NIF - Noranda Income Fund · NIF.UN Noranda Income Fund Annual Report 2010. Contents Letter to...

NIF.UN

Noranda Income Fund Annual Report 2010

Contents

Letter to Unitholders

Management’s Discussion and Analysis

Management’s Statement of Responsibility

Independent Auditors’ Report

Consolidated Financial Statements

Notes to Consolidated Financial Statements

Corporate Information* All dollar amounts are in Canadian dollars, unless otherwise stated.

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IBC

Noranda Income Fund is an income trust whose units trade on the Toronto Stock Exchange under the symbol “NIF.UN”. The Noranda Income Fund owns the CEZinc processing facility and ancillary assets (the “CEZinc processing facility”) located in Salaberry-de-Valleyfield, Québec. The CEZinc processing facility is the second largest zinc processing facility in North America and the largest zinc processing facility in eastern North America, where the majority of its customers are located. It produces refined zinc metal and various byproducts from zinc concentrates purchased from mining operations. The CEZinc processing facility is operated and managed by Canadian ElectrolyticZinc Limited.

ANNUAL REPORT 2010 NORANDA INCOME FUND 1

Letter to Unitholders

Dear Unitholders,

Our Processing Facility in Salaberry-de-Valleyfield, Québec operated at full capacity throughout 2010 and this positively impacted both the financial and operational results of our business. We were also encouraged that market conditions improved as the year progressed. For 2010, the Noranda Income Fund (“Fund”) recorded net earnings of $21.1 million, compared to a net loss of $3.3 million in 2009.

Notwithstanding our positive results, the Fund was not permitted to make any cash distributions in 2010 as we were renegotiating our debt that matured in December. During the third quarter, the negotiations were delayed by a number of factors, including a requisition at the end of August for a special meeting to replace the former independent trustees of the Board, followed by the unexpected resignation of all of the former independent trustees in early September.

The remaining Trustees of the Board moved quickly to fill the vacancies of the former independent trustees. During October 2010, Messrs. John J. Swidler, Jean Pierre Ouellet, Barry Tissenbaum and François R. Roy were appointed as the independent trustees. The current Independent Trustees were selected based on their extensive financial, operational and other relevant credentials as well as their extensive public-company board experience.

The Independent Committee was promptly reconstituted, a successful resolution to the special meeting was found and the focus turned to refinancing options for the Fund. A new financial advisor, TD Securities Inc. was appointed by the Independent Committee. In early December, the Fund successfully negotiated a six month $250 million Bridge Loan. The loan can be extended for a further six months, at the option of the Fund. It does not permit cash distributions to Unitholders.

In 2011, the Board will focus on implementing a long-term financing plan that places the Fund on a prudent financial footing as it approaches the scheduled expiration of the Supply and Processing Agreement on May 3, 2017. This will be balanced with the objective of returning cash distributions to Unitholders at sustainable levels.

In conclusion, I would like to thank our employees who have remained focussed on delivering results. I would also like to thank our Unitholders who have supported us, particularly with the transition of the new Independent Trustees and the completion of the Bridge Loan. Finally, I would like to thank all of our Trustees, for the guidance and support they have provided to the management team. In particular, I am very appreciative that our new Independent Trustees came on board at a time when some critical decisions were needed. They have worked diligently to increase their understanding of the Fund in a short period of time. Management and the Board remain committed to pursuing the best interests of the Fund and its Unitholders.

Mario ChapadosPresident and Chief Executive OfficerCanadian Electrolytic Zinc LimitedNoranda Income Fund’s Manager

NORANDA INCOME FUND ANNUAL REPORT 2010 2


This Management’s Discussion and Analysis (“MD&A”) of the financial position and results of operations of Noranda Income Fund (TSX: NIF.UN) is the responsibility of management and has been prepared as at February 16, 2011. The board of trustees of Noranda Operating Trust carries out its responsibility by reviewing this disclosure principally through its audit committee and it approves this disclosure prior to its publication.

This MD&A provides a review of the consolidated financial position, results of operations and performance of Noranda Income Fund (the “Fund”), Noranda Operating Trust (the “Operating Trust”) and the Noranda Income Limited Partnership (the “Partnership”), and the subsidiaries of the foregoing for the years ended December 31, 2010 and December 31, 2009. It should be read in conjunction with the Fund’s audited consolidated financial statements and notes to those statements. All financial information has been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”). All amounts are expressed in Canadian dollars, the Fund’s reporting currency, except where indicated.

Additional information regarding the Fund, including the Fund’s Annual Information Form, is available on SEDAR at www.sedar.com.

This MD&A contains forward-looking information and forward-looking statements within the meaning of applicable securities laws. See “Forward Looking Information” below.

OVERVIEW

The Fund is an unincorporated open-ended trust, established under the laws of Ontario, whose units trade on the Toronto Stock Exchange (“TSX”) under the symbol “NIF.UN”. The Fund was created to acquire Noranda Inc.’s CEZinc electrolytic zinc plant and processing facility (together with associated roasters, acid plants, remediation facilities, settling ponds, wastewater treatment plants and related assets and equipment) (the “Processing Facility”), located in Salaberry-de-Valleyfield, Québec, in 2002. Canadian Electrolytic Zinc Limited (the “Administrator” and alternatively, the “Manager”), a wholly-owned subsidiary of Xstrata Canada Corporation (“Xstrata Canada”) (through its Xstrata Zinc Canada division), operates

and manages the Operating Trust and administers the Fund. Concurrently with the creation of the Fund and the acquisition of the Processing Facility by the Partnership from Noranda Inc. in 2002, the Administrator entered into various agreements with the Fund and/or the Operating Trust relating to the management, administration and operation of the Fund, the Operating Trust, the Partnership and the Processing Facility. In August 2006, Xstrata Canada acquired Falconbridge Limited, the successor corporation to Noranda Inc. Xstrata Canada is a wholly-owned subsidiary of Xstrata Plc.

The Processing Facility, which the Fund indirectly owns through the Partnership, produces refined zinc metal and various byproducts from zinc concentrate purchased from mining operations and it sells refined zinc products to customers in the open market. The Fund earns a processing fee for processing zinc concentrate into zinc metal and it earns additional revenue from premiums, byproduct revenues and metal gains.

The Processing Facility is favourably located along major transportation networks which connect it to its principal markets in the United States and Canada.

Zinc is central to our daily lives. Its main use is to galvanize steel for the construction and automotive industries. Zinc is also used in the production of die-castings and brass. Zinc powders, oxide and dust are used in the manufacture of batteries, rubber tires, pigments and various creams.

The board of trustees of the Operating Trust (the “Board” or the “Trustees”), the majority of whom are independent from Xstrata Canada, oversees the Fund.

The Fund is in turn the sole unitholder of the Operating Trust. Pursuant to an administration agreement dated April 18, 2002 between the Fund and the Administrator (the “Administration Agreement”), Computershare Trust Company of Canada, the sole trustee of the Fund (the “Sole Trustee”), has delegated all of its power and authority to the Administrator, and the Administrator provides administrative and support services to the Fund.

Pursuant to a management services agreement dated April 18, 2002 between the Operating Trust and the Manager (the “Management Services Agreement”), the Manager provides management services to the Operating Trust.

Pursuant to an operating and management agreement dated May 3, 2002 between the Manager and the Partnership (the “O&M Agreement”), the Manager operates and maintains on an ongoing basis, the Processing Facility owned by the Partnership and provides management services to the Partnership.


In addition, Xstrata Canada and the Partnership are parties to a supply and processing agreement dated May 3, 2002 (the “Supply and Processing Agreement”), pursuant to which Xstrata Canada is obligated to sell to the Partnership until 2017 all of its zinc concentrate requirements up to 550,000 tonnes of zinc concentrate per year at a concentrate price based on the price of zinc metal on the London Metal Exchange (“LME”) for the “payable zinc metal” contained in the concentrate, less a fixed, escalating processing fee (calculated in Canadian dollars). Pursuant to the Supply and Processing Agreement, Xstrata Canada acts as exclusive agent for the Partnership to arrange for purchases of any additional zinc concentrate in excess of the 550,000 tonne amount described above, and for sales of zinc metal and byproducts and related hedging and derivative arrangements.

Further details concerning these arrangements relating to the management, administration and operation of the Fund, its subsidiaries and the Processing Facility are described under “Transactions with Related Parties” below.

Long-Term Business and Financial StrategyThe Board is charged with evaluating the Fund’s options and evaluating and supervising the formulation of the Fund’s business and operating plans, which the Manager is responsible for preparing. An independent committee of the Board (the “Independent Committee”), which is comprised entirely of independent Trustees has been established and it is responsible for reviewing and evaluating, among other things, all options available to the Fund in connection with the long-term refinancing of the Operating Trust’s debt, in coordination with the Board and management and the Manager. It is also responsible for reviewing and evaluating the potential conversion of the Fund from an income trust to a corporation in light of changes to certain Canadian income tax laws that became effective on January 1, 2011.

In order to develop a medium and long-term strategy for the Fund, the Board must first put in place a long-term financing plan that places the Fund on a prudent financial footing as it approaches the scheduled expiration of the Supply and Processing Agreement on May 3, 2017. The Trustees and management are considering all available refinancing options. Depending on the actual nature of the long-term financing that may be implemented and the related mandatory repayments that may be imposed, the Fund may be obliged to repay a significant portion of the debt (as at December 31, 2010 – $191.5 million) before May 3, 2017. This could reduce future free cash flow and cash available for distribution to holders of Fund units (the “Units”). Any solution must balance the

objective of reinstating cash distributions and the need for a financing plan that does not unduly risk unitholders’ equity as 2017 approaches and beyond.

While a long-term financial solution is expected to be found, the Fund continues to face a number of near and long-term challenges including, among other things, a stronger Canadian dollar, the need to secure long-term commercial sources of zinc concentrate when the Supply and Processing Agreement expires in 2017, increasing competition from low cost zinc processing capacity in China, declining spot treatment charges and the imposition of income taxes starting January 1, 2011. See “Risks and Uncertainties” below.

