax assets are recognized for all deductible temporary differences, carry-forward of unused tax losses and unused tax credits, to the extent that it is probable that taxable profit will be available against which the deductible temporary differences, and the carry-forward of unused tax losses can be utilized, except where the deferred income tax asset related to the deductible temporary difference arises from the initial recognition of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting profit or loss nor taxable profit or loss. The carrying amount of deferred income tax assets is reviewed at each balance sheet date and is adjusted to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the asset to be utilized. To the extent that an asset not previously recognized fulfils the criteria for recognition, a deferred income tax asset is recorded. Deferred tax is measured on an undiscounted basis using the tax rates that are expected to apply in the period when the liability is settled or the asset is realized, based on tax rates and tax laws enacted or substantively enacted at the balance sheet date. Deferred tax assets and liabilities are offset when they relate to income taxes levied by the same taxation authority and the Company intends to settle its current tax assets and liabilities on a net basis. Current and deferred tax relating to items recognized directly in equity are recognized in equity and not in the statement of earnings (loss). (k) Flow-through shares Under the terms of Canadian flow-through share legislation, the tax attributes of qualifying expenditures are renounced to subscribers. To recognize the foregone tax benefits, a deferred income tax expense and offsetting deferred income tax liability are recognized as the related expenditures are renounced. In addition, any premiums paid for flow-through shares in excess of the market value of the shares without the flowthrough features at the time of issue is credited to other liabilities and recognized in the statement of earnings (loss) at the time the qualifying expenditures are made. 9

12 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Significant accounting policies (continued) (l) Share-based payments Share-based payments made to non-employees and employees are measured and recognized using the fair value based method. Stock-options are typically issued fully vested and are valued at the date of grant using the Black-Scholes option pricing model with a corresponding increase to share-based payments and other reserves. When stock options are issued with a vesting period, each vesting tranche is considered a separate award with its own vesting period and grant date fair value. The fair value of each tranche is measured at the date of grant using the Black-Scholes option pricing model and compensation expense is recognized over the tranche s vesting period based on the number of awards expected to vest, by increasing share-based payments and other reserves. Upon the exercise of the stock options, consideration paid together with the amount previously recognized in share-based payments and other reserves is recorded as an increase to common shares. (m) Loss per share Basic loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted loss per share is computed using the weighted average number of common and common equivalent shares outstanding during the period. Common equivalent shares consist of the incremental common shares issuable upon the exercise of stock options and warrants unless their effect is anti-dilutive. (n) Reclamation and closure cost obligations The Company records a provision for the estimated future costs of reclamation and closure of operating projects, which are discounted to net present value using the risk free interest rate applicable to the future cash outflows. Estimates of future costs represent management s best estimate which incorporate assumptions on the effects of inflation, movements in foreign exchange rates other specific risks associated with the related liabilities. A provision for reclamation and closure is re-measured at the end of each reporting period for changes in estimates and circumstances. Changes in estimates and circumstances include changes in legal or regulatory requirements, increased obligations arising from additional mining activities, changes to cost estimates and changes to the risk free interest rate. A provision for reclamation and closure cost obligations is accreted over time to reflect the unwinding of the discount with the accretion expense included in finance costs. As at May 31, 2011, there is no reclamation and closure cost obligations as the Company had yet to begin building the mine site and the refinery is a zero-emission operation. (o) Revenue recognition The Company earns mineral processing revenue from the purchase, processing and sale of minerals. Revenue is recorded once the processed product is shipped, title is transferred, the amount of proceeds are determinable and collection is reasonably assured. 10

13 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Significant accounting policies (continued) (o) Revenue recognition (continued) The Company also earns refining revenue by processing silver and gold on behalf of other mining companies and precious metals commodity dealers. When the Company does not take legal ownership of the unprocessed minerals, the Company records only the processing fees associated with these refining services. The Company records these revenues when the refined metal is shipped to the customer, the amount of proceeds are determinable and collection is reasonably assured. (p) Financial instruments and fair value Financial assets and financial liabilities, including derivatives, are measured at fair value on initial recognition and recorded on the balance sheet. Measurement in subsequent periods depends on whether the financial instrument has been classified as held-fortrading, available-for-sale, held-to-maturity, loans and receivables or other financial liabilities. Financial assets and liabilities held-for-trading are measured at fair value with changes in those fair values recognized in the statement of operations. Financial assets and financial liabilities are measured at amortized cost using the effective interest method of amortization. Available-for-sale financial assets are measured at fair value with unrealized gains and losses recognized in the accumulated other comprehensive income until realized or a loss in value is determine to be other than temporary. Derivative instruments, including embedded derivatives, are recorded on the balance sheet at fair value. Changes in the fair values of derivative instruments are recognized in the statement of operations with the exception of derivatives designated as effective cash flow hedges. The Company has no such designated hedges. Transaction costs related to financial instruments are expensed when they are incurred, unless they are directly attributable to the acquisition or construction of mineral properties, plant and equipment. The Company defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In assessing the fair value of a particular contract, the market participant would consider the credit risk of the counterparty to the contract. Consequently, when it is appropriate to do so, the Company adjusts the valuation models to incorporate a measure of credit risk. Fair value represents management's estimates of the current market value at a given point in time. 11

14 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Significant accounting policies (continued) (p) Financial instruments and fair value (continued) The Company has certain financial assets and liabilities that are held at fair value. Cash and cash equivalents fair values approximate their historic value due to the short term nature of these items. The fair value hierarchy establishes three levels to classify the inputs to valuation techniques used to measure fair value. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices in markets that are not active, quoted prices for similar assets or liabilities in active markets, inputs other than quoted prices that are observable for the asset or liability (for example, interest rate and yield curves observable at commonly quoted intervals, forward pricing curves used to value currency and commodity contracts and volatility measurements used to value option contracts), or inputs that are derived principally from or corroborated by observable market data or other means. Level 3 inputs are unobservable (supported by little or no market activity). The fair value hierarchy gives the highest priority to Level 1 inputs and the lowest priority to Level 3 inputs. (q) Derivatives The Company periodically uses foreign exchange and commodity contracts to manage exposure to fluctuations in foreign exchange rates and silver prices. Derivative positions are recorded on the balance sheet at fair value with changes in fair value recorded in operations. 4. Changes in accounting standards Financial instruments disclosure In October 2010, the IASB issued amendments to IFRS 7 Financial Instruments: Disclosures that improve the disclosure requirements in relation to transferred financial assets. The amendments are effective for annual periods beginning on or after July 1, 2011, with earlier adoption permitted. The Company does not anticipate this amendment to have a significant impact on its consolidated financial statements. Income taxes In December 2010, the IASB issued an amendment to IAS 12 Income Taxes that provides a practical solution to determining the recovery of investment properties as it relates to the accounting for deferred income taxes. This amendment is effective for annual periods beginning on or after July 1, 2011, with earlier adoption permitted. Consolidation On September 29, 2010, the IASB posted a staff draft of a forthcoming IFRS on consolidation. The staff draft reflects tentative decisions made to date by the IASB with respect to the IASB s project to replace current standards on consolidation, IAS 27 - Consolidated and Separate Financial Statements and SIC-12, with a single standard on consolidation. The IASB plans on publishing the final standard on consolidation during the first half of 2011, with an anticipated effective date of January 1,

15 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Changes in accounting standards (continued) Financial instruments The IASB intends to replace IAS 39 Financial Instruments: Recognition and Measurement ( IAS 39 ) in its entirety with IFRS 9 Financial Instruments ( IFRS 9 ) in three main phases. IFRS 9 will be the new standard for the financial reporting of financial instruments that is principles-based and less complex than IAS 39, and is effective for annual periods beginning on or after January 1, 2013, with earlier adoption permitted. In November 2009 and October 2010, phase 1 of IFRS 9 was issued and amended, respectively, which addressed the classification and measurement of financial assets and financial liabilities. IFRS 9 requires that all financial assets be classified as subsequently measured at amortized cost or at fair value based on the Company s business model for managing financial assets and the contractual cash flow characteristics of the financial assets. Financial liabilities are classified as subsequently measured at amortized cost except for financial liabilities classified as at fair value through profit or loss, financial guarantees and certain other exceptions. The IASB has issued exposure drafts addressing impairment of financial instruments, hedge accounting and the offsetting of financial assets and liabilities, with comments due in March and April of The complete IFRS 9 is anticipated to be issued during the second half of Fair Value Measurement The IASB has issued a new standard, IFRS 13, Fair Value Measurement ( IFRS 13 ) which is effective from January 1, IFRS 13 is a comprehensive standard for fair value measurement and disclosure requirements for use across all IFRS standards. The new standard clarifies that the fair value is the price that would be received to sell an asset, or paid to transfer a liability in an orderly transaction between market participants, at the measurement date. IFRS 13 also establishes disclosures about fair value measurement. 5. Fair values and financial risk management The Company has exposure to risk of varying degrees of significance which could affect its ability to achieve its strategic objectives for growth and shareholder returns. The principal financial risk to which the Company is exposed are credit risk, liquidity risk, interest rate risk, foreign exchange rate risk, and metal price risk. The Company s Board of Directors has overall responsibility for the establishment and oversight of the Company s risk management framework and reviews the Company s policies on an ongoing basis. Credit risk Credit risk is the risk of an unexpected loss if a customer or third party to a financial instrument fails to meet its contractual obligations and arises principally from the Company s cash and cash equivalents and amounts receivable and long term deposits. The Company s exposure to credit risk with its customers is influenced mainly by the individual characteristics of each customer. The Company generally does not require collateral for sales. The Company takes into consideration the customer s payment history, their credit worthiness and the then current economic environment in which the customer operates to assess impairment. The Company closely monitors extensions of credit and has not experienced significant credit losses in the past. At May 31, 2011 and February 28, 2011, the Company had no material past due trade receivables. 13

16 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Fair values and financial risk management (continued) The Company invests its excess cash principally in highly rated government and corporate debt securities. The Company has established guidelines relative to diversification, credit ratings and maturities that maintain safety and liquidity. These guidelines are periodically reviewed by the Company s audit committee and modified to reflect changes in market conditions. The Company s maximum exposure to credit risk is as follows: May 31, 2011 February 28, 2011 March 1, 2011 Cash and cash equivalents $62,955,356 $2,440,255 $750,484 Restricted cash $1,005,678 $1,008,585 - Trade and other receivables $395,341 $150,040 $55,350 Liquidity risk Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company has in place a planning and budgeting process to help determine the funds required to support the Company s operating requirements as well as its planned capital expenditures. The Company manages its financial resources to ensure that there is sufficient working capital to fund near term planned exploration work and operating expenditures. The Company has considerable discretion to reduce or increase exploration plans or budgets depending on current or projected liquidity. The Company raised approximately $80.0 million by completing a private placement of common shares. The Company is currently evaluating alternatives to raise additional capital to increase liquidity but there is no certainty that additional capital will be raised. However given the considerable discretion to reduce or increase exploration plans the Company has sufficient funds to continue operations through Interest rate risk The Company is subject to interest rate risk on its cash and cash equivalents and believes that the results of operations, financial position and cash flows would not be significantly affected by a sudden change in market interest rates relative to the investment interest rates due to the short term nature of the investments. Excess cash is invested in highly rated investment securities at fixed interest rates with varying terms to maturity but generally with maturities of three months or less from the date of purchase. As at May 31, 2011, cash and cash equivalents of $62,955,357 ( $2,440,2554) consists of chequing and short-term investments maturing in less than 90 days with Canadian chartered banks with interest rates up to 1.45%. The Company has immaterial interests in equity instruments of other corporations. Foreign exchange rate risk The Company reports its financial statements in Canadian dollars; however, the Company has extensive operations in the United States as well as limited operations in Mexico. As a consequence, the financial results of the Company s operations as reported in Canadian dollars are subject to changes in the value of the Canadian dollar relative to the US dollar and Mexican Peso. 14

17 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Fair values and financial risk management (continued) The Company s operations in the United States are currently fully integrated with its Canadian operations, as such, the Company can be exposed to significant fluctuations in the exchange rate between the US dollar and the Canadian dollar. The Company s operations in the United States generate revenue and incur expenses principally in US dollars so foreign exchange gains or losses are subject to net operations. The Company does not currently enter into any foreign exchange hedges to limit exposure to exchange rate fluctuations. The Board of Directors continually assesses the Company s strategy toward its foreign exchange rate risk, depending on market conditions. Translation exposure The Company s functional and reporting currency is Canadian dollars. The Company s foreign operations with a Canadian functional currency translate their operating results from the currency in which their books and records are maintained into Canadian dollars resulting in foreign exchange gains or loss which are expensed in the reporting period. Therefore, exchange rate movements in the United States dollar and Mexican peso can have a significant impact on the Company s consolidated operating results. A 10% strengthening (weakening) of the Canadian dollar against the US$ dollar would have increased (decreased) the Company s net earnings (loss) before taxes from the financial instruments by the amount of $95,910 for the three months ending May 31, Metal price risk Metal price risk is the risk that changes in metal prices will affect the Company s report loss or the value of its related financial instruments. The Company derives some of its refining revenue from the purchase and sale of silver and gold material as well as charging refining fees in the form of retainage, (the retention of some of the refined product). The Company mitigates the price risk associated with the purchase and sale of silver and gold materials by entering into forward contracts to secure the margin associated with refining the materials. The Board of Directors continually assesses the Company s strategy towards its base metal exposure, depending on market conditions. Based on the quantities and market price of silver and gold at May 31, 2011, a 10% increase or decrease in the price of gold and silver would result in a $360,657 increase or decrease in the Company s after-tax net loss for the three months ending May 31,

18 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Restricted cash The Company has short term restricted cash consists of $1,005,678 of funds placed into a special bank account to guarantee the costs and interest expense for US$77.7 million in Federal Stimulus Program Recovery Zone Facility Bonds ( Tax Exempt Government Bonds ) that were placed on behalf of the Company in December These Tax Exempt Government Bonds currently bear interest at 0.6% per annum and the proceeds are held in trust until the Company secures a bank letter of credit or other type of guarantee for these Bonds. If the guarantee is not obtained by July 5, 2011 the date may be extended by mutual agreement or the trust proceeds will be repaid to the holders of the bonds. The restricted cash held by the Company covers the costs and interest expense on these bonds through July 4, 2011 which are recorded as deferred financing costs. The interest payable to the holders of the $US77.7 million Tax Exempt Government Bonds from their issue date through to May 31, 2011 which is approximately US$190,000, along with unpaid costs for establishing the bonds have been accrued in the Company s accounts and recorded as deferred financing costs until such time as the Letters of Credit is put into place and the Company can gain access to the funds. 7. Precious metals inventory Inventories consist of: May 31, February 28, March 1, $ $ $ Silver inventory 1,940,210 1,106,675 1,187,374 Gold inventory 1,666,359 1,577,173 1,691,607 Warehouse inventory 27,191 19,953 14,082 3,633,760 2,703,801 2,893, Reclamation bonds The Company has provided a reclamation bond for the Idaho Cobalt Project to the U.S. Forest Service amounting to $602,688 (2011- $604,430) representing the fair value of the security held. 9. Property, plant and equipment February 28, March 1, May 31, Accumulated Net Book Net Book Net Book Cost Depreciation Value Value Value $ $ $ $ $ Land 157, , , ,536 Plants undergoing refurbishment 12,949,897-12,949,897 11,562,983 7,878,507 Buildings 732, , , , ,670 Equipment 1,890,409 1,565, , , ,277 Office furniture and fixtures 363, ,690 47,582 49,504 71,030 16,093,590 2,159,984 13,933,606 12,577,725 9,094,020 The Company capitalizes the cost associated with refurbishing and constructing its mill and cobalt hydrometallurgical plant and will depreciate those assets when they are put into use. Non-refundable equipment deposits have been disclosed as long-term deposits and will be reclassified to property, plant and equipment when title is transferred. 16

19 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Mineral properties Mineral properties at May 31, 2011 consist of: May 31, February 28, $ $ Idaho Cobalt Belt (a) Idaho Cobalt Project (i) 56,394,090 55,824,777 Black Pine (ii) 3,290,345 3,289,329 Badger Basin (iii) 119, ,402 59,803,505 59,232,508 Other Projects (b) Morning Glory/Wallace Creek (i) 463, ,004 Queen of the Hills (ii) 81,239 78,298 Compass/Kernaghan (iii) 463, ,265 Virgin River (iv) 481, ,559 El Milagro (v) 33,600 - Other(vi) 149, ,679 1,673,610 1,615,805 61,477,115 60,848,313 (a) Idaho Cobalt Belt (i) Idaho Cobalt Project The Company owns 100% interest in 241 claims amounting to approximately 4,080 acres which comprise the Idaho Cobalt Project. A primary cobalt deposit located in Lemhi County, Idaho, acquired through staking in 1994 that has been extensively explored, developed and permitted and is now in the mine finance and initial construction phase of development. (ii) Black Pine The Company has a 100% interest in certain mineral claims in Lemhi County, Idaho. An option agreement effective until the year 2014 to share on a 50/50 basis with the optionor any payments received from joint venture partner. (iii) Badger Basin - Through staking, the Company has a 100% interest in certain mineral claims located in Lemhi County, Idaho. (b) Other Projects (i) Morning Glory/ Wallace Creek The Company has 100% interest in certain mineral claims located in Lemhi County, Idaho. (ii) Queen of the Hills - The Company holds a lease option to purchase 100% of certain mineral claims located in Lemhi County, Idaho. (iii) Compass / Kernaghan Lake The Company owns a 100% interest in certain claims that have demonstrated through airborne and ground exploration the potential for hosting gold mineralization located in Saskatchewan, Canada. 17

20 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Mineral properties (continued) (c) Other Projects (continued) (iv) Virgin River The Company s wholly owned subsidiary, Coronation Mines Ltd entered into joint venture exploration agreement with Cameco and AREVA on the Virgin River project located in the Athabasca Basin of northern Saskatchewan. The Company owns 2% of the project with the first right to offer to acquire up to 10% and has been carried through to $10 million worth of exploration and development. (v) El Milagro The Company has a 100% interest in a property in Tamaulipas, Mexico. (vi) Other Projects the Company has varying other interest of up to 100% in certain mineral claims located in Idaho, USA, Saskatchewan and Manitoba, Canada. 11. Convertible debenture On May 6, 2010, the Company issued an unsecured convertible debenture for $8,000,000 which matures in eighteen months from date of issuance and bears interest rate of 12% per annum, payable quarterly, during this term. The Convertible debenture can be converted at any time by the holder at a conversion price of $1.50 per share. The quarterly interest payment is settled by issuing common shares at the 5 day volume weighted average trading price per share. During the period from May 6, 2010 to February 28, 2011, the Company issued 429,772 common shares to settle $483,946 of interest owing on the debenture. In December 2010, the holder of the convertible debenture exercised its first term conversion right to convert $1,000,000 of the convertible debenture into 666,666 fully paid non-assessable common shares. In March 2011, the remaining $7,000,000 unsecured convertible debenture balance and accrued interest was paid for $9,333,333 in cash and 400,000 common shares were issued at a market value of $1.25 per share. 12. Share capital a) Authorized and issued The Company has 50,000,000 preferred shares without par value authorized for issue and an unlimited number of common shares without par value authorized for issue. At May 31, 2011, the Company had 90,682,205 common shares outstanding. At February 28, 2011, the Company had 36,948,871 common shares outstanding. At March 1, 2010, the Company had 34,503,617 common shares outstanding. 18

21 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Share capital (continued) b) Stock Options As at May 31, 2011 the outstanding stock options were as follows: Weighted ave. Options Exercise remaining Outstanding price contractual life Expiry date $ 40, years July 08, , years July 24, , years July 28, , years September 21, , years March 23, , years April 15, , years June 17, , years August 31, ,760, years June 17, ,871, The changes in stock options during the current and previous year were as follows: Weighted Average Exercise Price Weighted Average Exercise Price May 31, 2011 February 28, 2011 $ $ Balance outstanding, beginning of year 2,868, ,031, Activity during the period: Options granted 60, ,185, Options exercised - - (15,441) - Options cancelled on exercise of cashless option rights - - (155,987) 1.56 Options expired (57,142) 1.40 (176,426) 2.51 Balance outstanding, end of period 2,871, ,868, During the period ended May 31, 2011, 60,000 stock options were granted to a director. Using the fair value method to value the stock options, $16,317 was recorded to stock-based compensation expense. This amount was determined using a Black-Scholes option pricing model assuming no dividends are to be paid, the expected life will match the expiry of the option agreement, a weighted average volatility of the Company s share price of 77% and a weighted average risk free rate of 1.71%. 19

22 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Share capital (continued) c) Warrants As at May 31, 2011 outstanding warrants were as follows: Number of Warrants Exercise Price Expiry Date $ 2,493, May 2, , May 6, ,200, March 10, ,666, March 10, ,026, The Company received Toronto Stock Exchange and shareholder approval to extend the expiry date from May 2, 2011 to May 2, 2012, subject to an acceleration right of 2,493,447 outstanding share purchase warrants issued on April 29, None of the warrants are publicly traded and each warrant entitles the holder to purchase at $2.80 per share, one common share of the Company. On March 10, 2011, the Company completed an equity financing of 53,333,334 units at a price of $1.50 per Unit resulting in gross proceeds of $80,000,000. Each unit is comprised of one common share and one-half of one transferable common share purchase warrant, each whole common share purchase warrant entitling the purchase of one common share of the Company at a price of $2.00 per share until March 10, The relative value of the transferrable warrants of $11,748,547 ( $313,838) was determined on a relative fair value basis using a Black-Scholes option pricing model assuming no dividends are to be paid, the expected life will match the expiry of the warrant, a weighted average volatility of the Company s share price of 82% ( %) and a weighted average risk free rate of 2.18% ( %). The changes in warrants during the current and previous years were as follows: May 31, 2011 Weighted Average Exercise Price February 28, 2011 Weighted Average Exercise Price $ $ Balance outstanding, 3,160, ,493, beginning of year Activity during the period: Warrants issued 29,866, , Balance outstanding, end of period 33,026, ,160,

23 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Capital risk management The Company s objectives when managing capital are to ensure there are adequate capital resources to safeguard the Company s ability to continue as a going concern, continue the development and exploration of its mineral properties and to maximize growth of its business and provide returns to its shareholders. The Company s capital structure consists of shareholders equity, comprising issued common shares plus share based payments and other reserves less the deficit. The Company manages its capital structure and makes adjustments to it based on economic conditions and the risk characteristics of the underlying assets. The Company, upon approval from its Board of Directors, will balance its overall capital structure through new share or debt issuances or by undertaking other activities as deemed appropriate under specific circumstances. The Company expects its current capital resources and projected cash flows from continuing operations will not support existing operations. The Company will require additional financing to support existing operations and to bring its Idaho Cobalt Project into production with a Technical Report estimated cost to construct and commission the mine / concentrator and the cobalt production facility at US$138.7 million. Capital, as defined above, is summarized in the following table: May 31, February 28, March 1, $ $ $ Convertible debenture - 6,775,801 - Equity portion of convertible debenture - 252,916 - Common shares 149,021,990 84,588,098 81,384,410 Share purchase warrants 20,954,848 9,206,301 8,892,463 Share-based payments and other reserves 6,535,544 6,266,311 5,279,312 Deficit (32,184,540) (30,045,584) (26,706,156) 144,327,842 77,043,843 68,850,029 In order to facilitate the management of its capital requirements, the Company prepares annual budgets that are updated as necessary depending on various factors, including successful capital deployment and general industry conditions. The annual budget and quarterly updated forecasts are approved by the Board of Directors. 14. Segmented information The Company operates in two operating segments, that being exploration of mineral properties and precious metals refining. All revenues generated are located in the United States in the Refinery operating segment. The Company s non-current assets by geographic location and operating segment are as follows: May 31, 2011 February 28, 2011 March 1, 2010 Explora tion Refine ry Exploration Refinery Exploration Refinery $ $ $ $ $ $ Canada 7,070,598-5,513,917-3,229,039 - Mexico 33, United States 69,876,902 5,592,089 68,268,717 5,19 9,064 65,277,351 5,255,214 76,981,100 5,592,089 73,782,634 5,19 9,064 68,506,390 5,255,214 21