In 2010, the Fund renewed the Operating Trust’s then-existing credit facility (the “Revolving Facility”). On May 3, 2010, the Revolving Facility was extended to November 3, 2010 so that it would more closely coincide with the refinancing of the Operating Trust’s $153.5 million senior secured notes (the “Senior Notes”) that matured on December 20, 2010.

In the interim period between May 3, 2010 and the maturity of the Revolving Facility and Senior Notes, a number of events hindered or delayed the Fund’s ability to implement a long-term refinancing plan, including:• On July 30, 2010, following receipt by the Fund of a non-

binding proposal from Xstrata Canada to acquire the outstanding priority units of the Fund (the “Priority Units”) by way of take-over bid, the Fund and Xstrata Canada announced that they had entered into a non-binding letter of intent (“LOI”) with respect to a potential acquisition of the Fund by Xstrata Canada. A condition of the LOI was that no refinancing could be completed.

• On August 30, 2010, certain holders of Priority Units of the Fund (the “Requisitioning Unitholders”) requisitioned a special meeting of the unitholders of the Fund (the “Unitholders”) to consider removing from office all of the former independent trustees of the Operating Trust and to replace them with four trustees nominated by the Requisitioning Unitholders.

• On September 1, 2010, following discussions between the Fund and Xstrata Canada and between the former independent committee of the Board and the Requisitioning Unitholders, the Fund announced that Xstrata Canada had withdrawn its proposal and provided notice that it was terminating the exclusivity agreement entered into between Xstrata Canada and the Fund related to the LOI.

• On September 10, 2010, the former independent trustees of the Board and the members of the former independent committee, unexpectedly resigned from the Board.



• Following these resignations, an expanded search by the Board, in conjunction with the independent recruiting firm Egon Zehnder International, was begun to identify qualified candidates to fill the independent trustee vacancies on the Board. Effective October 7, 2010, the Board (in accordance with the procedures set out in the Trust Indenture of the Operating Trust dated April 18, 2002, (the “Trust Indenture”) appointed each of Messrs. John J. Swidler, Jean Pierre Ouellet, Barry Tissenbaum and François R. Roy as independent Trustees. The Independent Committee was re-established and reconstituted with the new independent Trustees.

• Following a search and evaluation of possible qualified financial advisors, the Independent Committee engaged a new financial advisor, TD Securities Inc. (“TD Securities”) on October 25, 2010. On October 27, 2010, the Operating Trust obtained a one-

month extension from November 3, 2010 to December 3, 2010 of the maturity of the Revolving Facility to allow the Independent Committee of the Board to continue working with its independent financial advisor, TD Securities, to review refinancing alternatives with respect to the Revolving Facility and the Senior Notes.

At the beginning of November 2010, following discussions between the Requisitioning Unitholders and the Independent Committee, the Independent Committee and the Requisitioning Unitholders came to an agreement which resulted in the withdrawal of the meeting requisition and cancellation of the scheduled special meeting of the Fund’s Unitholders.

Subsequently, the Fund successfully negotiated a six month $250 million bridge financing (the “Bridge Facility”) from a syndicate of Canadian chartered banks (the “Syndicate”). The closing of the transaction occurred on December 2, 2010. A portion, or $130 million term loan tranche (“Term Loan Tranche”) was used to fully repay all amounts outstanding in respect of the Operating Trust’s $153.5 million Senior Notes that matured on December 20, 2010. The remainder, a $120 million operating line of credit (“Revolving Facility Tranche”) represented an amended credit facility allowing operations to continue in the normal course of business as the Fund continues to pursue alternative long-term financing. The remainder of the $23.5 million of the Senior Notes were repaid from the Revolving Facility Tranche. The maturity of the Bridge Facility is June 2, 2011, subject to a further extension of six months at the option of the Operating Trust at similar terms and conditions, and mandatory principal repayments in certain circumstances.

The terms of the Bridge Facility are substantially the same as the terms of the Operating Trust’s prior Revolving Facility, subject to certain modifications. The Bridge Facility contains covenants that restrict the Fund (and its subsidiaries) in several respects, including their ability to make distributions or redeem or repurchase units. The Bridge Facility is secured by the assets of the Fund, the Operating Trust, the Partnership and the Manager. The lenders also required, as a condition to the refinancing, that Xstrata Canada reaffirm its credit support, as it had provided credit support in the past in connection with the Operating Trust’s Revolving Facility. In consideration for the credit support, the Operating Trust paid Xstrata Canada a fee of US$400,000. Further details concerning the Bridge Facility, the nature of the credit support by Xstrata Canada obtained in connection therewith and the terms of the amended credit agreement are set out under “Liquidity and Capital Resources” below and are also contained in the Fund’s press release dated December 2, 2010 and its related material change report dated December 6, 2010. Copies of these documents are available on SEDAR at www.sedar.com.

The Independent Committee continues to consider and evaluate long-term refinancing alternatives available to the Fund, along with possible structural options for the Fund in light of the changes to certain Canadian income tax laws applicable to income funds that became effective on January 1, 2011 (discussed further below under “Overview – Structure of the Fund”).

Cash DistributionsIn 2009, the Fund was negatively impacted by the significant downturn in economic activity that arose from the financial crisis. Market conditions deteriorated rapidly in the first half of 2009 impacting the Fund’s financial and operating results as well as distributions to Unitholders. The monthly distribution to Priority Unitholders was reduced from 8.5 cents to 4 cents a month in February 2009. With the February distribution falling below the base distribution of $0.08333 per month, the Fund’s subordination feature was triggered, with the result that since February 25, 2009, the ordinary units of the Partnership (the “Ordinary Units”) held by a subsidiary of Xstrata Canada have not been paid a distribution. In July 2009, the cash distribution to Priority Unitholders was also suspended.

The Fund returned to profitability in 2010 with net earnings of $21.1 million, compared to a net loss of $3.3 million in 2009. However, the Fund was renegotiating its bank debt, and consistent with the terms of the extension of the Revolving Facility in April 2010, it was not permitted to make any cash distributions to the Unitholders during the extension period. As a result, no cash distributions were paid to holders of Priority Units or Ordinary Units during 2010.


Looking ahead, the Fund’s long-term objective is to maximize unitholder value and, when possible, provide stable monthly distributions at a sustainable level to unitholders. While this objective is supported by the Fund’s ability to maximize zinc metal production and byproduct revenues, minimize unit costs and exercise a disciplined use of capital, the decision on whether or not to reinstate distributions and at what level will only be made once the Board has agreed upon a long-term financial strategy and business plan.

The ability of the Fund to provide stable monthly cash distributions at a sustainable level is subject to various risks and assumptions. See the discussion under “Overview – Long-Term Business and Financial Strategy” above and “Risks and Uncertainties” and the “Forward-Looking Information” below for further details.

Structure of the FundOn January 1, 2011, the specified flow-through entity legislation became effective and income funds can no longer make distributions to unitholders without the imposition of entity level taxation. The Fund has the option of either remaining as a taxable income trust or converting to a corporation. However under both scenarios, the cash realized from operations will be reduced by income taxes payable.

If the Fund remains as an income trust, the taxable income that is not distributed to its Uniholders would be taxed at a rate of approximately 48%. Taxable income that is distributed to its Uniholders, will be taxed at the corporate tax rate (28.4% in 2011, 26.9% in 2012 and beyond) and the amount distributed to Unitholders will be treated as a dividend from a taxable Canadian corporation.

If the Fund converts to a corporation, the successor corporation would be subject to corporate tax rates (28.4% in 2011, 26.9% in 2012 and beyond) regardless of whether it distributes its taxable income annually to Unitholders or not.

The Independent Committee and the Board are currently considering the taxation implications of conversion while also considering the implications to the Fund and its Unitholders of remaining as a trust.

Regardless of the course that the Board ultimately recommends, it is expected that any conversion of the Fund to a corporation will require the approval of the Fund’s Unitholders and Xstrata Canada. There is no assurance that the Unitholders or Xstrata Canada will provide their approval.

RESULTS OF OPERATIONS

2010 Highlights• Zinc production was 17% higher than in 2009.• Zinc metal sales were 10% higher than in 2009.• Byproduct revenues were 25% higher than in 2009.• Debt was reduced by $16.4 million.• Four new highly-qualified and experienced Independent

Trustees joined the Board and reconstituted the Independent Committee.

• TD Securities was appointed to act as the Fund’s exclusive independent financial advisor, reporting directly to the Independent Committee.

• The Fund obtained a Bridge Facility for an amount of $250 million from a syndicate of lenders. The Bridge Facility enables the Fund to continue to pursue a long-term refinancing plan.

Selected Financial Highlights($ millions, except per-unit amounts) 2010 2009 2008

Revenues $ 643.0 $ 468.9 $ 600.7Revenues less raw material purchase costs 271.4 215.6 297.6Net earnings before income taxes 21.9 (3.3) 27.7Net earnings 21.1 (3.3) 27.7Net earnings per Priority Unit (basic and diluted) 0.56 (0.09) 0.74Total assets 487.2 501.4 467.6Long-term debt 191.5 207.9 196.6Distributions declared per Priority Unit – 0.285 1.02In-Kind distributions declared per Priority Unit 0.48 – –Distributions declared per Ordinary Unit $ – $ 0.285 $ 1.02

The Processing Facility operated at full capacity in 2010 and this positively impacted both the financial and operational results of the business, whereas in 2009, it operated at 80% of the normal operating level from March 1st to September 30th because of the weakness in the sulphuric acid market.



The Fund’s consolidated net earnings for 2010 totalled $21.1 million, compared to a net loss of $3.3 million in 2009. The $24.4 million increase was mainly due to higher production, sales, byproduct revenues and premiums, partially offset by higher interest expense, reclamation expense and selling, general and administration expense and a stronger Canadian dollar.

Sales in 2010 were $659.1 million, compared to $483.2 million in 2009. The 36% increase in sales was primarily the result of higher zinc and sulphuric acid sales volumes, higher prices for all of the Fund’s products and higher premiums. Zinc sales in 2010 were 269,114 tonnes compared to 243,969 tonnes in 2009. Zinc prices in 2010 averaged US$0.98 per pound compared to US$0.75 per pound in 2009. Byproduct revenues from sulphuric acid and copper in cake increased to $34.5 million in 2010 from $27.6 million in 2009. The increase was mainly due to a higher sulphuric acid netback and copper price, and higher sulphuric acid sales, partially offset by lower copper in cake sales.