24 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Other supplementary cash flow information For the period ended May 31, February 28, $ $ Fair value of stock options transferred to share capital on options exercised from contributed surplus - 21,281 Unpaid deferred financing costs in trade and other payables 774,880 1,151,829 Unpaid mineral property purchases in trade and other payables - 276,680 Issuance of common shares on conversion of debenture interest 500, ,946 Issuance of common shares on conversion of convertible debenture - 1,000, Commitments (a) (b) (c) The Company has certain obligations with respect to mineral property expenditures. Pursuant to employment agreements the Company may be obligated to pay up to $3,452,867 if certain management is terminated without cause or good reason. The Company has annual operating lease commitments of approximately $114,000 for each of the next five years. 17. Key management personnel compensation Three Months Ended Three Months Ended May 31, 2011 May 31, 2010 $ $ Salaries, management fees, and short-term employee benefits, including bonuses 154, , , , Transition to International Financial Reporting Standards As disclosed in Note 2, these condensed interim consolidated financial statements represent the Company s initial presentation of the financial results of the operations and financial position under IFRS for the period ended May 31, 2011 in conjunction with the Company s annual audited consolidated financial statements to be issued under IFRS as at and for the year ended February 28, As a result, these condensed interim consolidated financial statements have been prepared in accordance with IAS 34 using accounting policies consistent with IFRS. Previously the Company prepared its condensed interim and annual consolidated financial statements in accordance with Canadian GAAP. 22

25 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Transition to International Financial Reporting Standards (continued) IFRS 1, First-time Adoption of International Financial Reporting Standards, sets forth guidance for the initial adoption of IFRS. Under IFRS 1 the standards are applied retrospectively at the transitional statement of financial position date with all adjustments to assets and liabilities taken to retained earnings unless certain exemptions are applied. The Company has applied the following exemptions to its opening statement of financial position dated March 1, 2010: First-time exemptions and exceptions applied (a) Estimates In accordance with IFRS 1, an entity s estimates under IFRS at the date of transition to IFRS must be consistent with estimates made for the same date under previous GAAP, unless there is objective evidence that those estimates were in error. The Company s IFRS estimates as of March 1, 2010 are consistent with its Canadian GAAP estimates for the same date. (b) Cumulative translation differences IFRS 1 allows a first-time adopter to not comply with the requirements of IAS 21, The Effects of Changes in Foreign Exchange Rates, for cumulative translation differences that existed at the date of transition to IFRS. The Company has chosen to apply this election and has eliminated the cumulative translation difference and adjusted the deficit by the same amount at the date of transition to IFRS. If, subsequent to adoption, a foreign operation is disposed of, the translation differences that arose before the date of transition to IFRS will not affect the gain or loss on disposal. (c) Share-based payments IFRS 2, Share-based payments, applies to all grants of equity settled transactions made after November 7, 2002 that have not vested at the transition date. A company may also choose to apply the standard to any equity instruments that were granted before November 7, 2002, or that were granted after that date, and vested before the date of transition, but only if the company has previously disclosed the fair value of the instrument, determined at the measurement date. The Company elected to apply IFRS 2 to all share-based payments that had not yet vested at the transition date. Changes in accounting policies In addition to the exemptions and exceptions discussed above, the following narrative explains the significant differences between the previous Canadian GAAP and the current IFRS accounting policies applied by the Company. The following is not a complete summary of all of the differences between Canadian GAAP and IFRS. Unless a quantitative impact was noted below, the impact from the change was not material to the Company and only the differences having an impact on the Company are described below and included in the referenced financial statement schedules below. 23

26 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Transition to International Financial Reporting Standards (continued) A - IAS 21 Foreign Exchange Translation The Company s subsidiary, Essential Metals Corporation, has a functional currency in accordance with IFRS that is the US dollar while under Canadian GAAP it was the Canadian dollar. This change in accounting policy results in a change in the methodology of consolidation which results in the non-monetary assets being translated at each quarter end s current rate, and the foreign exchange difference is recorded as an additional component of equity called foreign currency translation reserve and included as a component of comprehensive income or loss. Under Canadian GAAP these non-monetary assets were translated at the historical exchange rate with the foreign exchange difference being recorded as a foreign exchange gain or loss in the statement of operations. These changes are referenced as A in the attached restated financial statements. B IAS 12 Deferred Income Taxes Foreign Exchange Translation Under IFRS, the calculation of deferred income tax balances of foreign subsidiaries with a functional currency different from the tax paying currency requires recognition of changes in deferred tax balances due to differences between the current and historical exchange rates for non-monetary assets and liabilities. Compound Financial Instruments Under Canadian GAAP, if a compound instrument can be settled without the incidence of tax, deferred taxes would not be recorded related to the temporary difference (i.e., the tax base of the liability component is considered equal to its carrying amount and no temporary difference arises). Under IFRS, the deferred tax consequences of a financial instrument containing both a liability and equity component should be recognized both in profit or loss and in equity in accordance with the classification of the component parts under IFRS. Backwards Tracing Under IFRS, current and deferred taxes are recognized in the income statement except to the extent that tax arises from an item that has been recognized outside the income statement. Accordingly, the effect of re-measuring taxes that were initially recognized outside the income statement is recorded in equity or other comprehensive income as applicable. The practice of tracking the re-measurement of taxes back to the item that originally triggered the recognition is commonly referred to as backwards tracing. Canadian GAAP prohibits backwards tracing, except on business combinations and financial reorganizations; accordingly, the effect of remeasuring taxes is generally recognized in the income statement, even if the taxes were initially recognized outside the income statement. Under Canadian GAAP, the Company recognized the effect of re-measuring taxes related to certain share issue costs in the income statement. Upon transition to IFRS, the Company recorded an adjustment to reclassify the effect of re-measuring taxes related to these items within equity, from retained earnings to reserves within share capital. These backwards tracing adjustments had no impact on total equity. These changes are referenced as B in the attached restated financial statements. 24

27 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Transition to International Financial Reporting Standards (continued) Reconciliation of the statement of financial position at March 1, 2010 as reported from Canadian GAAP to IFRS: Effect of Canadian transition to Reference GAAP IFRS IFRS $ $ $ Assets Current assets Cash and cash equivalents 750, ,484 Precious metals inventory 2,893,063-2,893,063 Trade and other receivables 55,350-55,350 Prepaid expenses and deposits 52,253-52,253 3,751,150-3,751,150 Reclamation bond 654, ,893 Long-term deposits 4,370,527-4,370,527 Property and equipment A 10,048,153 (954,133) 9,094,020 Mineral properties 57,437,167-57,437,167 Deferred tax assets B - 2,204,997 2,204,997 76,261,890 1,250,864 77,512,754 Liabilities Current liabilities Trade payables 1,524,967-1,524,967 Accrued and other payables 1,238,159-1,238,159 2,763,126-2,763,126 Deferred tax liabilities B 746,927 5,152,672 5,899,599 3,510,053 5,152,672 8,662,725 Shareholders' equity Common shares B 80,720, ,240 81,384,410 Share purchase warrants 8,892,463-8,892,463 Share-based payments and other reserves 5,279,312-5,279,312 Deficit A, B (22,140,108) (4,566,048) (26,706,156) 72,751,837 (3,901,808) 68,850,029 76,261,890 1,250,864 77,512,754 25

28 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Transition to International Financial Reporting Standards (continued) Reconciliation of the statement of financial position at May 31, 2010 as reported from Canadian GAAP to IFRS: Effect of Canadian transition to Reference GAAP IFRS IFRS $ $ $ Assets Current assets Cash and cash equivalents 8,501,592-8,501,592 Precious metals inventory 2,891,098-2,891,098 Trade and other receivables 44,684-44,684 Prepaid expenses and deposits 62,461-62,461 11,499,835-11,499,835 Reclamation bond 649, ,293 Long-term deposits 4,272,346-4,272,346 Property and equipment A 10,085,044 (991,103) 9,093,941 Mineral properties 58,246,059-58,246,059 Deferred tax assets B - 2,132,740 2,132,740 84,752,577 1,141,637 85,894,214 Liabilities Current liabilities Trade payables 1,203,212-1,203,212 Accrued and other payables 692, ,101 1,895,313-1,895,313 Convertible debenture 7,610,581-7,610,581 Deferred tax liabilities B 654,335 5,451,785 6,106,120 10,160,229 5,451,785 15,612,014 Shareholders' equity Common shares B 82,261, ,240 82,925,558 Share purchase warrants 9,167,818-9,167,818 Equity portion of convertible debenture B 419,371 (103,645) 315,726 Share-based payments and other reserves 5,279,312-5,279,312 Foreign currency translation reserve A - (90,043) (90,043) Deficit A, B (22,535,471) (4,780,700) (27,316,171) 74,592,348 (4,310,148) 70,282,200 84,752,577 1,141,637 85,894,214 26

29 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Transition to International Financial Reporting Standards (continued) Reconciliation of the statement of operations and comprehensive loss at May 31, 2010 as reported from Canadian GAAP to IFRS: Effect of Canadian transition to Reference GAAP IFRS IFRS $ $ $ Revenue - refinery 1,588,333-1,588,333 Cost of revenues (1,395,552) - (1,395,552) 192, ,781 Expenses Bank charges, interest and financing costs 7,367-7,367 Office 95,239-95,239 Foreign exchange loss A, B 231,345 (13,439) 217,906 Accretion on convertible debenture 29,952-29,952 Administration 71,778-71,778 Depreciation A 57,215 (7,641) 49,574 Accounting and audit 28,804-28,804 Legal fees 21,843-21,843 Shareholder information 32,211-32,211 Listing and filing fees 14,806-14,806 Advertising and promotion 6,174-6,174 Management fees 2,403-2, ,137 (21,080) 578,057 Loss from operations (406,356) (21,080) (385,276) Other income 4,093-4,093 Loss before income taxes (402,263) (21,080) (381,183) Income taxes B 6,900 (235,732) (228,832) Net loss for the period (395,363) (256,812) (610,015) Exchange differences on translating foreign operations A - (90,043) (90,043) Net comprehensive loss for the period (395,363) (346,855) (700,058) Deficit, beginning of period A, B (22,140,108) (4,566,048) (26,706,156) Deficit, end of period (22,535,471) (4,822,860) (27,316,171) Basic and diluted loss per share (0.01) (0.01) Weighted average number of basic and diluted common shares outstanding 34,865,947 34,865,947 27

30 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Transition to International Financial Reporting Standards (continued) Reconciliation of the statement of cash flows at May 31, 2010 as reported from Canadian GAAP to IFRS: Effect of Canadian transition to Reference GAAP IFRS IFRS $ $ $ Operating activities Net loss for the period A, B (395,363) (214,652) (610,015) Items not involving cash Depreciation A 57,215 (7,641) 49,574 Accretion on convertible debenture 29,952-29,952 Income taxes B - 235, ,732 Unrealized foreign exchange loss A, B 231,345 (13,439) 217,906 Change in working capital items (926,797) - (926,797) (1,003,648) - (1,003,648) Investing activities Deposits for property, plant and equipment (158,749) - (158,749) Mineral property expenditures (808,892) - (808,892) Purchase of property, plant and equipment, net of deposits A (94,106) 1,914 (92,192) (1,061,747) 1,914 (1,059,833) Financing activities Issuance of common shares and warrants for cash 2,000,063-2,000,063 Issuance of convertible debenture for cash 8,000,000-8,000,000 Share and convertible debenture issue expenses (183,560) - (183,560) 9,816,503-9,816,503 Effects of exchange rate changes on the balance of cash held in foreign currencies A - (1,914) (1,914) Net cash inflows (outflows) 7,751,108-7,751,108 Cash and cash equivalents, beginning of period 750, ,484 Cash and cash equivalents, end of period 8,501,592-8,501,592 28