In 2010, the Fund realized zinc premiums of US$0.044 per pound, up from US$0.035 per pound in 2009. The increase in realized premiums compared to the previous year reflects the impact of improved annual contract premiums and an increase in the level of spot premiums.

Transportation and distribution costs in 2010 of $16.1 million were higher than the $14.3 million recorded in 2009. Higher zinc metal shipment volumes and transportation rates explain the increase.

Raw material purchase costs in 2010 increased to $371.6 million from $253.3 million in 2009. The increase was mainly due to higher average zinc metal prices and an increase in the volume of concentrate consumed.

Revenues less raw material purchase costs (“Net Revenues”) in 2010 were $271.4 million, compared to $215.6 million in 2009. The $55.8 million increase was mainly due to higher sales volumes, byproduct revenues and premiums, partially offset by the impact of a stronger Canadian dollar.

Production costs in 2010 were $177.3 million, $11.6 million higher than the $165.7 million recorded in 2009. Production from March 2009 until the end of September 2009 ran at about 80% of the normal operating level. The increase in costs in 2010 is mostly due to an increase in the cost of labour, energy and operating supplies, as a result of higher zinc metal production in 2010 compared to 2009.

Production Cost Breakdown Increase/ ($ millions) 2010 2009 Decrease

Labour $ 60.3 $ 55.4 $ 4.9Energy 62.1 57.9 4.2Operating supplies 36.5 31.9 4.6Other 15.2 12.5 2.7Production cost before change in inventory 174.1 157.7 16.4Change in inventory 3.2 8.0 (4.8) $ 177.3 $ 165.7 $ 11.6

Selling, general and administration (“SG&A”) costs in 2010 were $23.8 million, compared to $17.6 million in 2009. SG&A costs were higher in 2010 due to costs that were incurred as a result of the work and expenses incurred by the Fund on the strategic review, the costs incurred related to the change in the Independent Trustees during the year, the preparation work related to the special unitholder meeting requisitioned by the Requisitioning Unitholders and costs incurred for the Bridge Facility.

The foreign exchange gain in 2010 was $1.2 million, compared to a gain of $9.6 million in 2009. The large foreign exchange gain in 2009 was a result of a weakening Canadian dollar on the Fund’s net US dollar monetary liability. The foreign exchange gain was largely offset by a decrease in the value of in-process and finished inventory. The decrease in the value of inventory is realized in Net Revenues as the metal is sold to customers (thereby increasing the Net Revenues recorded by the Fund in 2010 and 2009).

In 2010, the commodity hedging loss was $0.3 million and the financial instrument gain was $5.7 million. During the period, the change in the market value of the Fund’s financial instruments resulted in these amounts being recorded. See also “Financial Instruments and Other Instruments” below.

In 2010, amortization was $33.7 million, compared to $36.0 million in 2009. During the first quarter of 2010, the Fund reviewed and increased the useful life of certain property, plant and equipment, based on experience with these assets, to better reflect their expected use in time. These changes were applied prospectively from January 1, 2010. This resulted in a $4.3 million decrease in amortization expense for the year. This impact on earnings was partially offset by the impact of the significant drawdown in zinc metal inventory in 2009.


In 2010, reclamation expense was $0.7 million, compared to a recovery of $3.6 million recorded in 2009. The recovery in 2009 was due to a decline in the expected future reclamation spending, which has resulted in a reduction in the present value of future site restoration and reclamation liabilities based on a review of the site restoration and reclamation expenditures completed by the Fund, including work from a third-party engineering firm.

In 2010, net interest expense was $13.5 million compared to $11.1 million in 2009. The increase in net interest expense in 2010 was mostly due to higher interest spreads on the Revolving Facility and the Bridge Facility.

Ordinary Unitholders’ non-controlling interests in earnings in 2010 was an expense of $7.3 million, down from a credit of $1.1 million in 2009. The decrease was due to the Fund’s higher earnings in 2010.

Summary of Quarterly ResultsThe following table provides a summary of quarterly results for the past two years ended December 31, 2010 and December 31, 2009, respectively:

($ millions, except per-unit amounts and production amounts) 2010 Q1 Q2 Q3 Q4

Revenues $ 167.6 $ 153.9 $ 152.9 $ 168.7Net earnings (loss) 7.1 8.5 2.2 2.6Net earnings (loss) per Priority Unit (basic and diluted) $ 0.19 $ 0.22 $ 0.06 $ 0.09Production (tonnes) 66,466 65,144 66,605 69,113

2009 Q1 Q2 Q3 Q4

Revenues $ 102.5 $ 82.6 $ 128.7 $ 155.1Net earnings (loss) (2.7) (0.7) (1.3) 1.4Net earnings (loss) per Priority Unit (basic and diluted) $ (0.07) $ (0.02) $ (0.04) $ 0.04Production (tonnes) 58,080 53,062 51,871 65,587* 1 tonne = 2,204.62 pounds

Fourth-Quarter 2010 Results The Fund reported net earnings of $3.4 million for the fourth quarter of 2010, compared to $1.4 million in the same quarter a year ago. The $2.0 million increase was mainly due to higher zinc metal premiums and byproduct revenues, partially offset by higher selling, general and administration expense and a stronger Canadian dollar.

Revenues in the fourth quarter of 2010 were $168.7 million, up from the $155.1 million recorded in the same quarter of 2009. Much of this increase was due to the higher zinc metal premiums, and byproduct revenues.

In the fourth quarter of 2010, zinc metal production was 69,113 tonnes, compared to 65,587 tonnes in the same quarter of 2009. Zinc recoveries in the fourth quarter of 2010 at 97.0%, compared to 97.4% in the fourth quarter of 2009.

Zinc metal is used in a wide range of industries. Its major use, which accounts for 50% of the total zinc metal consumption in North America, is in the production of galvanized steel. The improvement in consumer demand that was witnessed earlier in the 2010 year continued into the fourth quarter. Stronger orders were realized from the galvanizing and the die cast alloy sectors which were supported by improved demand from automotive and general manufacturing end use markets.

Fourth quarter 2010 sales were 65,716 tonnes versus 65,337 tonnes in the fourth quarter of 2009.

Zinc metal premiums were 4.7 cents US per pound in the fourth quarter of 2010, compared to 3.7 cents US per pound in the same quarter of 2009 due to higher premiums obtained on spot sales.

In the fourth quarter of 2010, the Fund generated $12.5 million in revenue from the sale of its copper in cake and sulphuric acid, compared to $6.6 million in the fourth quarter of 2009.

Revenues from the sale of sulphuric acid were $5.0 million in the fourth quarter of 2010, up from $2.6 million in the fourth quarter of 2009 as a result of higher netbacks, partially offset by lower sales volumes. Sulphuric acid sales totalled 97,290 tonnes in the fourth quarter of 2010, compared to 99,692 tonnes in the fourth quarter of 2009. Copper in cake revenues were $7.2 million in the fourth quarter of 2010 compared to $3.6 million in the fourth quarter of 2009 as a result of higher copper prices and copper in cake sales volumes. Copper in cake sales volumes in the fourth quarter of 2010 totalled 780 tonnes compared to 520 tonnes in the corresponding period of 2009.

Cash realized from operations, before net changes in non-cash working capital items in the fourth quarter of 2010, was $15.5 million compared to $16.9 million in the fourth quarter of 2009. During the fourth quarter of 2010, non-cash working capital increased by $12.0 million. The increase in working



capital primarily resulted from increases in accounts receivable and inventory, partially offset by an increase in accounts payable and accrued liabilities. The increases resulted from the increase in the price of zinc during the quarter.

Capital expenditures in the fourth quarter of 2010 were $7.9 million, compared to $5.9 million in the fourth quarter of 2009. Sustaining capital accounted for almost all of the expenditures in the recent quarter.

There were no cash distributions paid to Unitholders during the fourth quarter of 2010.

KEY PERFORMANCE DRIVERS

The principal factor affecting the Fund’s performance is the processing of zinc concentrates into zinc metal. This activity results in the Fund earning a processing fee. In 2010, the processing fee accounted for 80% of the Fund’s Net Revenues (2009 – 81%).

A second key factor affecting the performance of the Fund is the premiums that are realized on the sale of zinc products to customers. Zinc metal is sold to customers on the basis of an LME zinc price plus a premium that is negotiated between the buyer and seller. Premiums can vary according to various factors including product form, quantity, quality and payment terms. In 2010, product premiums accounted for 5% of the Fund’s Net Revenues (2009 – 4%).

The sale of byproducts (copper in cake and sulphuric acid) and zinc metal recovery gains generated 12% and 3%, respectively, of the Fund’s Net Revenues in 2010 (2009 – 12% and 3%).

The Canada/US exchange rate also impacts the Fund’s performance through premiums, byproduct revenues and zinc recovery gains which, collectively, represented 20% of the Net Revenues in 2010 (2009 – 19%). As the processing fee is earned in Canadian dollars, 80% of the Fund’s Net Revenues are not exposed to currency risk.

Two other performance drivers that impact the Fund are managing costs and a disciplined use of capital.

The Fund provides annual guidance for a number of its key performance drivers, including production, sales, processing fee, and capital expenditures. Guidance for 2011 key drivers can be found in “Outlook” below.

The following table provides a summary of the performance of these key drivers for the years ended December 31, 2010 and December 31, 2009, respectively. The discussion of key performance drivers that follows is subject to various risks and uncertainties, some of which are discussed under “Risks and Uncertainties” and “Forward-Looking Information” below, which investors are encouraged to read carefully.