31 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Transition to International Financial Reporting Standards (continued) Reconciliation of the statement of financial position at February 28, 2011 as reported from Canadian GAAP to IFRS: Effect of Canadian transition to Reference GAAP IFRS IFRS $ $ $ Assets Current assets Cash and cash equivalents 2,440,255-2,440,255 Restricted cash 1,008,585-1,008,585 Precious metals inventory 2,703,801-2,703,801 Trade and other receivables 150, ,040 Prepaid expenses and deposits 59,770-59,770 6,362,451-6,362,451 Deferred financing costs 1,681,112-1,681,112 Reclamation bond 604, ,430 Long-term deposits 568, ,341 Property and equipment A 13,924,789 (1,347,064) 12,577,725 Mineral properties 60,848,313-60,848,313 Deferred tax assets B - 2,701,560 2,701,560 83,989,436 1,354,496 85,343,932 Liabilities Current liabilities Trade payables 502, ,321 Accrued and other payables 1,756,310-1,756,310 2,258,631-2,258,631 Convertible debenture 6,775,801-6,775,801 Deferred tax liabilities B - 7,042,648 7,042,648 9,034,432 7,042,648 16,077,080 Shareholders' equity Common shares B 83,862, ,426 84,588,098 Share purchase warrants 9,206,301-9,206,301 Equity portion of convertible debenture B 364,049 (111,133) 252,916 Share-based payments and other reserves 6,266,311-6,266,311 Foreign currency translation reserve A - (1,001,190) (1,001,190) Deficit A, B (24,744,329) (5,301,255) (30,045,584) 74,955,004 (5,688,152) 69,266,852 83,989,436 1,354,496 85,343,932 29

32 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Transition to International Financial Reporting Standards (continued) Reconciliation of the statement of operations and comprehensive loss at February 28, 2011 as reported from Canadian GAAP to IFRS: Effect of Canadian transition to Reference GAAP IFRS IFRS $ $ $ Revenue - refinery 3,655,926-3,655,926 Cost of revenues (3,176,473) - (3,176,473) 479, ,453 Expenses Stock-based compensation 1,008,280-1,008,280 Bank charges, interest and financing costs 777, ,395 Office 357, ,953 Foreign exchange loss A, B 348,920 (577,698) (228,778) Accretion on convertible debenture 335, ,648 Administration 274, ,216 Depreciation A 232,284 (30,561) 201,723 Accounting and audit 225, ,010 Legal fees 124, ,895 Shareholder information 90,308-90,308 Listing and filing fees 43,158-43,158 Advertising and promotion 32,965-32,965 Management fees 26,394-26,394 3,877,426 (608,259) 3,269,167 Loss from operations (3,397,973) 608,259 (2,789,714) Other income 46,825-46,825 Loss before taxes (3,351,148) 608,259 (2,742,889) Income taxes B 746,927 (1,343,466) (596,539) Net loss for the year (2,604,221) (735,207) (3,339,428) Exchange differences on translating foreign operations A - (1,001,190) (1,001,190) Net comprehensive loss for the year (2,604,221) (1,736,397) (4,340,618) Deficit, beginning of the year A, B (22,140,108) (4,566,048) (26,706,156) Deficit, end of the year (24,744,329) (5,301,255) (30,045,584) Basic and diluted loss per share (0.07) (0.12) Weighted average number of basic and diluted common shares outstanding 35,896,376 35,896,376 30

33 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Transition to International Financial Reporting Standards (continued) Reconciliation of the statement of cash flows at February 28, 2011 as reported from Canadian GAAP to IFRS: Effect of Canadian transition to Reference GAAP IFRS IFRS $ $ $ Operating activities Net loss for the year A, B (2,604,221) (735,207) (3,339,428) Items not involving cash Depreciation A 232,284 (30,561) 201,723 Income taxes B (746,927) 1,343, ,539 Stock-based compensation 1,008,280-1,008,280 Unrealized foreign exchange loss A, B 97,912 (577,698) (479,786) Change in working capital items (1,026,357) - (1,026,357) (3,039,029) - (3,039,029) Investing activities Mineral property expenditures (2,880,945) - (2,880,945) Purchase of property, plant and equipment, net of deposits A (607,703) (23,594) (631,297) (3,488,648) (23,594) (3,512,242) Financing activities Issuance of common shares and warrants for cash 2,000,063-2,000,063 Issuance of convertible debenture for cash 8,000,000-8,000,000 Restricted cash (1,008,585) - (1,008,585) Deferred financing costs, net of accounts payable (529,283) - (529,283) Share issue expenses (244,747) - (244,747) 8,217,448-8,217,448 Effects of exchange rate changes on the balance of cash held in foreign currencies A - 23,594 23,594 Net cash inflows (outflows) 1,689,771-1,689,771 Cash and cash equivalents, beginning of year 750, ,484 Cash and cash equivalents, end of year 2,440,255-2,440,255 31

34 Notes to unaudited condensed interim consolidated financial statements As at May 31, 2011, February 28, 2011 and March 1, Subsequent events On July 5, 2011, the Company extended the date and term of the construction trust account holding the Recovery Zone Facility Bonds funds from July 5, 2011 to October 6, 2011 by remarketing the bonds, and posting 2 irrevocable standby letters of credit totaling US$803,704. The letters of credit guarantee all costs and interest associated with the extension. On July 8, 2011, the Company provided a collateral deposit for Stage I and Stage II Construction in the amount of US$2,232,866 to secure a reclamation surety bond in the amount of US$6,300,000 from a recognized bonding company as required by the Forest Service to implement the Plan of Operations. The original cash deposit of US$622,226 posted for Stage I Construction will be refunded upon the final acceptance of the Surety Bond. 32

35 Management s Discussion and Analysis For the First Quarter Ending May 31, 2011 Date of Report: July 15, 2011 Suite West Hastings Street Vancouver, BC, Canada V6C 2W2 Symbol: Toronto Stock Exchange - FCO

36 Table of Contents 1.1 Date Overview Summary Highlights for Quarter ended May 31, Risk Management Basis of Analysis Property Activities... 3 (a) Idaho Cobalt Project Idaho, USA... 3 (b) Essential Metals Corporation ( EMC ) Idaho, USA... 8 (c) Black Pine Idaho, USA... 8 (d) Badger Basin Idaho, USA... 8 (e) Morning Glory Idaho, USA... 9 (f) Queen of the Hills Idaho, USA... 9 (g) Wallace Creek Idaho, USA... 9 (h) El Milagro Mexico... 9 (i) Compass Lake Saskatchewan, Canada... 9 (j) Kernaghan Lake / Bell Saskatchewan, Canada... 9 (k) Virgin River Saskatchewan, Canada (l) Other Projects Outlook Selected Annual Information Summary of Quarterly Results Results of Operations Liquidity Capital Resources Off-Balance Sheet Arrangements Transactions with Related Parties Fourth Quarter Proposed Transactions Critical Accounting Estimates Changes in Accounting Policies including Initial Adoption (a) Changes in Accounting Standards (b) Transition to International Financial Reporting Standards ( IFRS ) Financial Instruments and Other Instruments Other MD&A Requirements (a) Disclosure of Outstanding Share Data (b) Internal Controls over Financial Reporting and Disclosure Controls (c) Additional Information... 30

37 This Management Discussion and Analysis ( MD&A ) should be read in conjunction with the unaudited interim condensed consolidated financial statements of Formation Metals Inc. or the ( Company ) and the notes thereto, for the three months ended May 31, 2011 which have been prepared in accordance with International Financial Reporting Standards ( IFRS ) and with the audited financial statements and related notes thereto, of the Company for the year ended February 28, 2011 which were prepared in accordance with Canadian Generally Accepted Accounting Principles and are available through the internet on SEDAR at All dollar amounts herein are expressed in Canadian Dollars unless stated otherwise. This Management Discussion and Analysis includes certain statements that may be deemed "forward-looking statements" which the Company believes it has a reasonable basis for disclosing. All statements in this discussion, other than statements of historical facts, that address future production, reserve potential, exploration drilling, exploitation activities and events or developments that the Company expects are forward-looking statements. Although the Company believes the expectations expressed in such forward-looking statements are based on reasonable assumptions, investors are cautioned such statements are not guarantees of future performance and actual results or developments may differ materially from those in the forward-looking statements. Factors that could cause actual results to differ materially from those in forward-looking statements include market prices, exploitation and exploration successes, continued availability of capital and financing and general economic, market or business conditions. 1.1 Date This MD&A is prepared as of July 15, Overview Summary Formation Metals Inc. (the Company ) is a mineral exploration, development and refining company listed on the senior board of the Toronto Stock Exchange under the symbol FCO. The Company, either directly or indirectly through its wholly owned subsidiaries Formation Holdings Corp., Formation Capital Corporation, U.S., Formation Holdings US, Inc., US Cobalt, Inc., Coronation Mines Limited and Minera Terranova S.A. de C.V., has, for the years since inception, been engaged in the business of exploring for minerals in Canada, the United States and Mexico. In September 2005, the Company s 100% owned Essential Metals Corporation reached commercial production at its Sunshine Precious Metals Refinery. The Company s main focus is currently centered on its flagship property, the 100% owned Idaho Cobalt Project (the ICP ), located in Lemhi County, Idaho, near the town of Salmon. Other minerals being explored for by the Company s various subsidiaries include silver, gold, copper, lead, zinc, uranium and rare earth elements. The ICP is currently under construction with initial site clearing completed (Stage I) and road upgrades to the mine site underway (part of Stage II). The project is a fully permitted, shovel ready, primary cobalt deposit that will be capable of producing high purity cobalt ( HPC ) metal suitable for critical applications in the superalloy sector. All required environmental permits to commence construction for the project have been received from the various permitting agencies. A National Instrument Compliant Technical Report (the Technical Report ), was completed September 14, 2007, revised May 19, 2008, amended and restated June 23, 2008 and SEDAR filed on July 15, 2008 and was derived from a more comprehensive economic Bankable Feasibility Study. The Technical Report is an engineering document designed to assess the mineral resources of the ICP and evaluate, among other things, the economic parameters of the deposit for potential financiers for the purpose of securing funds for mine development. The National Pollution Discharge Elimination System ( NPDES ) permit became effective in March 2009, and the Record of Decision ( ROD ) for the Mine Plan of Operation was upheld in April In December 2009, the Company announced it received approval from the United States Department of Agriculture Forest Service, the lead permitting agency for the ICP, to begin construction of the ICP. Stage I construction was concluded in April of Stage I consisted primarily of clearing timber from the site in preparation for laying the foundations to be used for the mine site structures. These structures include the crusher building, concentrator building and the tailings and waste rock storage facility. During the quarter, management secured $80 million in an equity financing that closed on March 10, 2011 to proceed with Stage II construction of the ICP. BNP Paribas Securities Corp. ( BNP Paribas ) is acting as the lead arranger for a senior secured debt facility and is expected to provide the Company with a form of credit facility to back proceeds of US$77.7 million generated through the sale of tax exempt industrial bonds issued by the State of Idaho in support of the ICP. Once the ICP is in operation, currently targeted for the second calendar quarter of 2012, the Company will be the United States sole integrated primary cobalt miner and refiner of superalloy grade HPC metal. 1