Year 2010 2009

Zinc concentrate processed (tonnes) 482,376 447,059Zinc grade (%) 54.2 53.8Zinc recovery (%) 97.4 97.5Zinc metal production (tonnes) 267,328 228,600Zinc metal sales (tonnes) 269,114 243,969Processing fee (cents/pound) 38.5 38.0Zinc metal premium (US$/pound) 0.044 0.035Byproduct revenues ($ millions) 34.5 27.6 Copper in cake production (tonnes) 2,537 3,054 Copper in cake sales (tonnes) 2,257 2,378 Sulphuric acid production (tonnes) 403,779 372,156 Sulphuric acid sales (tonnes) 411,220 359,909Average LME copper price (US$/pound) 3.42 2.34Sulphuric acid netback (US$/tonne) 41 31Average LME zinc price (US$/pound) 0.98 0.75Average US/Cdn exchange rate 1.03 1.14* 1 tonne = 2,204.62 pounds

Zinc Metal Production Capacity The amount of zinc metal produced in a year is a function of four main factors: (1) the volume of zinc concentrate processed; (2) the grade of the zinc concentrate processed; (3) the zinc recoveries and (4) changes to work-in-process inventory levels.

In 2010, 482,376 tonnes of zinc concentrate were processed, compared to 447,059 tonnes in 2009. In 2010, the average concentrate grade was 54.2% and zinc recovery was 97.4% compared to 53.8% and 97.5% in 2009. Work-in-process inventory levels were drawn down in 2010, while in 2009 work-in-process inventory levels were built up.

In 2010, the bulk of the zinc concentrate came from five mines: Brunswick, Antamina, Perseverance, Kidd Creek and Duck Pond. Four of the five mines are owned or partly-owned by entities within the Xstrata group.

The annual zinc metal production capacity of the Processing Facility, under normal operating conditions, is 270,000 tonnes of zinc. The Fund continues to believe that the Supply and Processing Agreement will provide sufficient concentrate to run the Processing Facility at its productive capacity until its expiry in May 2017.

In 2010, the Processing Facility began to replace the liners protecting the concrete walls in the cell house. The project is expected to take three to four years and it is expected to be completed without having to stop production. However, the project requires two cells to be off-line at any time, thereby reducing availability by approximately 2%. As a result, effective annual zinc metal production capacity has been reduced from 270,000 tonnes to 265,000 tonnes of zinc metal.


The target for productive capacity is subject to various risks and uncertainties, some of which are set out under “Risks and Uncertainties” and “Forward Looking Information” below.

Production Production in 2010 was 267,328 tonnes compared to 228,600 tonnes in 2009. Production was lower in 2009 due to the fact that the Processing Facility ran at 80% of the normal operating level for seven months of the year.

In 2010, the average grade of the zinc concentrate was 54.2% compared to 53.8% in 2009. The zinc recovery in 2010 was 97.4%, comparable to the 97.5% recovery that was achieved in 2009. The Fund pays for 96% of the zinc in the concentrate it purchases; therefore, any recovery over 96% results in additional revenue for the Fund.

Sales Zinc metal is used in a wide range of industries. Its major use is in the production of galvanized steel. Sales in 2010 were 269,114 tonnes compared to 243,969 tonnes in 2009. The increase in sales in 2010 is directly related to an improvement in sales to all end-users, particularly the steel industry. Inventories of zinc metal were reduced by approximately 2,000 tonnes during 2010.

Processing Fee In 2010, the processing fee was $0.385 per pound, compared to $0.38 per pound in 2009. The processing fee is adjusted annually: (i) upward by 1% and (ii) upward or downward by 10% of the year-over-year percentage change in the average cost of electricity per megawatt hour for the Processing Facility. Based on the annual 1% increase and the average increase in electricity costs, the processing fee for 2011 is expected to be $0.389 per pound.

Premiums With the improvement in sales came an increase in premiums, which averaged US$0.044 per pound in 2010 compared to US$0.035 per pound in 2009. The increase in realized premiums compared to the previous year reflects the impact of improved annual contract premiums and an increase in the level of spot premiums.

Byproducts The Fund produces copper in cake and sulphuric acid as byproducts from refining zinc concentrates. In 2010, the Fund generated $34.5 million in revenue from the sale of its copper in cake and sulphuric acid, compared to $27.6 million in 2009.

Copper in CakeCopper in cake revenues in 2010 were $16.0 million compared to $13.7 million in 2009. In 2010, copper prices averaged $3.42 per pound, compared to $2.34 per pound in 2009. Copper in cake sales volumes in 2010 totalled 2,257 tonnes, compared to 2,378 tonnes in the prior year. In 2009, the Fund’s

copper in cake production was being shipped to Xstrata’s Kidd copper metallurgical facility for conversion. With the closure of this facility in May 2010, new alternatives had to be identified for the sale of this product. The Fund’s copper in cake contains between 65% and 75% copper and is produced in the purification process. Because of the entrainment of impurities such as cadmium, lead and zinc, this residue is complex to treat, limiting the options available for treatment. Currently, a large portion of the copper in cake is sold to a customer in Europe. The Fund is in the process of testing this material at two other facilities in Europe and expects to have copper in cake inventories back to normal levels by the end of 2011.

As at December 31, 2010, there were 1,090 tonnes of copper in cake in inventory with an estimated net realizable value of $7.6 million, based on the December 31, 2010 copper price and exchange rate, and the estimated treatment charges and transportation cost. The book value associated with this inventory as at December 31, 2010 was $3.4 million.

Sulphuric AcidRevenues from the sale of sulphuric acid rose to $17.5 million in 2010 from $13.0 million in 2009. Sulphuric acid netbacks in 2010, which were supported by higher spot pricing, improved to US$41 per tonne compared to US$31 per tonne in 2009. Sales volumes were also higher in 2010 at 411,220 tonnes compared to 359,909 tonnes a year ago.

The improvement in the netback in 2010 was due to improved market fundamentals leading to higher selling prices on non-contractual business, as supply tightened and industrial demand grew in step with increased manufacturing activity. Demand for sulphuric acid outside of the industrial market was strong and regular contract customers witnessed an increase in demand from their customers. While the Sudbury operations of Vale Inco resumed full production, the increase in demand coupled with supply constraints at other producers left the market relatively balanced to tight in 2010.

Exchange Rate The stronger Canadian dollar has had a negative impact on the Fund’s financial results. In 2010, a one-cent Canadian strengthening in the average Canadian/US exchange rate would have negatively impacted the Fund’s annual cash available for distribution by approximately $0.6 million. In 2010, the Canadian dollar strengthened to $1.030 per US dollar from $1.142 per US dollar in 2009. See also “Financial Instruments and Other Instruments” below.

Costs Production costs include labour, energy, supplies and other costs directly associated with the production process, plus or minus changes in inventory levels. Production costs in 2010 were $177.3 million, compared to $165.7 million in 2009. In 2009, production ran from March until the end of



September at about 80% of the normal operating level. The increase in costs in 2010 is mostly due to an increase in the cost of labour, energy and operating supplies, as a result of higher zinc metal production in 2010 compared to 2009.

Capital Expenditures Capital spending was $24.2 million in 2010, relatively unchanged from 2009. Most of the 2010 capital was spent on sustaining the Fund’s operation, including $3.6 million on the cell house rehabilitation project and $7.6 million on replacement anodes for the cell house.

OPERATING CASH FLOWS

Cash realized from operations, before net changes in non-cash working capital items in 2010 was $66.9 million compared to $36.5 million in 2009. During 2010, non-cash working capital increased by $26.0 million due to an increase in accounts receivable and a decrease in accounts payable and accrued liabilities, partially offset by a decrease in inventory.

DISTRIBUTION POLICY

Distribution Policy and Limitation The Fund did not pay any cash distributions to Priority Unitholders or Ordinary Unitholders in 2010 because the Fund was renegotiating its debt, and consistent with the terms of the extension of the Revolving Facility in April 2010, it was not permitted to make any cash distributions to the Unitholders during the extension period. The Fund’s long-term objective is to maximize unitholder value and, when possible, provide stable monthly distributions at a sustainable level to unitholders.

The Fund’s policy is to make cash distributions to its Unitholders of an amount equal to its net cash flows from operations in a year (without taking into account variations in working capital), less amounts put towards debt reduction and reserves for operating and capital expenditures, as the Board of the Operating Trust considers appropriate.

On October 27, 2010, the Fund completed an amendment with a syndicate of banks to further extend the maturity date of its then-existing Revolving Facility from November 3, 2010 to December 3, 2010. Consistent with the terms of the previous six-month extension of the Revolving Facility in April 2010, the Fund was not permitted to make cash distributions to Unitholders during the period from November 3, 2010 to December 3, 2010.

Subsequently, in December 2010 and as discussed further under “Liquidity and Capital Resources” below, the Fund successfully negotiated a six month $250 million Bridge Facility from the Syndicate. The Bridge Facility was used to repay the Operating Trust’s $153.5 million Senior Notes that matured as at December 20, 2010. The Bridge Facility consists of a

$130 million Term Loan Tranche and a $120 million Revolving Facility Tranche allowing operations to continue in the normal course of business as the Fund continues to pursue alternative long-term financing. Consistent with the terms of the prior Revolving Facility, the Fund is not permitted to make cash distributions to holders of its Units during the term of the Bridge Facility.

However, the Fund did have taxable income for 2010 and under the terms of the Trust Indentures of the Fund and the Operating Trust, it was required to distribute by December 31st of each year, all taxable income. For further details, see “Distribution Policy – Distributions and Taxable Income” below.

Cash distributions on Ordinary Units of the Partnership are subordinated to distributions on Priority Units of the Fund until 2017 except upon the occurrence of certain events. Each Ordinary Unit is entitled to receive a cash distribution on a monthly basis in an amount that is equal to the monthly cash distribution paid to each Priority Unit, provided each Priority Unit is first paid an amount that is equal to the monthly cash distribution of not less than $0.08333 per Priority Unit (the “Base Distribution”) before any amount is paid to the holder of the Ordinary Units. If, notwithstanding the subordination of the Ordinary Units, the cash available for distribution is not sufficient to make the Base Distribution on the Priority Units in a month, the amount of the deficiency shall not accumulate and will not be paid to holders of the Priority Units. If the cash available for distribution in a month is not sufficient to make a distribution on the Ordinary Units that is equal to the distribution on the Priority Units, the amount of the deficiency will accumulate and be paid to holders of the Ordinary Units if there is excess cash available for distribution, above the Base Distribution, in a subsequent month. Any accumulated distribution deficiency related to the Ordinary Units is not accrued by the Fund until such time, excess cash available for distribution above the Base Distribution is available and a cash distribution is approved by the Board. In the event of an exchange of Ordinary Units on a one-to-one basis for Priority Units after May 2, 2017, any accumulated distribution deficiency related to the Ordinary Units prior to the exchange is not accrued by the Fund until such time excess cash available for distribution above the Base Distribution is available, and a cash distribution is approved by the Board. Subsequent to the exchange, there will be no further accumulation of the distribution deficiency. As at December 31, 2010, the accumulated distribution deficiency was $2.5 million.

The Fund’s distribution policy and practices are impacted by various risks, uncertainties and other factors, which are discussed in greater detail in this section and in the sections entitled “Liquidity and Capital Resources” and “Forward-Looking Information” below.


Distributions and Taxable Income Under the terms of its Trust Indenture, the Fund is required on December 31st of each year to distribute to its unitholders an amount equal to the Fund’s taxable income for the year, to the extent that such amount has not already been distributed in the year. To the extent that such distributions cannot be made in cash, they are required to be made by an in-kind distribution of Fund units (which units are automatically consolidated such that the number of units held by a unitholder after the distribution of additional units and the consolidation is the same number of units held by the unitholder immediately prior to the distribution of additional units).

Therefore, on December 17, 2010 the Board of Trustees of the Operating Trust approved a distribution of $0.48 per Priority Unit. It was payable on December 31, 2010, and it was settled “in-kind” by the distribution of additional Priority Units (the “In-Kind Distribution”) on December 31, 2010. The In-Kind Distribution was intended to ensure that, as required under the terms of its Trust Indenture, the Fund would not be liable to pay taxes under the Income Tax Act (Canada) (the “Tax Act”) for the year ending December 31, 2010. The In-Kind Distribution distributed to Priority Unitholders additional Priority Units having a value at least equal to the Fund’s taxable income for the year. The amount of the In-Kind Distribution was equal to the estimated amount of the Fund’s taxable income for the purposes of the Tax Act for 2010 since no cash distributions had been made to Unitholders during 2010.

Immediately following the In-Kind Distribution, the Priority Units were automatically consolidated such that the number of outstanding Priority Units after the consolidation equalled the number of Priority Units outstanding immediately prior to the In-Kind Distribution. As a result, a Canadian resident Unitholder held the same number of Priority Units after the automatic consolidation as such Unitholder held immediately prior to the In-Kind Distribution.

As a result of the In-Kind Distribution, Unitholders had taxable income allocated to them in 2010 for Canadian tax purposes without any corresponding cash distribution, unless exempted from income tax pursuant to the Tax Act. The impact for Canadian residents holding the Priority units in an investment account was that the aggregate adjusted cost base of the Priority Units was increased by the amount of the In-Kind Distribution, or $0.48 per unit. There was no Canadian income tax consequence if the Priority Units were held by a registered retirement savings plan, a registered retirement income fund, a deferred profit sharing plan, a registered education savings plan, a registered disability savings plan or a tax-free savings account.

For non-resident Unitholders, they are subject to Canadian withholding tax on the In-Kind Distribution. Accordingly, unless alternative arrangements were made by the Unitholder with respect to the withholding tax obligations, the intermediary

through which the non-resident Unitholder held their Priority Units may have withheld a portion of the Priority Units distribution to the non-resident Unitholder. The withheld portion of the Priority Units may then have been sold by the intermediary on behalf of the non-resident Unitholder to satisfy such Unitholder’s withholding tax liability. The effect of such a withholding would be that the non-resident Unitholder held fewer Priority Units immediately following the In-Kind Distribution and the automatic consolidation than such Unitholder held immediately prior to the In-Kind Distribution.

Tax Pools The Fund has certain tax pools available to shelter taxable income. The largest of these tax pools comprise capital cost allowance (“CCA”). These pools are available to the Unitholders in their respective interest in the Partnership. As at the end of December 31, 2010, the CCA tax pools available were as follows:

($ thousands)Class Federal Québec Rate

1 $ 9,265 $ 9,285 4%1 6,748 6,765 6%3 740 687 5%6 4 3 10%8 5 2 20%10 53 21 30%17 9 8 8%26 347 338 5%39 – 1 25%41 130,291 140,255 25%Total $ 147,462 $ 157,365

Standardized Distributable Cash Standardized distributable cash is defined as the GAAP measure of cash from operating activities after adjusting for capital expenditures, restrictions on distributions arising from compliance with financial covenants restrictive at the time of reporting, and minority interests.

As a result of the limitation on distributions that were put in place by the Revolving Facility and the terms of the Bridge Facility, there was no standardized distributable cash in 2010.

LIQUIDITY AND CAPITAL RESOURCES

As at December 31, 2010, the Fund’s debt was $191.5 million (net of deferred financing fees), down from $207.9 million at the end of December 2009. The Fund’s cash and cash equivalents as at December 31, 2010 totalled $2.9 million, unchanged from December 31, 2009.



The Fund has a $250 million Bridge Facility in place. The Bridge Facility is comprised of a $130 million Term Loan Tranche and a $120 million Revolving Facility Tranche. The Bridge Facility was put in place to refinance the prior Revolving Facility of the Operating Trust that matured on December 3, 2010 and to fully repay all amounts outstanding in respect of the Operating Trust’s $153.5 million Senior Notes that matured on December 20, 2010. Its purpose is to enable the Fund to continue to pursue a long-term refinancing plan. The amount available to be drawn on the Revolving Facility portion will vary on a monthly basis and is based on percentages of the Fund’s inventory and accounts receivable from the previous month.

The amount available on the Revolving Facility Tranche of the Bridge Facility as at December 31, 2010 was $112 million, of which $65 million was drawn, including letters of credit outstanding.

Fluctuations in working capital balances as a result of operations are generally funded by, or used to repay, the Bridge Facility (or the prior Revolving Facility). During 2010, $527.3 million of debt was drawn and $540.7 million was repaid including the Senior Notes.

The terms of the Bridge Facility are substantially the same as the terms of the Operating Trust’s prior Revolving Facility, subject to certain modifications. The Bridge Facility also contains customary representations, warranties, covenants and conditions to funding. The Fund’s inability to meet these representations, warranties, covenants and conditions may require it to seek additional funding sources and may impact upon the Fund’s ability to make distributions. The Bridge Facility is secured by all of the assets of the Fund, the Operating Trust, the Partnership and the Manager.

The amended credit agreement entered into in respect of the Bridge Facility contains covenants that restrict the Fund (and its subsidiaries) in several respects, including their ability to make distributions or redeem or repurchase units. In addition, certain covenants under the Bridge Facility amended credit agreement require the Fund to maintain, at the end of each quarter, the following leverage ratio, interest coverage ratio, and current ratio: • The leverage ratio at the end of each quarter, on a rolling

four-quarter basis, is calculated by dividing the total debt at the end of the period by the earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the period, as defined in the Bridge Facility agreement, and must not exceed 4.25 to 1.

• The interest coverage ratio at the end of each quarter, on a rolling four-quarter basis, is calculated by dividing the EBITDA for the period by the total interest expense for that period net of the interest expense related to any subordinated loans, as defined in the Bridge Facility agreement, and must be no less than 3 to 1.

• The current ratio is calculated at the end of each quarter by dividing the current assets by the total of the current liabilities (which includes the revolving facility portion of the Bridge Facility but excludes the term portion), as defined in the Bridge Facility agreement, at the balance sheet date, and must be no less than 1 to 1.

All of the covenants under the Bridge Facility agreement were met as at December 31, 2010 and are summarized below:

Ratios December 31, 2010

Leverage ratio1 (must not exceed 4.25 to 1) 2.3 to 1Interest coverage ratio1 (must be no less than 3 to 1) 6.4 to 1Current ratio (must be no less than 1 to 1) 1.5 to 11 four quarter rolling average

The Bridge Facility agreement lists events that constitute an event of default should they occur. Events that constitute a default include the non-payment by the Fund of principal, interest or other obligations of the Fund in respect of the Bridge Facility agreement and a breach of any covenant pursuant to the Bridge Facility agreement. If any event of default occurs under the Bridge Facility agreement, the Bridge Facility lenders will be under no further obligation to make advances to the Fund and may require the Fund to repay any outstanding obligations pursuant to the Bridge Facility agreement, which would negatively impact the Fund’s ability to make cash distributions. There were no conditions of default existing as at December 31, 2010.

The Syndicate also required, as a condition to the Bridge Facility refinancing, that Xstrata Canada reaffirm its credit support, as provided in the past in connection with the Operating Trust’s prior Revolving Facility. In consideration for the credit support, the Operating Trust paid Xstrata Canada a fee of US$400,000. Xstrata Canada’s main items of credit support are discussed further below.

The maturity of the Bridge Facility is June 2, 2011, subject to a further extension of six months at the option of the Operating Trust at similar terms and conditions, and mandatory principal repayments in certain circumstances.


As at December 31, 2010, the Fund had a working capital deficiency of $59.9 million, mainly because of the Fund’s debt expiring in 2011. As discussed above, the Fund currently expects to refinance the existing Bridge Facility prior to its maturity. The Fund’s inability to further extend the Bridge Facility or secure a long-term refinancing may require it to seek additional financing sources. Any refinancing may be done at less favourable terms than what currently exist and may restrict future distributions and require that a portion of the debt be paid down. There is no assurance that such indebtedness could be renewed or refinanced, which would have an adverse material effect on the Fund. The Fund’s ability to implement a long-term refinancing plan with respect to the Bridge Facility is subject to various additional risks and uncertainties, including obtaining any necessary credit support from Xstrata Canada and/or the Manager, which currently provide credit support for the Fund’s Bridge Facility, that may be required or determined to be beneficial to the Fund and the Operating Trust in connection with any refinancing plan, together with those discussed under “Risks and Uncertainties” below.