38 1.2.2 Highlights for Quarter ended May 31, 2011 Idaho Cobalt Project Concluded an $80 million Equity Financing for ICP JDS Energy & Mining Inc. Construction Managers fully integrated into ICP operations Sunshine Precious Metals Refinery: Processed 2,311 Ounces of Gold Processed 1,315,266 Ounces of Silver Other Projects: Acquired Core Central Land Package on Mexican El Milagro Silver / Lead / Zinc Project Continued Positive Results from Virgin River Uranium Project with $3 Million Drill Program Planned for 2011 Corporate: Extended 2,493,447 Warrants Exercisable at $2.80 to May 2, 2012 Full settlement of $8 Million Unsecured Convertible Debenture Adopted and began reporting in accordance with International Financial Reporting Standards ( IFRS ) Subsequent to the End of the Quarter: Stage II Construction on ICP Commences with Earthworks Contractor Mobilized for Road Upgrades Risk Management The nature of the mining industry involves significant risks. Even with the Company s careful evaluation of its mineral resources using in-depth experience and knowledge, these risks may not be completely eliminated. As such, it is impossible to guarantee that current or future exploration programs will establish additional mineable reserves. Historically, the values of mine ores and market prices of the commodities being explored have been highly volatile. To lessen the exposure to risk, the Company routinely engages numerous, highly qualified independent professional consultants to continually re-evaluate its mineral properties. The status of world economies and financial markets, environmental legislation, and government regulation, all have significant impact on the industry. The Company cannot forecast the status of future financial markets nor predict government policies and legislation as such applies to the resource sector. In addition, as the mining industry rapidly moves towards higher sustainable development and environmental standards, the Company continues to work toward maintaining or surpassing these elevated standards of sustainability and corporate social responsibility. Insurance is very costly in this industry due to unforeseen mining and environmental risks such as cave-ins, fire and flooding. It is not always possible to insure against such risks and the Company may decide not to insure as a result of excessively high premiums or other reasons making insurance impractical. The Company believes in the right of all individuals, including visitors, to a safe work environment and employs policies and procedures to provide effective control measures and personal awareness of the risks involved in daily activities Basis of Analysis The sections that follow provide information about the important aspects of our operations and investments, on a consolidated basis, and include discussions of our results of operations, financial position and sources and uses of cash, as well as significant future commitments. In addition, we have highlighted key trends and uncertainties to the extent practical. 2

39 The content and organization of the financial and non-financial data presented in these sections are consistent with information used by our chief operating decision makers for, among other purposes, evaluating performance and allocating resources. The following discussion should be read in conjunction with the Company s audited consolidated financial statements for the period ended February 28, 2011 and notes thereto. As part of our decision-making process we monitor many economic indicators, especially those most closely related to the demand, supply and pricing of metals, as well as the politico-economic situation in the main commodity supplier and consumer countries. Political developments affecting metal production can change quickly in some of the major cobalt producing countries such as the Democratic Republic of Congo, Zambia, Cuba, Russia, and in particular, those countries that are currently coping with armed conflicts. While most economic indicators impact our operations to some degree, we are especially sensitive to capital spending in cobalt intensive industries such as the re-chargeable battery sector, aerospace, hightech, medical prosthetics, industrial, high-temperature steels and environmental applications such as gas and coal to liquids processes, oil desulphurization, wind turbine generators and hybrid-electric vehicles. We also monitor cobalt related consumption expenditures on such items as computers, cell phones, paints and cutting steels Property Activities The Company holds mineral exploration properties in Canada, the United States and Mexico. The Company s 100% owned subsidiary Essential Metals Corporation is engaged in the operation of a precious metals refining business located in the State of Idaho. The Company conducts its exploration independently as well as through joint venture agreements with third parties. The following is a brief discussion of the Company s major mineral exploration and development projects: (a) Idaho Cobalt Project Idaho, USA The Company s principal property is the 100% owned Idaho Cobalt Project, a primary cobalt deposit located in Lemhi County, Idaho, acquired through staking in The property is held by the Company s 100% owned subsidiary Formation Capital Corporation, U.S. and has been extensively explored, developed to a positive feasibility stage and is fully environmentally permitted. Stage I Construction was completed during the first quarter of the previous fiscal year. Stage II construction commenced subsequent to the end of the fiscal quarter with the mobilization of earthworks equipment and the initiation of road upgrades in mid June, As at the filing of this report, access road upgrades are nearing completion and the commencement of mine site construction earthworks is imminent. The project covers an area of approximately 4,080 acres and includes 241 mining claims. The Company has exercised its lease option agreement and now owns a 100% interest in these claims. This project is not subject to any net smelter return or any other royalty payments. In December 2009, the Company and the United States Department of Agriculture Forest Service signed the Forest Service Evaluation which approved and finalized the Company s Mine Plan of Operations for the ICP. The approval and finalization of the Company s Mine Plan of Operations allowed the Company to commence Stage I Construction on the ICP. The Company is in the process of securing final financing for the continued construction and development of the ICP. Stage I Construction consisted of timber clearing for the crusher and concentrator site, tailings and waste rock storage facility, topsoil stock pile area and road areas around the mill site. Stage II Construction involves access road upgrades, currently nearing completion, mine site facility construction and mine development. Stage III Construction allows for mine development of workings below the water table and is not expected to commence for several months. In June of 2010, the Company signed a Powerline Right of Way and Use Agreement with Noranda Mining Inc. and Intalco Aluminum Corporation, to provide power for use by the Company in its operations relating to the ICP. In September 2010, the Company announced it received two Certificates of Allocation from the State of Idaho authorizing a total of US$46.7 million in Stimulus Act Recovery Zone Facility Bonds to the Company as ultimate beneficiary to be issued by the Industrial Development Corporation of Lemhi County, Idaho and the Industrial Development Corporation of Shoshone County, Idaho. 3

40 In December 2010, the Company was issued revised Certificates of Allocation from the State of Idaho authorizing an additional US$31.0 million apart from the previously issued US$46.7 million in Federal Stimulus Program Recovery Zone Facility Bonds. As a result, the Company s wholly owned subsidiaries, Formation Capital Corporation, U.S. and Essential Metals Corporation, are the sole beneficiaries of US$77.7 million in Federal Stimulus Program Recovery Zone Facility Bonds. The interest rate on the bonds is benchmarked with the Securities Industry and Financial Markets Association ( SIMFA ) Municipal Swap Index. These tax exempt industrial facility bonds were sold to the public prior to their December 31, 2010 expiry date and the funds were placed in a trust account until such time as the Company secures a bank letter of credit, or other type of guarantee securing the debt, at which time the Company will gain access to the funds. In addition, the Company placed US$1,038,280 into a restricted cash bank account to guarantee the interest and costs associated with the issued bonds. Subsequent to the end of the quarter, and by mutual agreement, interest was paid up to July 5, 2011 and the new amount of US$803,704 was placed in the restricted cash bank account to cover the extended interest and associated costs until October 6, 2011, or until such time as a bank letter of credit or guarantee is obtained. If such a guarantee is not obtained the trust proceeds will be repaid to the holders of the bonds. The funds received from the sale of the tax exempt bonds will be used to develop the Company's cobalt mine located in Lemhi County and to retro-fit its hydrometallurgical facility located in Shoshone County, Idaho. The Company also announced in September 2010, that it was in the process of finalizing the amount of the ICP capital costs eligible for financing with Solid Waste Private Activity Bonds ( SWBs ). This amount is expected to be US$45.4 million. In addition to the guarantee supporting the Recovery Zone Bonds, a guarantee must also be secured to support the SWBs. Once guarantees are secured for both types of bonds, it is expected that the Company will apply to the State for allocation in connection with the SWBs. The SWB s do not have an expiry date and have an expenditure look back period of 18 months from end of construction. The Company engaged Thornton Farish Inc, bond brokers and investment advisors, as the underwriter for the recovery zone facility and solid waste bonds. Thornton Farish is widely recognized as one of the early pioneers of industrial revenue bond financing. The firm has extensive expertise and experience in all forms of tax-exempt bond financing, particularly with solid waste financing in many industrial and agricultural sectors. In addition, the Company also mandated BNP Paribas to act as sole Mandated Lead Arranger and bookrunner for a senior secured debt facility (the Facility ) for the construction and operation of the ICP. Based on an indicative term sheet negotiated between BNP Paribas and the Company through its financial advisor, Auramet Trading, LLC, the Facility may take the form of an amortizing construction / term loan or Letter of Credit supporting the issuance of the aforementioned tax exempt industrial facility bonds. The establishment of the Facility remains subject to, amongst other things, customary due diligence by the lenders, currently in progress, and credit approval. BNP Paribas is rated AA by Standard & Poor's and is the largest bank in the eurozone by deposits. With operations in 85 countries, BNP Paribas provides a full range of product and distribution capabilities, including a dedicated group specializing in providing debt solutions to the energy, metals and mining industries for project and structured finance. BNP Paribas is a market leader in global project finance and mine project finance, with a global syndication capability. In December 2010, BNP Paribas chose Micon International Limited ( Micon ), through a selective bid process, to act as Independent Technical Engineer to provide the necessary due diligence technical reviews required for the Company s ICP debt financing. Micon commenced work with the assembly of a team of experts specifically selected to address all of the important aspects of the ICP. A due diligence technical review meeting and the preliminary site inspection took place in December of Micon continues to work closely with the Company s Construction Manager JDS Energy and Mining Inc. ( JDS ) and in house engineers. Management has been advised they anticipate the final report in a matter of weeks. Early in the calendar year, the Company signed a Letter of Intent with JDS for Project and Construction Management services for the ICP. JDS is working on a target based project risk/reward basis that includes an on-budget, on schedule and no harm execution accountability. Project development includes comprehensive overall project design and execution review to enhance the ICP (now complete), detailed design, procurement and contract execution and construction management through to commissioning and handover. In the previous fiscal quarter, drill assays results from the ICP confirmed economic ore grade mineralization in an additional 390 feet along strike to the south and 200 feet down dip, representing a 14% increase in the known strike extension of the Ram deposit to 3,200 feet. These results are expected to increase the reserve / resource base and mine life of the project. A total of 5,727.5 feet were drilled in six holes in a previously untested area along the southern extension of the Ram deposit. 4