This credit support by Xstrata Canada in respect of the Bridge Facility is currently provided in the form of: • limited recourse and/or unconditional guarantees, pledges

and general security agreements provided by affiliates of Xstrata Canada, including Canadian Electrolytic Zinc Limited (the Manager), which acts as the administrator of the Fund, manager of the Operating Trust and manager and operator of the Processing Facility;

• consent agreements pursuant to which the Manager has restricted its ability to terminate the Administration Agreement, Management Services Agreement and the O&M Agreement relating to the Fund, the Operating Trust and the Partnership (which is the direct owner of the Processing Facility); and

• consent agreements pursuant to which Xstrata Canada has also restricted its ability to terminate the Supply and Processing Agreement while the Fund’s current Bridge Facility is outstanding, even if such agreement is breached by the Partnership.

Further details concerning the Bridge Facility, the credit support of Xstrata Canada obtained in connection therewith and the terms of the amended credit agreement are contained in the Fund’s press release dated December 2, 2010 and its related material change report dated December 6, 2010. Copies are available on SEDAR at www.sedar.com. A copy of the amended credit agreement entered into in connection with the Bridge Facility is also available on SEDAR at www.sedar.com.

No independent obligation exists that would require Xstrata Canada and/or its affiliates to provide a similar level of credit support in connection with any long-term refinancing of the Bridge Facility. The lack of continued credit support by Xstrata Canada and its affiliates, if withheld in connection with any refinancing plan, could have a material adverse effect on the available credit, if any, and the related terms, conditions and covenants that may be extended to or required from the Fund and its affiliates in connection with any refinancing. In addition, the Fund expects that the terms and conditions of any long-term refinancing may include an obligation to repay a significant portion of the debt outstanding before May 3, 2017, the date Xstrata Canada’s supply obligation under the current Supply and Processing Agreement terminates. As discussed elsewhere in this MD&A, the Independent Committee of the Board has retained TD Securities as its independent financial advisor to assist it with its continuity consideration of potential long-term financing alternatives.

The Fund has provided forward-looking information regarding the Bridge Facility and its long-term refinancing plans, which are subject to various risks and uncertainties. Some of the risks, uncertainties and assumptions underlying this information can be found in the sections entitled “Risks and Uncertainties” and “Forward-Looking Information” below.

OUTSTANDING UNITS

Outstanding Unit Data As at February 16, 2011

Priority Units 37,497,975Ordinary Units and Special Fund Units 12,500,000

As noted above, a wholly-owned subsidiary of Xstrata Canada holds 12,500,000 Ordinary Units of the Partnership, which represent all of the outstanding Ordinary Units of the Partnership, and which are exchangeable for Priority Units on a one-for-one basis only after May 2, 2017, or earlier upon the occurrence of certain events. The 12,500,000 outstanding special voting units of the Fund listed above (the “Special Fund Units”) provide voting rights in respect of the Fund to the holder of Ordinary Units. Further details concerning the rights, privileges and restrictions attached to the Fund’s outstanding Priority Units and Special Fund Units and the outstanding Ordinary Units of the Partnership, are contained in the Fund’s 2009 Annual Information Form under the section entitled “General Description of the Capital Structure”. A copy is available on SEDAR at www.sedar.com.



CONTRACTUAL OBLIGATIONS

The following table shows the Fund’s contractual obligations schedule for the years 2011 to 2015:

(millions of Canadian dollars) Payments due by period

2015 Contractual Obligations Total 2011 2012 2013 2014 and beyond

Bank Debt $ 194.7 $ 194.7 $ – $ – $ – $ –Operating Leases 1.8 1.0 0.6 0.2 – –Purchase Commitments 13.5 10.2 2.4 0.9 – –Future Site Restoration and Reclamation 37.8 0.1 0.6 0.1 1.8 35.2Total $ 247.8 $ 206.0 $ 3.6 $ 1.2 $ 1.8 $ 35.2

TRANSACTIONS WITH RELATED PARTIES

Other than as described elsewhere, the Fund entered into the following transactions with related parties.

Pursuant to the O&M Agreement dated May 3, 2002 between the Partnership and the Manager, a wholly-owned subsidiary of Xstrata Canada, the Manager is responsible for the ongoing operation and management of the Processing Facility and provides management services to the Partnership in exchange for a management fee and reimbursement of certain specified costs incurred by the Manager in the course of performing its duties. These services include, among other things, preparing annual operating and maintenance plans and capital improvement plans for approval by the directors of the general partner of the Partnership, reporting to the general partner of the Partnership on the operation of the Processing Facility and the business of the Partnership, providing accounting and record keeping services including coordination and management of accounting, cash management, treasury and other systems and preparing financial statements and other reports on operations.

Pursuant to the Supply and Processing Agreement dated May 3, 2002 between Xstrata Canada and the Partnership, which expires on May 3, 2017, unless extended, Xstrata Canada is obligated to sell to the Partnership a maximum of up to 550,000 tonnes of zinc concentrate per year at a price based on the zinc metal price on the LME less a processing fee ($0.385 per payable zinc metal in 2010). Canada and the Partnership, Xstrata Canada is obligated to sell to the Processing Facility, except in certain circumstances, all of its zinc concentrate requirements up to 550,000 tonnes of zinc. Additionally, the Supply and Processing Agreement provides that Xstrata Canada will act as exclusive agent for

the Partnership to arrange for purchases of any additional zinc concentrate in excess of the 550,000 tonnes described above, and for sales of zinc metal and byproducts, and related hedging and derivative arrangements. The expiry of the Supply and Processing Agreement will result in a concurrent termination of the O&M Agreement. If the Supply and Processing Agreement terminates and is not replaced with a similar agreement providing for a known supply source of zinc concentrate, the Partnership will need to seek out alternative zinc concentrate supply relationships, including those which may cause it to become dependent on seaborne supplies of zinc concentrate.

Under the terms of an Administration Agreement dated April 18, 2002 between the Fund and the Administrator, the Administrator provides administrative services to the Fund and management services to the Operating Trust. Pursuant to the Administration Agreement, Computershare Trust Company of Canada, the sole trustee of the Fund, has delegated all of its power and authority to the Administrator and the Administrator provides certain administrative and support services to the Fund, including those necessary to: (i) ensure compliance by the Fund with continuous disclosure obligations under applicable securities legislation; (ii) provide investors relations services; (iii) provide or cause to be provided to Unitholders all information to which Unitholders are entitled under the Fund’s Trust Indenture including relevant information with respect to income taxes; (iv) call, hold and distribute materials, including notices of meetings and information circulars, in respect of all meeting of Unitholders; (v) provide for the calculation of distributions to Unitholders; (vi) attend to all administrative and other matters arising in connection with any redemption of units; and (vii) ensure compliance with the Fund’s limitations on non resident ownership. All costs relating thereto are for the account of the Fund.


Pursuant to the Management Services Agreement dated April 18, 2002 between the Operating Trust and the Manager, the Manager provides management services to the Operating Trust. These services include assisting the Operating Trust in: (i) developing, implementing and monitoring a strategic plan; (ii) developing an annual business plan which may include operational and capital expenditures budgets when appropriate; (iii) developing acquisition strategies, investigating potential acquisitions and analyzing the feasibility of potential acquisitions; (iv) carrying out acquisitions or dispositions and related financings required for such transactions; (v) assisting in connection with any financing of the Operating Trust or the Fund; and (vi) preparing, planning and co-ordinating management and Trustees’ meetings. In consideration for providing the services under the Management Services Agreement, the Manager is entitled to reimbursement of its direct and indirect costs and expenses incurred in connection with its duties under the Management Services Agreement.

For further details concerning the above agreements, reference is made to the Management Information Circular of the Fund dated October 18, 2010, the Fund’s 2009 Annual Information Form (under the headings “The Administration Agreement”, “The Management Services Agreement” and “The Operating and Management Agreement”), and the notes to the Audited Consolidated Financial Statements of the Fund for the year ended December 31, 2010 (under the headings “Significant Agreements” and “Related Party Transactions”). Copies are available on SEDAR at www.sedar.com.

Any agreements entered into by Xstrata Canada as agent on behalf of the Partnership with any party related to Xstrata Canada, and which are material to the Partnership, must be on terms that are, collectively, no less favourable to the Partnership than those available at the time from a reputable, non-related party. These agreements must be reviewed and approved by the Audit Committee of the Operating Trust, all of the members of which are unrelated to Xstrata Canada.

In addition, as discussed above under “Liquidity and Capital Resources”, Xstrata Canada and the Manager have entered into various agreements and provided certain consents in connection with providing credit support in respect of the Operating Trust’s existing Bridge Facility (which are the same as the credit support provided by Xstrata Canada and the Manager in respect of the Operating Trust’s prior Revolving Facility).

During the twelve month period ended December 31, 2010, Xstrata Canada sold to the Partnership $335.9 million of zinc concentrate (2009 – $283.1 million) and provided $1.2 million in sales agency services (2009 – $1.3 million). The sales agency services are provided on a cost recovery basis.

The administration, management and operating services provided by the Manager are provided on a cost recovery basis and for a management fee of $0.3 million per annum, adjusted upward annually by 2%. As a result of the Administration Agreement between the Fund and the Administrator, the Management Services Agreement between the Operating Trust and the Manager and the O&M Agreement between the Partnership and the Manager, the Manager has been paid the following amounts for administration, management and operating services in respect of the Fund and its subsidiaries and assets for the years ended December 31, 2010 and December 31, 2009, respectively.

Services provided by Xstrata Canada ($ millions) 2010 2009

Salary and benefits1 $ 67.5 $ 61.6Support services 1.2 1.2O&M Agreement management fee 0.3 0.3Total $ 69.0 $ 63.11 This represents all amounts paid in respect of salaries and benefits for all of the

employees of the Manager in connection with the operation of the Processing Facility and the services provided to the Fund and the Operating Trust.

In addition, the Fund undertakes other transactions with Xstrata Canada and affiliated companies, at terms that reflect market rates. The table below summarizes sales and purchases that were transacted with Xstrata Canada and affiliated companies for 2010 and 2009, respectively:

Sales and Purchases ($ millions) 2010 2009

Sales Sales of zinc metal $ 72.1 $ 80.3Sales of byproducts 21.5 27.4Purchases

Purchases of raw materials and operating supplies 8.9 4.2Credit support from Xstrata Canada $ 0.4 $ –



FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS

Due to the structure of the Processing Facility’s purchase and sale contracts, the Fund has the ability to manage its exposure to fluctuations in zinc market prices. Zinc metal products are generally sold approximately two months after the concentrate from which they are made is delivered. As a result, by pricing the “payable” zinc metal contained in zinc concentrate at the LME zinc reference price in the second month following its delivery, and by pricing the processing fee in Canadian dollars, the Supply and Processing Agreement limits the exposure to zinc metal price fluctuations during the period in which the concentrate is transformed into zinc metal. This results in matching the timing of pricing of the purchase of zinc concentrate with the expected timing of sales of the refined zinc metal produced from that concentrate. The Fund, through Xstrata Canada, enters into hedges (“inventory management program”) to the extent that the natural hedge does not fully minimize exposure to fluctuations in zinc prices. As at December 31, 2010, the Fund had bought forward approximately 16 million pounds of zinc, related to inventory management hedges. The fair value of these positions as at December 31, 2010 was $2.2 million and is recognized as a commodity financial instrument asset on the Fund’s consolidated balance sheet.

In addition, some customers request a fixed sales price (instead of the LME average price in the month of shipment) in order to lock in the price of their zinc purchases for a future period of time, generally not exceeding one year. These arrangements, referred to as fixed forward sales contracts, are generally made available to customers who request them and who meet the Fund’s credit criteria for such contracts. When entering into a fixed forward sales contract, the Fund, through its sales agent, Xstrata Canada, offsets this price risk by hedging with appropriate futures contracts with maturities and quantities which will match those which the customer has contracted to purchase the metal. These futures contracts typically allow the Fund to receive the LME average price plus premium in the month of shipment, while customers pay the agreed-upon price plus premium. In the event that the futures contracts have to be terminated early, due to the customer cancelling a fixed price order, Xstrata Canada, on behalf of the Fund has the right to charge the customer with the cost of settling the LME contract. The fair value of these open futures contracts as at December 31, 2010 was recognized as a commodity hedging instrument asset of $3.5 million and a long-term commodity hedging instrument asset of $0.4 million on the Fund’s consolidated balance sheet.

The Fund has applied hedge accounting to its fixed forward sales contracts, and as such, in addition to recording the fair value of the fixed forward contract, the fair value of the related fixed sales commitment has also been recognized as a firm commitment liability of $3.5 million and a long term-firm commitment liability of $0.4 million. Any net difference in the change in the fair value of both items between reporting dates represents the ineffective portion of the hedge, and is recorded as a commodity hedging gain or loss.

The Fund does not enter into any hedging contracts for the purposes of speculation.

The Fund has separated and recorded at fair value, embedded derivatives resulting from the provisional pricing feature in the Supply and Processing Agreement. Under the terms of this agreement, final prices for purchases of concentrate (“quotational pricing”) are based on the LME price prevailing on a specified future date after shipment (“quotational period”). The Fund accounts for changes in the fair value of unsettled concentrate payable amounts resulting from quotational pricing with reference to forward LME rates for the remaining quotational period through gains or losses recorded in raw material purchases costs and corresponding adjustments in accounts payable and accrued liabilities. During the twelve month periods ended December 31, 2010, the Fund recorded an increase of raw material purchase costs of $2.5 million related to the change in fair value of the embedded derivatives resulting from the quotational pricing feature of its zinc concentrate payables (2009 – an increase of $4.3 million).

The Fund has exposure to the US dollar for its cash, accounts receivable, inventory, accounts payable and accrued liabilities and bank debt. The Fund attempts to manage the overall economic exposure to the US dollar by matching US dollar assets to US dollar liabilities. This currency exposure is managed in part through US dollar overnight transactions. As at December 31, 2010, the Fund had bought forward US dollars with a notional amount of US$79.1 million and sold forward dollars with a notional amount of $79.1 million. An unrealized gain of $0.4 million related to these open positions was recorded in accounts receivable as at December 31, 2010.


CRITICAL ACCOUNTING ESTIMATES AND CHANGES

IN ACCOUNTING POLICY

Reference should be made to the Fund’s Audited Consolidated Financial Statements for the year ended December 31, 2010. A copy is available on SEDAR at www.sedar.com.

Future Site Restoration and Reclamation Estimated future site restoration and reclamation costs included within future site restoration and reclamation may vary based on changes in operations, costs of restoration and reclamation activities, and regulatory requirements.

The majority of the estimated future site restoration and reclamation expenditures currently recorded relate to the reclamation of residue ponds at the Processing Facility. Although the ultimate amount to be incurred is uncertain, the liability for future site restoration and reclamation on an undiscounted basis is estimated to be approximately $37.8 million. The cash flows required to settle the liability are expected to be incurred from now until 2046. The estimated future site restoration and reclamation expenditures may vary based on changes in operations, cost of restoration and reclamation activities and regulatory requirements.

The estimate for future site restoration and reclamation impacts upon the amount of reclamation expense that is incurred on the statement of net earnings, and the balance of the future site restoration and reclamation found in the long-term liabilities section of the balance sheet. Actual site restoration and reclamation expenditures reduce the Fund’s cash realized from operations.

Revenue Recognition The Fund recognizes revenue from the sale of refined metals and byproducts at the time of the sale, when the rights and obligations of ownership pass to the buyer. This generally occurs upon shipment. Prices for provisionally priced sales are based on market prices and exchange rates prevailing at the time of shipment and are adjusted based upon market prices and exchange rates until final settlement with customers, pursuant to the terms of sales contracts. Price changes for shipments awaiting final pricing at the end of a reporting period could have a material effect on future revenues. As at December 31, 2010, $7.5 million in revenues were awaiting final pricing.

The following table provides an analysis of the revenues awaiting final pricing:

Accountable Average Metal Content Provisional Price (tonnes) (U.S.$/pound)

Zinc metal 331 $ 1.10Copper in cake 915 $ 4.37

The Fund makes a portion of its sales based on the average price from the previous month (month prior pricing). In a market in which zinc prices are rising, a portion of the Fund’s revenues will lag behind the higher zinc prices; while in a market in which zinc prices are falling, a portion of the Fund’s revenues will benefit from higher zinc prices from the month prior.

Income Taxes The Fund follows the liability method of accounting for future income taxes. Under the liability method, future income tax assets and liabilities are determined based on differences between the accounting basis and the tax basis of the assets and liabilities, and are measured using the currently substantively enacted tax rates and laws expected to apply when these differences reverse. The effect of a change in income tax rates on future tax liabilities and assets is recognized in income in the period in which the change occurs.

In June 2007, the Federal Government substantively enacted its tax legislation, Bill C-52, relating to the taxation of existing income and royalty trusts, at effective rates similar to Canadian corporations commencing in 2011. Prior to June 2007, the Fund estimated the future income tax on certain temporary differences between amounts recorded on its balance sheet for book and tax purposes at a nil effective tax rate. Under the new legislation, the Fund now estimates the effective tax rate on post 2010 reversal of these temporary differences to be 28.4% in 2011 and 26.9% in 2012 and beyond. The Fund has estimated its future income taxes based on its best estimates of future results of operations, tax pool claims and assuming no material changes to the Fund’s organizational structure.

The Fund estimates that the unrecognized temporary differences outstanding as at December 31, 2010 are approximately $57 million. The future tax liability related to the Partnership is only recognized for the portion of the Partnership that is owned by the Priority Unitholders. The Fund’s estimate of its future income taxes will vary based on actual results of the factors described above, and such variations may be material.



Taxable income and net taxable capital gains for the year that are not distributed to unitholders in cash or in units are generally taxed in the Fund at the highest federal and provincial tax rates that is applicable to individuals. Effective as at January 1, 2011, distributions of taxable income are taxed at the “Specified Investment Flow-Through Entity” rate. This will result in a two-tiered tax structure similar to that of corporations whereby the taxable portion of distributions will be subject to income tax payable by the Fund at a rate of 28.4% in 2011 and 26.9% in 2012 and beyond, while taxable Canadian Unitholders will receive the favourable tax treatment on distributions currently applicable to qualifying dividends.

Property, Plant and Equipment Included in the $487.2 million of assets as at December 31, 2010 ($501.4 million as at December 31, 2009) were property, plant and equipment with a carrying value of $285.7 million (2009 – $295.8 million). This amount represents 59% (2009 – 59%) of the book value of the asset base. As such, the estimates used in accounting for property, plant and equipment and the related amortization charges are critical and have a material impact on the Fund’s financial condition and earnings. Property, plant and equipment are recorded at cost and the amortization is based on estimated service lives of the assets, calculated on a straight line basis. Assets under construction are not amortized until put into use.

During the first quarter of 2010, the Fund reviewed and increased the useful life of certain property, plant and equipment, based on experience with these assets, to better reflect their use in time. These changes were applied prospectively from January 1, 2010. The impact on amortization expense for the twelve months ended December 31, 2010 was to decrease amortization expense by $4.3 million.

Property, plant and equipment are regularly reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is assessed by comparing the carrying amount of an asset to be held and used with the sum of the undiscounted cash flows expected from its use and disposal. If such assets are considered impaired, the impairment loss to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value, generally determined on a discounted cash flow basis. Any impairment results in a write-down of the asset and a charge to net earnings during the year.

Inventories As at December 31st, zinc and byproduct related inventories at the end of 2010 and 2009 included the following balances:

($ millions) 2010 2009

Raw materials $ 18.2 $ 28.3Work-in-process 14.4 24.3Finished products 37.2 49.6 $ 69.8 $ 102.2

These inventories are valued at the lower of average cost or net realizable value. Based on the estimated volumes, the Fund has estimated the value of raw materials and work-in-process. Costs represent the average cost and include raw material purchase costs, labour, energy, supplies and amortization of certain plant equipment. Realizable value includes metal prices, net of the costs required to complete the production of zinc metal. As at December 31, 2010 and December 31, 2009, all of the above inventories were recorded at cost.

Supplies Inventory As at December 31, 2010, the supplies inventory balance was $8.8 million (December 31, 2009 – $8.6 million). The Fund uses the accounting principle of the lower of average cost and net realizable value. If a portion of the supplies inventory became obsolete, the Fund would be required to write off the difference between the salvage value and the book value of the obsolete inventory.

If a supplies inventory write-off were required, net earnings for that year would be reduced and the balance in the inventories account would have to be lowered. There would be no net impact on the Fund’s cash realized from operations.