41 During the quarter, the Company completed a fully subscribed equity financing (the "Financing") originally announced on January 27, 2011 for gross proceeds of $80.0 million. The Financing was sold in all of the provinces of Canada, except Québec, and certain offshore jurisdictions and consisted of Units priced at $1.50 per Unit. Each Unit is comprised of one common share in the capital of the Company (a "Common Share") and one half of one Common Share purchase warrant. Each whole Common Share purchase warrant (a "Warrant") entitles the holder to purchase one Common Share for 36 months at a price of $2.00. The Company's Common Shares currently trade on the Toronto Stock Exchange under the symbol "FCO" and the Warrants trade on the Toronto Stock Exchange under the symbol "FCO.WT". The Financing was conducted on a best efforts agency basis by a syndicate co-led by Byron Securities Limited and Cormark Securities Inc. and also included Jennings Capital Inc. (collectively, the "Agents"). The Agents were granted an option, exercisable at any time for a period of 30 days, to purchase additional Units equal to 15% of the number of Units sold pursuant to the offering at the issue price of the Units, to cover over-allotments, if any and for market stabilization purposes. No portion of this option was exercised by the Agents. In consideration for the services rendered by the Agents under the offering, the Agents received a cash commission of 6% of the gross proceeds of the Offering and received broker warrants to purchase an aggregate number of Common Shares equal to 6% of the number of Units issued under the offering, at a purchase price of $1.50 for a period of 24 months. Concurrent with the close of the Financing, the Company repaid the balance owing of $7.0 million on the $8.0 million unsecured convertible debenture (the "Debenture") issued to Coalcorp Mining Inc. ("Coalcorp") on May 7, The Debenture was repaid through a mutually agreed cash and share settlement in the amount of $9.33 million in cash for the unsecured debenture balance and any accrued and unpaid interest and 400,000 common shares issued at market value of $1.25 per share. The successful conclusion of the $80.0 million equity financing has allowed the Company to commence Stage II Construction. The completion of construction is estimated to take between 12 and 14 months, after which initial production of HPC metal could commence. According to the Company s independent Technical Report completed in 2007, the amount of financing required to complete the ICP construction was estimated to be US$138.7 million. This figure did not include the post reclamation financial assurance (bonds) for both surface disturbance reclamation and long-term water treatment. More recent internal estimates by management in coordination with JDS places the figure at US$141.9 million, which takes into account the bonding requirements and previous equipment purchases. Since completion of the 2007 Technical Report, the Mine Plan has been re-engineered and optimized to maximize the extraction of the highest grade ore material in the shortest possible time frame in order to provide an optimized cash flow scenario in the early years of mine life. This has resulted in a re-positioning of the portal bench and other engineering modifications associated with this re-positioning. This has not materially changed capital costs but has made the operation more streamlined. The approval of the Plan of Operations for the Idaho Cobalt Project by the U.S. Forest Service outlines a 5-stage approach for posting the bonds that is coordinated with the development and operation of the Idaho Cobalt Project. Stages I and II pertain to all surface disturbance activities including Phase I of the tailings and waste rock storage facility expansion schedule (operational years approximately 1-6). The total bond requirement for Stages I and II is approximately US$6.3 million. Presently, US$622,226 has been posted for Stage I (i.e., site clearing) activities which were completed in April Subsequent to the end of the quarter, US$2,232,866 in cash was posted to secure a reclamation surety bond in the amount of approximately US$6.3 million, in conjunction with the commencement of Stage II construction. As at the filing of this report, the access road upgrade segment of Stage II Construction is nearing completion and the commencement of mine site earthworks is imminent. Such work is expected to commence with portal bench access construction, followed by concurrent mill and concentrator site earthworks. Subsequent to the end of the quarter, the mine site earthworks bidding analysis was completed with the contract awarded to Dahle Construction of Salmon, Idaho. Dahle Construction is currently crushing surface material in Blackbird Pit for Panther Creek Road improvements while surveyors are completing final survey volumes for Williams Creek Road, while JDS is reviewing the earthworks quantities of materials required to reduce time schedules and cost. In conjunction with the increased traffic and earthworks equipment arriving at the mine site, the Company has implemented a security check point at the entrance to the mine site access gate. A powerline construction bid walk is scheduled for July 15, 2011, with bid submittals deadline set for July 21, Ongoing engineering continues to proceed with the modified portal bench design report submitted for agency review, 69 kv power line design complete and issued for bid, and the tram engineering re-alignment is now complete and is ready for survey and final confirmation. 5

42 The paste backfill design is still in process. Micon Engineering due diligence final technical inquiries were completed in the beginning of June, 2011, concluding the technical portion and JDS assistance in Micon s due diligence. At the cobalt production facility outside of Kellogg Idaho, where ICP concentrate is to be processed into high purity end product metals, progress during the quarter concentrated on process design, building design, and commencement of equipment specification preparation and bidding activities. Subsequent to the end of the quarter, the mass balance engineering was advanced to the point that equipment sizing and specification development could proceed. Additionally, the process design basis was advanced concurrent with the modeling. According to current JDS progress reports, it is anticipated that the process design will be essentially complete before the end of July, With the process flowsheet established, the cobalt production facility building size was finalized and preliminary concrete foundation drawings have been prepared. The building request for proposal package (design/supply/install) was sent to several vendors with a bid closing date of later in July, Provided there are no delays in obtaining a building permit, it is anticipated that ground breaking at the refinery could commence the second half of August, 2011, with building erection starting late September. Stage III includes posting the bond for long-term water treatment prior to mine development below the water table. The amount of the Stage III bond was previously determined by the Forest Service at approximately US$20.6 million; however, the Company successfully appealed this decision and is currently working with the Forest Service to determine the appropriate discount rate for use in calculating the bond for Stage III. Stage IV and Stage V correspond with Phases II and III of the tailings and waste rock storage facility expansion schedule (operational years approximately 7-10) and amount to approximately US$1.9 million, and US$0.8 million, respectively. The Company has been in discussions with an insurance broker and anticipates the actual cost for surface disturbance bonding will be approximately US$4.8 million, of which only US$2.4 million for Phase 1 is required to cover the first 6 years. Similarly, from these discussions, the Company anticipates the cost of the long-term water treatment bonding will be approximately US$7.2 million. Previous exploration and development drilling demonstrated that the permissive sequence for cobaltiferous mineralization in the Ram deposit remains open at both the north and south ends along strike and remains open down dip. This represents a currently defined strike length of approximately 3,200 feet. A 6,000 foot diamond drill program was initiated in late July, 2010 in a previously untested area on the ICP and concluded in October, 2010 with final assay results released in January, The data from this verification drill program has provided information needed to optimize mine design and production plans and has been used to maximize ore production as early in mine life as possible. In addition, the program also provided material for initial metallurgical test work to assist in determining the economic viability of extracting the heavy Rare Earth Elements ( REE s ) and gold that are known to occur on the property. Additional material for follow-up metallurgical testing will be obtained once underground operations commence. Potential revenue from the production of REE s and gold was not included in the Company s Technical Report. The aforementioned SEDAR filed Technical Report, derived from the more comprehensive Bankable Feasibility Study, revealed the conservative base case scenario utilizing a 7.5% discount rate and utilizing a US$22.52 per pound high purity cobalt metal price, returned a pre-tax Net Present Value ( NPV ) of US$87.29 million with an Internal Rate of Return ( IRR ) of 22.30%. Mining methods are being modified to reduce construction and operating costs improving the NPV and IRR. Capital costs may be further reduced during detailed engineering and re-assessment of capital expenditures as the prices of several inputs have decreased since the Technical Report was completed prior to the onset of the world financial crisis. These optimization studies are ongoing. Prior to the completion of the Technical Report, an updated resource estimate was completed by Mine Development & Associates (MDA) in October of 2006 and is summarized in the following table. Total Cobalt Project Resource utilizing 0.2% cut-off: Category Tons % Cobalt % Copper Oz/ton Gold Measured ( M ) 1,840, Indicated ( I ) 813, Total M&I 2,654, Inferred 1,121, M&I Contained Metal 33.3 million lbs 32.9 million lbs 41,000 Oz Inferred Contained Metal 13.1 million lbs 17.8 million lbs 19,000 Oz 6

43 The resource estimate was prepared in conformance with the requirements set out in the Standards of Disclosure for Mineral Projects defined by National Instrument , under the direction of Mr. Neil Prenn, P.Eng., a Principal of MDA, who is an independent Qualified Person as defined by National Instrument This report was SEDAR filed on November 03, The proven and probable mineral reserves outlined in the Technical Report are 2,636,200 tons with an average grade of 0.559% cobalt, 0.596% copper and oz per ton gold, based on a cut off grade of 0.2% cobalt for a ten year mine life. The inferred resource for the ICP, not a part of this study, is 1,121,600 tons grading 0.585% cobalt, 0.794% copper and oz per ton gold as reported in the October 2006 MDA report mentioned above. A draft Environmental Impact Statement ( EIS ) was made available to the public on February 23, On May 24, 2007, the public comment period for the draft EIS on the ICP concluded. The comments revealed strong support for the project with greater than 90% of the respondents in favour of the mine. Pursuant to the January 2009 Record of Decision, the Company must provide a water management plan which includes provisions to demonstrate that construction phase sediments will not be captured by third party facilities unless agreements are in place with third parties to utilize those facilities. To comply with this requirement, the Company is currently resurfacing all roads and installing Best Management Practices. Best Management Practices are generally-accepted, informally-standardized techniques, methods or processes that have proven themselves over time to optimally accomplish given tasks. For project access and site roads, these Best Management Practices refer to sediment control devices. This will result in an immediate reduction in sediment load to area drainages. In addition, the intelligent sequencing of construction and implementation of requisite Best Management Practices will manage sediment production and release. These provisions are designed to demonstrate that construction phase sediments will not be captured by any third party facilities. Current estimates indicate that the total remaining capitalization expenditures for the ICP are expected to be on the order of US$141.9 million which includes the reclamation bonding costs. This new cost estimation consists of US$88.4 million for the mine concentrator, infrastructure and bonding, and US$53.6 million for the retrofitting of the hydrometallurgical plant. These costs include mechanical and electrical equipment, construction materials, labor and labor supervision, and contracted direct and indirect costs for these facilities. Approximately US$17.0 million has been incurred in securing the delivery of long lead time items for the mine site that are currently being stored in a company owned facility and in a nearby leased storage facility outside of the town of Salmon, Idaho. The 9,600 square foot company facility is located on a 3 acre lot on the outskirts of Salmon, Idaho. The company facility will also act as a staging area for the transportation of mine employees to and from the mine site, as well as an offloading area for mine concentrate for transportation to the Company s hydrometallurgical facility located in northern Idaho. Mine equipment stored at the staging areas include ball mill components, flotation cells, power transformer, bridge crane, vibratory feeders, crusher and concentrator building components, cyclone package and the aerial tram towers, cables, drive system, bucket and tram loading and discharge terminals. The equipment will be used to process primary cobalt ore at a production rate of 800 tons per day at the cobalt mine site. Concentrate from the mine will be shipped to the Company s 100% owned hydrometallurgical facility in northern Idaho for processing into high purity, superalloy grade cobalt metal at a design rate of approximately 1,500 tons per year on average over a minimum 10 year mine life. The mine life is expected to be longer than the minimum ten years outlined in the Technical Report, as the primary deposit remains open along both strike directions and at depth and including inferred material would add an additional 4 years to the mine life. In addition, numerous other targets remain to be explored and developed on the property. Access road upgrades are currently in progress with the Company and JDS actively preparing for earthworks construction at the mine site itself and at the cobalt production facility. Pre-bid qualification meetings were held during the quarter with 19 contractors in the area to ensure that the Company fulfils its mandate to hire locally whenever possible. There are 7 engineering companies fully engaged and working on finalizing different aspects of the engineering plans for the mine and the cobalt production facility. This includes engineering work on site, roads, portal bench, tram layout revisions, power line layout, tailings and waste rock storage facility final design and concentrator site layout and design. 7

44 An intensive hiring program is underway for both locations and includes professional recruitment campaigns for more senior positions and advertising with employment agencies and / or employment websites for staff positions. There is a local qualified workforce in both the Salmon and Kellogg areas to draw from and we expect to fill our labour needs without serious difficulty. Between now and October 2012, the Company expects to hire a total of 52 employees for the Salmon operation and an additional 41 employees for the Kellogg facility totaling 93 new jobs in Lemhi and Shoshone Counties, Idaho. These additional jobs are expected to have a very positive impact on both local economies. Once operational, the ICP would be the only primary cobalt producer in the Western Hemisphere making Formation Metals Inc. the United States sole integrated cobalt miner and refiner of high purity, superalloy grade cobalt. Once in full production, the project would create approximately 200 well paying jobs in two Idaho counties. (b) Essential Metals Corporation ( EMC ) Idaho, USA Big Creek Hydrometallurgical Complex (the Complex ) and the Sunshine Precious Metals Refinery EMC acquired the Complex in 2002 for the purpose of retrofitting the hydrometallurgical facility for cobalt production to meet the processing requirements of the ICP. In 2004, management restarted the precious metals refining section of the facility, known as the Sunshine Precious Metals Refinery, to help meet increasing North American demand for silver and gold refining. EMC now receives commercial quantities of product from several major customers and continues to grow this division of its business. The refinery is a zero liquid discharge operation and as such management has ascertained through consultation with legal counsel and environmental experts that there are no legal requirements related to reclamation of real property upon temporary shut down or closure of the refinery. EMC has been receiving silver doré from major silver producers, high grade silver products from silver users, mints and from other sources. Silver produced by the refinery is accepted for good delivery on both the Dubai Multi Commodities Centre and the Dubai Gold and Commodities Exchange. Prior to and during the first fiscal quarter, JDS concentrated its efforts on finalizing budgets and engineering and procurement tasks involving several areas at the cobalt production facility. Engineering emphasis continued on flowsheet development and refinements to the heat and water balances. Specifications for the cobalt production facility as well as initial equipment sizing and layout design are underway. The planned cobalt production facility building and the existing refinery building collectively comprise the Big Creek Hydrometallurgical Complex. EMC operations include the Sunshine Precious Metals Refinery, the solvent extraction electro-winning ( SX-EW ) copper plant, the hydrometallurgical plant, the concentrate loading and unloading facility and the associated land package and buildings. In addition to retro-fitting the hydrometallurgical complex, the Company is also retro-fitting the SX-EW copper plant in conjunction with the development of the ICP in order to process the cobalt-copper-gold concentrate expected to be produced from the project into high purity base and precious metal end products. The Company s refinery operations currently generate revenue from both toll material and purchased material. The Company s principal objective is to generate revenue from toll material; however, given the value of the precious metals being refined, credit conditions have on occasion required the Company to purchase the material from customers. Toll material fees vary by customer and can consist of straight fees and/or retainage, (the retention of some of the refined product). Purchased material generally has a similar value attributed to the refining process as toll but requires the recognition of the sale at the gross value in accordance with generally accepted accounting principles. From time to time the Company enters into forward sale contracts in those situations where it does purchase material to eliminate exposure to silver and gold price fluctuations. (c) Black Pine Idaho, USA The Company has a 100% interest in certain mineral claims with prospects for copper, cobalt and gold located in Lemhi County, Idaho. An option agreement is in effect until the year 2014 to share on a 50/50 basis with the optionor any payments received from a joint venture partner. (d) Badger Basin Idaho, USA The Company has a 100% interest in certain mineral claims acquired through staking with prospects for copper and cobalt located in Lemhi County, Idaho. 8

45 (e) Morning Glory Idaho, USA The Company has a 100% interest in certain mineral claims with prospects for gold and silver located in Lemhi County, Idaho. The Company also has a 100% lease option on certain additional mineral claims located in the same area. A total of US$45,900 ( US$45,900) has been paid to date to the optionor. To exercise the option, the Company must pay a total purchase price of US$1,000,000 including the advance annual minimum royalty payments. (f) Queen of the Hills Idaho, USA The Company holds a lease option to purchase 100% of certain mineral claims with prospects for gold and silver located in Lemhi County, Idaho. A total of US$25,200 ( US$25,200) has been paid to date to the optionor. Total purchase price of US$1,000,000 including advance payments must be made to exercise the option. (g) Wallace Creek Idaho, USA The Company has a 100% interest in certain mineral claims with prospects for gold and silver located in Lemhi County, Idaho. The Company also has a 100% lease option on certain additional mineral claims located in the same area. To exercise the option, the Company must pay a total purchase price of US$1,000,000 of which US$25,600 has been paid to date. (h) El Milagro Mexico The Company entered into a purchase option agreement in 1998 that was completed at year end February 28, The Company now has a 100% interest in the prospective silver rich base metal property. The primary target defined within the Milagro Concessions is the Santa Maria Vein, a 1-4 meter wide tabular subvertical NNE trending breccias vein that has been mapped over a strike length of 450 meters, with a lead-rich polymetallic assemblage and bonanza silver grades. This vein, localized along the footwall contact of a sericite altered dike, is cemented by a fine grained intergrowth of galena, sphalerite, pyrite, barite and manganese oxides. Silver grades in the sulphitic vein material have been reported in the range of 1.5 to 5.5 kg per tonne (Tschauder, 1988). The Company recently embarked on a strategic land acquisition program that has complemented the existing core land holdings of the El Milagro project. These additional holding cover the extension of the Santa Maria Vein occurrence and it is management s intention to further pursue exploration of this project over the course of the current fiscal year. Prior to the recent land acquisition, the El Milagro project had essentially been maintained in a care and maintenance status for a number of years. As a result, an impairment analysis conducted by management resulted in a write down of the project for financial statement purposes amounting to $348,535 for the year ended February 28, It has been reported to management that the Mexican Government intends to establish a Protected National Area in the general area that encompasses the Milagro project. The Company has been advised by its legal council that this new designation will involve additional environmental scrutiny by Mexican permitting authorities, but in no way precludes the exploration, development and mining of minerals from the property. The permitting of the project is not expected to be any more onerous than what the Company s internal environmental standards and guidelines require and what it has already experienced and is familiar with during the exploration and development of its other mineral projects. The Company intends to further evaluate the mineral occurrences on the property and define targets for further development. (i) Compass Lake Saskatchewan, Canada The Company owns 100% of the prospective gold property. A helicopter-borne aerotem IV electromagnetic and magnetometer survey has been completed on the project. Results from the survey will be used to determine targets for exploration and drill target evaluation. (j) Kernaghan Lake / Bell Saskatchewan, Canada The Company granted an option whereby the optionee has earned 80% interest in certain mineral claims by making certain payments (received), and completing exploration work totaling $1,000,000 (deemed completed). The project area is located near the northeast rim of the Athabasca Basin approximately 42 km north of Points North Landing. The Kernaghan / Bell project currently consists of 13 mineral claims totaling 4,342 hectares. The target unconformity depth ranges from 160m to 290m. To date 38 diamond drill holes within the property outline totaling 10,051.4m have been drilled targeting the unconformity. 9

46 The completed drilling for the 2009 program consisted of 8 drill holes, KB04 through KB11, totaling 2,683.4m. Geochemical analyses were received for basement systematic and selective samples collected for drill holes KB-04 to KB-11. These samples returned anomalous uranium intersections with a maximum partial uranium value returned from Ker A Conductor in drill hole KB-11 of 160 ppm and a maximum partial uranium value returned from K 1 Conductor in drill hole KB-07 of 34.2 ppm, none of the holes drilled in 2009 intersected significant uranium mineralization. A Geochemical Compilation Report was sent out to joint venture partners and filed for assessment credit. Approval of the assessment filing will keep the project land in good standing until There is no proposed budget for field work for (k) Virgin River Saskatchewan, Canada In the year ended February 28, 1999, the Company entered into a joint exploration agreement with UEM Inc. UEM Inc. was a corporation owned 50% by Cameco Corporation ( Cameco ) and 50% by AREVA on the Virgin River project located in the Athabasca Basin of northern Saskatchewan. Subsequently, UEM was dissolved and both Cameco and AREVA became equal partners (49% each) in the joint exploration agreement. Cameco is the operator of the project. The Company s wholly owned subsidiary, Coronation Mines Ltd. owns the remaining 2% of the project with the first right of offer to acquire up to 10% of the project and has been carried through to $10.0 million worth of exploration and development. Over $26.8 million has been spent on the project to date exploring for a large unconformity-type deposit that has resulted in the discovery of the Centennial Deposit. The Centennial Deposit has been traced over 650 metres of strike length and has a minimum across strike width ranging from 10.0 metres to 52.5 metres. Approximately $8.9 million was reported by Cameco as having been spent on the 2009 and 2010 drill programs that were designed to follow up on the drill results from the Centennial Zone. The joint venture has approved a budget of $3.0 million for continued drilling on the Virgin River project for 2011, currently underway.. The 2011 drill program will utilize two drill rigs on and immediately surrounding the current extent of the Centennial deposit with a focus on extending the deposit along strike to both the north and south. High grade U 3 O 8 intersections of up to 298 GT have been intersected within the deposit. GT is defined as % grade U 3 O 8 multiplied by thickness in metres. A total of 8,562.6 metres were drilled in 2010 in five pilot diamond drill holes and in fourteen diamond drill directional off cut holes. A location map of the drill holes with GT values is available on the Company s website at Results from the 2010 program included high-grade mineralization intersected in drill hole VR-040W2 (8.40% U 3 O 8 over 9.0 metres) collared on Line ( L ) 6+50N and drill hole VR029W2 (7.46% U 3 O 8 over 13.2 metres) on L7+00N in the southern portion of the Centennial Deposit. Drill holes VR-042-W1 and W4 returned assay results of 1.93% U 3 O 8 over 8.3 metres and 0.15% U 3 O 8 over 6.5 metres respectively. Initially interpreted to represent a separate zone of mineralization paralleling the Centennial Deposit to the east, the additional results obtained from the drilling of this mineralized structure remains inconclusive and further drill testing along strike is planned for the 2011 drill program. Drilling was also successful in tracing the faulted quartzite controlling structure on the Centennial deposit along strike to the north of L13+00N and south of L6+00N. Drill hole VR-038W3, located on L10+00N, tested for the presence of an interpreted cross structure associated with the mineralization present on L10+50N where a previously drilled, single off cut diamond drill hole, VR-031W3, returned high grade uranium mineralization of 8.78 % U 3 O 8 over 33.9 metres. Diamond drill programs from 2004 to 2010 on the Centennial Zone have resulted in 35 significant primary uranium intersections returning results greater than 10.0 GT (see table on the following page). 10

47 Significant diamond drill results greater than 10.0 GT from the Centennial Deposit (updated) Max Grade Avg Grade DDH Depth Depth Thickness GT From (m) To (m) (m) (%U 3 O 8 ) (%U 3 O 8 ) (mx%) VR VR-018W VR VR-021W VR VR-022W VR VR VR-027W VR-027W VR-027W VR-027W VR-029W VR-029W VR VR-031W VR-031W VR-031W VR-031W VR-031W VR-032RW VR VR-033W VR-033W VR VR VR-036W VR-036W VR-036W VR VR-037W VR-037W VR-038W VR-040W VR-042W Note: Inductively Coupled Plasma - Optical Emission Spectroscopy Split assay results with core recovery intervals of less than 75% were replaced by shielded probe results. Cameco has indicated they are exploring for a McArthur River style uranium deposit, and Formation Metals management is very encouraged with results to date. All uranium assays were carried out by the Saskatchewan Research Council (SRC) of Saskatoon, Saskatchewan. Delayed neutron counting (DNC) and / or X-ray fluorescence spectroscopy (XRF) U 3 O 8 check assays were completed on all split assay samples returning greater than 1.0% U 3 O 8. The average of the check assays and the ICP-OES results were used in the calculations of grade thicknesses. Mr. Eric (Rick) Honsinger, P.Geo., of Formation Metals Inc., is the Qualified Person who has reviewed and approved the information in this MD&A with respect to the Virgin River Project based on an examination of the data submitted to the Company by the project operator Cameco Corporation. 11

48 (l) Other Projects The Company has varying other interests of up to 100% in certain mineral claims located in Idaho, Saskatchewan and Manitoba Outlook In the coming quarter, the Company expects to focus its activities on completing the debt portion of funding for project financing and the commencing of Stage II Construction of the ICP mine. Financing efforts include securing a credit facility for issued tax exempt industrial bonds, securing off-take, and/or other means deemed reasonable by management. In addition, the Company will continue to seek opportunities to form additional exploration joint ventures in order to reduce shareholder risk. As a mineral exploration and development company, the future liquidity of the Company will be affected principally by the level of exploration and development expenditures and by its ability to raise capital in the equity markets. Pending commercial production from the ICP, the ability of the Company to effectively manage the mine and the hydrometallurgical complex will become the primary criterion for profitability. Until the debt portion of the financing has been secured, the Company s current cash position is not sufficient to fund capitalization expenditures for the completion of construction of the mine, mill and retrofitting of the hydrometallurgical complex. During the most recently completed quarter, the Company s closing share price ranged from a high of $1.56 at the beginning of the quarter to a low of $0.96 in mid May. Over the past several weeks the share prices has consistently closed at or very near $1.00 in response to weak summer markets and overall uncertainty in the equity markets caused by political and economic turmoil in numerous countries around the globe. Figure 1: Formation Metals Share Price, March 1, 2011 July 15, 2011 Outlook for the Cobalt Market Fiscal 2010 and 2011 have been less turbulent than previous years for many metal prices including cobalt. High purity cobalt rose to nearly US$52/lb in early 2008 and subsequently fell to approximately US$17/lb where it bottomed. During 2010 cobalt prices started the year around US$24/lb, softened to around US$19.50/lb in March then rose to near US$25/lb in April. Average prices then remained in a narrow trading range between US$21/lb and US$22/lb until late in the year. Average prices during 2011 have traded in a range between US$17.50/lb and US$21/lb. The crisis in the financial markets caused significant damage throughout the world but most analysts believe that the remaining effects should only impact markets in the short term. The mid to long term outlook for the cobalt market is expected to remain strong through 2013 and beyond with demand for all types of cobalt (including treatment of intermediates, and recycled scrap) by some market participants projected to exceed 90,000 tonnes by The unfortunate Japanese earthquake and tsunami have slowed some cobalt end markets especially those related to the rechargeable battery and automotive sectors, however the impacts are not expected to be long lasting. 12

49 The Cobalt Development Institute (CDI) estimates, from companies that report to them, that refined cobalt production for 2010 was approximately 76,363 tonnes; however, these estimates do not include production of refined cobalt from companies treating various cobalt-containing intermediate products and scrap who do not report their numbers to the CDI. There is significant potential new cobalt production that could come from the Democratic Republic of Congo (DRC) and various nickel laterite projects; however, many of the nickel laterite projects have been delayed, have suffered massive cost over-runs or have been placed on hold. Many analysts in the industry still have concerns about the viability and reliability of the new nickel laterite projects. In addition, the bulk of this possible new production will be in the form of mixed sulfide concentrate, impure cobalt chemicals and low-mid grade metal that will, in many cases, require additional processing. Very little, if any, of this potential new production is expected to be in the form of high purity cobalt metal. In recent years there has been significant cost pressure in the production of cobalt with CRU Strategies (UK) in past years projecting that long run marginal costs would soon be exceeding US$14/lb. Projected increased consumption is due primarily to growing demands in the aerospace, catalyst and rechargeable battery sectors. This is spurred on, in large part, despite the world financial crisis, by the rapid modernization and GDP growth of China and India, utilization of new energy sources and new environmental considerations such as the widespread adoption of hybrid electric vehicles, adoption of land based turbine electrical power generation from natural gas, and a desire for more fuel efficient aircraft engines. Several potential new cobalt applications were announced over the course of the previous year, including some exciting potential uses to advance solar energy viability and reduce current costs. Figure 2 below outlines cobalt consumption by end use for Figure 2: Cobalt Consumption by End Use. Source CDI 2009 The United States remains the primary consumer of superalloy grade cobalt for the aerospace, land based turbine, medical prosthetic and rechargeable battery industries. Jet aircraft in the aerospace industry require high purity cobalt metal that is suitable for critical applications in the superalloy sector. Apart from US demand, China is projected, by major players in the aerospace industry, to require 2,600 new commercial jet aircraft worth over US$280 billion over the next 20 years while India is projected to require over 900 jets worth over US$100 billion during the same period. By 2026, an additional 29,000 new aircraft are expected to be required to replace aging fleet craft (10,400 aircraft) and keep up with new demand (18,600 aircraft). In April 2009, Boeing s chief executive said that the economic slump that occurred in that year was an aberration that the plane maker would overcome. He remarked to Boeing shareholders at the company s annual meeting I believe the current downturn is an aberration, a once-in-a-lifetime storm. Boeing announced that they still have an aircraft manufacturer s backlog of more than 3,700 commercial aircraft. In May 2011, at a metals conference in Philadelphia, aero engine manufacturers GE Aerospace and Pratt & Whitney both stated they are adopting policies to mitigate potential shortages in critical, rare and/or strategic metals based on internal risk assessments. To underline the importance of availability of critical and strategic metals, Pratt & Whitney also noted that they expect major increases in engine orders from 2014 onwards, for both commercial and military aircraft. Additional high purity cobalt units are expected to be required for the production of land based gas turbines which generate electricity from natural gas, coal bed methane and other sources. Demand for land based gas turbines (LBGTs) continues to grow despite the global slowdown according to a major US producer of high performance alloys for LBGTs. They predicted that global LBGT builds rose to around 1,550 units in 2009, an increase of approximately 19% from 2008, when around 1,300 of the large size turbines were built. They also predict approximately 1,650 LBGTs/year to be built by Demand for the turbines is being driven by several factors, including the push for greater power generation capacity in emerging markets, environmental concerns, and growth in so-called microturbines as backup sources of power for hospitals and other institutions. Increasing build rates are also driving growth in the maintenance, refitting and overhaul business. 13

50 In addition, the demand for cobalt in the rechargeable battery sector has grown between 13% and 26% over the last few years, due primarily to increasing demand for hybrid electric vehicles and rapidly expanding wireless technology growth in first and third world countries. The earthquake and related tsunami that occurred in Japan in March 2011 has impacted demand for cobalt in certain sectors, particularly the rechargeable battery and automotive sectors. Analysts predict that impacts from these events will be short lived. These factors, coupled with political concerns, environmental concerns, supply problems, and long lead times for new projects mean that only a portion of previously predicted new cobalt production is expected to materialize in the next few years. Demands by more than 100 international and local Congolese Non Government Organization s for major changes to disadvantageous mining contracts in the DRC has been only partly satisfied. A few contracts were taken back and some modifications were implemented on a few others. Significant concerns continue with corruption, environmental pollution, water quality and social inequality. Their goal is not just to ensure higher national revenues, but also to address long-standing community concerns about environmental pollution and compensation for people displaced by mining operations. Additional pressure is being applied to address environmental protection and rehabilitation of land after mining, neither having ever been previously considered in the DRC or in many other parts of the world outside of the US. Adding the costs to deal with these social and environmental concerns and payments of reasonable state taxes would significantly add to production costs in the future. Future resource nationalization and royalty issues could also have an increasing effect on new potential production as almost half of the world s cobalt reserves and resources are in the DRC. In mid April 2010, the DRC once again implemented new laws to restrict the export of concentrates and intermediate cobalt and copper products. If this holds, then large amounts of new capital will be required to transform these cobalt units into finished end products for export. Recent published estimates have China importing over 30,000 tonnes / year of cobalt units contained within these concentrates and intermediate cobalt products. If this export ban holds, China will need to have all of these cobalt and copper units processed in the DRC before the units can be exported. The long term average price of cobalt from 1980 to 2010, (in 2010 dollars) was over US$22/lb. Management believes that this figure represents a conservative view of future cobalt prices. Potential for cobalt prices, especially high purity metal, to return to new highs is considered likely, especially with either political instability in the DRC and/or responsible environmental, social and post mining reclamation policies (including real cost bonding) being put into place within the DRC and other third world countries with cobalt production. For reference on historical and present cobalt prices see Figure 3. Figure 3: Cobalt Price, US $/lb High Purity Cobalt Market Cobalt used for the production of superalloys for critical applications must be of the highest purity and must meet strict specification requirements in terms of chemical content. Such specifications relate not only to the level of purity but more importantly, impose strict maximum levels measured at the parts per million (ppm) levels for specific impurities and other trace elements. 14

51 The Company s technical staff and consultants utilizing various reliable industry sources project that the total amount of cobalt metal produced annually is approximately 22,000 24,000 tonnes. Of this approximately 8,500 to 9,500 tonnes are suitable for superalloy applications. Of this number, only around 6,000 tonnes are suitable for critical applications in the superalloy sector. Annual consumption of cobalt metal in the superalloy sector is widely reported to be around 13,500 tonnes / year and is projected to rise to over 17,500 in the next few years. The ICP is projected to produce approximately 1,500 tonnes annually of high purity cobalt metal, which represents just over 10% of the existing high purity cobalt metal market. These figures indicate that a substantial shortfall may soon exist for cobalt suitable for superalloy applications and is likely to continue into the future. This is the material the ICP is planning on producing. The US presently consumes almost 60% of all available superalloy cobalt, with the aerospace industry accounting for 64% of its use worldwide and land based turbines accounting for an additional 26% of world consumption (Figure 4). According to the US Geological Survey, the US currently produces no cobalt metal of any grade. Figure 4: Consumption of Superalloy Cobalt by Region and Industry Source: Roskill, 2006 and 2007 By Region By Industry Vale and Xstrata account for over 90% of present production of high purity cobalt, with some industry analysts reporting that Glencore (controlling shareholder in Xstrata) now controls up to 40% of all global cobalt units (including all grades). Xstrata is reporting lower production quantities, likely due to reduced availability of feed, while consumption of high purity cobalt continues to increase. Although there are various new producers and potential new entrants to the cobalt market, most will supply intermediate concentrate, impure cobalt chemicals or low-mid grade metal. There will be few, if any, high purity cobalt market entrants, aside from Formation Metals Inc. In addition, while the Company owns the Big Creek Hydrometallurgical Complex which is expected to produce high purity cobalt metal, other potential producers would face constructing expensive new refineries with considerably greater risk than that of modifying an existing one. It is estimated that modifying an existing refinery is 1/3 to 1/2 the cost of building a new facility and in fact there are few, if any, existing refineries available for retrofitting. A new refinery could also face many potential commissioning problems including not meeting design capacity. Factors Affecting New Production Many factors that can negatively affect new production and future production forecasts are generally related to the location of possible new mines and that location s geo-political situation, world financial markets, the rising cost of materials, availability of technical staff and increasingly stringent regulatory and environmental requirements. These include: DRC political problems and concerns about corruption and environmental protection DRC value added/ export ban policy Power problems in DRC and other areas in Africa Shortage of skilled manpower and specialized equipment Country risk and resource nationalization issues have increased China s new investments in DRC may have negative impact on western companies Significant new taxes and royalties being brought in or been suggested in many countries Credit market concerns US weakening dollar and associated rise in other countries 15

52 Capital cost increases to place new mines into production leading to delay or cancellations Rapidly rising long run marginal industry costs Rising costs to permit and construct new refineries and few new refineries are planned Significant recent increases in oil, freight, labor and acid costs Imports to China of raw cobalt ore and concentrates in 2010 of around 30,000 tonnes contained cobalt from less than 3,000 tonnes in This came mostly from the DRC and has now supposed to have been banned by the DRC Government Nickel market concerns about future surplus, increased production of low nickel stainless steel and increased production of pig nickel in China. Technical and commercial barriers for supply of high purity cobalt for superalloy applications, especially critical applications Possible new social and environmental requirements with associated costs in third world countries could eventually match those in the US Usually requires vertical integration from mining to refining to produce high purity cobalt metal Production There have not been significant changes with regards to the global cobalt production profile over the last few years as production is mainly derived as a co-product of the mining and processing of copper and nickel ores, but advances in hydrometallurgical extraction techniques and improved prices have seen the development of more primary cobalt projects. One major exception is the vast amounts of raw cobalt units, in the form of hetrogenite ore, imported into China from the DRC. These shipments have included upward of 15,000 to 20,000 tonnes of contained cobalt per annum. This significant trade volume has been greatly reduced because of falling grades, increased shipping costs and recent changes to the DRC Mining Code making these shipments illegal. There also are continuing production increases from new and/or expanding operations in the DRC. The export of these new cobalt units, has largely replaced traditional hetrogenite raw ore exports to China, and has helped feed China s expanding processing capacity. During the past few years China has been constructing new cobalt processing facilities and importing increasing amounts of impure cobalt units from the DRC and nickel laterite projects. Cobalt production (in all forms) from these imported materials has risen from 8,000 tonnes annually in 2004 to almost 33,000 tonnes in The breakdown of refined cobalt production sources is as follows: Nickel Industry: 48%, Copper Industry & Other: 37% Primary Cobalt Operation Industry: 15% Recovery from secondary sources of cobalt can occur through the introduction of recycled material but this is only economic at higher cobalt prices. Recent higher cobalt prices have resulted in this type of recovery and, as such, little stockpiled material remains. Final products can be in the form of cathodes, powders, oxides, salts or solutions. The following table outlines CDI published production figures from 2004 through 2010: According to the CDI (2009), in the past 7 years refined cobalt production had been growing at an average rate of 2,725 tonnes per year ( tpy ) and in the past 4 years this has increased to an average of 3,230 tpy, mainly as a result of the phenomenal increase in Chinese output since China has mostly utilized raw ore and intermediate materials imported from the DRC. This increased output helped satisfy a huge increase in Chinese demand as that market moved into industrial overdrive. 16