COMMITMENTS AND CONTINGENCIES

Manager’s Pension Plan Upon the termination of the O&M Agreement, the Partnership will acquire the Manager from Xstrata Canada. If this occurs, the Partnership will establish a pension plan for the employees of the Manager. Pension plan assets and liabilities will be transferred into the newly-established pension plan, subject to obtaining regulatory approvals.

As at December 31, 2010, the estimated liability of the Manager’s pension plan was $124.5 million (2009 – $106.5 million). There is currently $117.7 million of assets within the Manager’s pension plan (2009 – $104.5 million).

The cost of providing benefits through defined benefit pension plans and post-retirement benefit plans is determined by an actuarial calculation. Cost and obligation estimates depend upon management’s assumptions about future events, which are used by actuaries in calculating such amounts. These assumptions include discount rates, the expected return of plan assets and future compensation increases. In addition, actuarial consultants utilize subjective factors, such as withdrawal and mortality rates. Actual results may differ materially from those estimates based on these assumptions.

Litigation In August 2004, the Processing Facility was served with a motion to form a class action before the Québec Superior Court, following an accidental discharge of sulphur trioxide. In June 2008, the Québec Superior Court dismissed the motion to institute a class action. The plaintiff appealed the decision. In August 2009, the Québec Court of Appeal dismissed the motion.

In December 2009, the Processing Facility was served with a new motion for leave to institute a class action. The Processing Facility brought several motions to have the motion for leave to form the class action dismissed. The Québec Superior Court dismissed the Processing Facility’s motions in December 2010. The Processing Facility will appeal the decisions on those motions before the Québec Court of Appeal in February, 2011. The motion for leave to form a class action is expected to be heard by the Québec Superior Court in late March 2011, pending the decision of the Québec Court of Appeal.

The Manager continues to maintain that the class action suit is unfounded.

Appropriation of Land The Fund is currently in discussions with Québec’s Ministry of Natural Resources regarding land that the Fund is currently using. This land was appropriated by the provincial government a number of years ago. The Fund’s cash payment, if any, cannot be determined.

Guarantees Some of the Fund’s inceptive agreements, specifically those related to the acquisition of the Processing Facility and the debt, include an indemnification provision where the Fund may be required to make payments to Xstrata Canada or lenders for breach of fundamental representations and warranty terms in the applicable agreement. As at December 31, 2010, the Fund does not believe these indemnification provisions would require any material cash payment by the Fund.

The Fund indemnifies its Trustees and officers against claims reasonably incurred and resulting from the performance of their services to the Fund and the Operating Trust, and maintains liability insurance for its Trustees and officers.

CONVERGENCE TO INTERNATIONAL FINANCIAL REPORTING

STANDARDS (“IFRS”)

Effective January 1, 2011 Canadian publicly listed entities are required to prepare their financial statements in accordance with IFRS as issued by the International Accounting Standards Board (“IASB”), instead of current Canadian GAAP. The changeover date applies to interim and annual financial statements relating to years beginning on or after January 1, 2011. For the Fund, the changeover date of January 1, 2011 will require the preparation of the initial opening comparative balance sheet as of January 1, 2010 (the “Effective Date”) and the restatement for comparative purposes of amounts reported by the Fund for the year ended December 31, 2010. The Fund is on track with its schedule for initial reporting under IFRS effective January 1, 2011 for its interim consolidated financial statements for the period ending March 31, 2011.



This table below provides investors and others a better understanding of the Fund’s IFRS changeover plan and the resulting effects of IFRS accounting on, for example, the Fund’s financial statements and operating performance measures. Readers are cautioned that it may not be appropriate to use such information for any other purpose. This information reflects the Fund’s most recent assumptions and expectations. Circumstances may arise which could change these assumptions or expectations.

Key Activity Key Milestones Status

IFRS Conversion Scoping Phase Review of current Canadian GAAP standards The review is complete. versus IFRS. Identification of significant differences.Decisions on Accounting Policies and Decision on accounting policy choices and The Fund has completed the assessment of IFRS 1 First-Time Adoption IFRS 1 for each assessed area. differences. It has made decisions on Assessment of differences between IFRS accounting policy choices and IFRS 1 First-Time and the Fund’s current Canadian Adoption exemptions for each area, GAAP practices and accounting policies. as of the Effective Date.Information Technology (“IT”) Evaluation Identification of IT requirements for The Fund has identified the IT requirements for IFRS conversion. IFRS conversion. The changes identified do not represent significant changes to the Fund’s

IT systems.Control Environment: Internal Control over Review and assessment of impact As the Fund implements IFRS accounting Financial Reporting (“ICOFR”) and of accounting policy changes relating to policies and IFRS 1 exemptions, appropriate Disclosure Controls and Procedures (“DC&P”) IFRS conversion on ICOFR and DC&P. changes are being made to ensure effective

ICOFR and DC&P. The changes identified do not require significant changes to the Fund’s ICOFR and DC&P. We have provided on-going training to key employees, senior management and Board of Trustees in regards to IFRS.

Financial Statement Preparation Identification of transactions impacted Changes and re-mapping of the financial by IFRS conversion. statements and notes to the financial

statements started in 2009 and continues into 2011.

Financial Impact Analysis for Analysis of differences between Canadian Quantification of differences between Transactional Areas GAAP and IFRS that was completed is Canadian GAAP and IFRS is near completion. being quantified by management. The results of the policy choices made to date

and the analysis thereon are outlined below. Business Activities Impact Identification of impacts on business Identification of impacts is near completion activities to be completed. and we do not foresee major business activities

impact. The Fund does not expect the transition to IFRS to result in any breach of covenants of the Bridge Facility.

In order to prepare the Fund’s opening balance sheet as of the Effective Date, the Fund has identified the following IFRS 1 exemptions and IASB pronouncements that differ from Canadian GAAP and that are expected to impact the Fund’s consolidated financial statements.


Basis for Consolidation Under Canadian GAAP, the Fund determines whether it should consolidate an entity using the variable interest entity or the voting control model. Under IFRS, the Fund will consolidate an entity if it is determined to be controlled by the Fund similar to the voting control model or if the entity is deemed to be a Special Purpose Entity (“SPE”) when the substance of the relationship indicates control and is no different than if it is a subsidiary. Indicators of control include, amongst other factors, the power to govern the financial and operating policies of an entity, having more than one half of the voting power, having half or less of the voting power but having de facto control, being exposed to the SPE’s benefits and risks or when the activities of the SPE are being conducted on behalf of the reporting entity.

As a result, the Fund has concluded that the Manager will be consolidated by the Fund under IFRS. This change primarily results in a preliminary increase of approximately $6.5 million in the Fund’s accrued benefit obligation of the Manager’s pension plan, net of plan assets as at the Effective Date. The consolidation of the Fund is not expected to have a material impact on the net earnings of the Fund. After the Effective Date, the Fund plans to recognize its future actuarial gains and losses through Other Comprehensive Income with no impact on earnings.

In addition, the Fund will disclose additional items specific to IAS 19, including the disclosure of employee benefits for key management personnel as required under IAS 24, Related Party Transactions.

Classification of Priority and Ordinary Units IAS 32 requires a financial instrument which gives the holder the right to put the instrument back to the issuer for cash to be classified as a financial liability, unless certain criteria are met to allow for classification as equity. Since the Fund Priority Units give unitholders the right to put back their units to the Fund, the Fund expects that the Priority Units would be reclassified from equity to liabilities under IFRS. This would mean that any distribution to Unitholders which would currently be treated as equity transactions would be shown as expenses in the statement of comprehensive income under IFRS.

There is no equivalent standard under IFRS to EIC 151 under Canadian GAAP dealing with exchangeable units. In addition, the Ordinary Units do not provide unitholders the right to put back their units to the Fund. Therefore, the Ordinary Units are expected to be reclassified from non-controlling interests into unitholders’ equity in the consolidated financial statements under IFRS.

Borrowing Costs IFRS requires the capitalization of borrowing costs directly attributable to the acquisition, construction, or production of a qualifying asset as part of the cost of that asset. Under Canadian GAAP, the Fund made an accounting policy choice to expense these costs as incurred. Upon the adoption of IFRS, the Fund will capitalize borrowing costs of qualifying assets. January 1, 2010 has been selected as the transition date to adopt the IFRS requirements for borrowing costs. The Fund did not have any significant qualifying assets as at January 1, 2010 or throughout the year ending December 31, 2010. As a result, this accounting difference is not expected to have any impact on the Fund 2010 financial statements under IFRS.

Impairment of Long-Lived Assets Canadian GAAP generally uses a two-step approach to impairment testing: first comparing asset carrying values with undiscounted future cash flows to determine whether impairment exists, and then measuring any impairment by comparing asset carrying values with the fair value. IFRS uses a one-step approach for both testing for and measurement of impairment, with asset carrying values compared directly with the recoverable amount (defined as the higher of fair value less costs to sell and value in use both using discounted future cash flows). In addition, under IFRS, any impairment loss must be reversed, if the circumstances leading to the impairment change and cause the impairment to be reduced.

As at the Effective Date, the Fund does not expect an asset impairment due to the diffrences in methodologies.

Provisions IFRS Provisions, Contingent Liabilities, and Contingent Assets requires a provision to be recognized when: there is a present obligation as a result of a past transaction or event; it is probable that an outflow of resources will be required to settle the obligation; and a reliable estimate can be made of the obligation. “Probable” in this context means more likely than not. Under Canadian GAAP, the criterion for recognition in the financial statements is “likely,” which is a higher threshold than “probable.” Therefore, it is possible that some contingent liabilities would meet the recognition criteria under IFRS that were not recognized under Canadian GAAP.

The Fund does not expect the difference in methodologies to result in recording of additional provisions upon transition to IFRS.



Future Site Restoration and Reclamation Differences between IFRS and Canadian GAAP exist in relation to the measurement of provisions, such as the methodology for determining the best estimate where there is a range of equally possible outcomes, and the requirement under IFRS for provisions to be discounted where material, using the appropriate current market-based pre-tax discount rate. Further, IFRS 1 allows for a “short-cut” method to calculate the opening depreciated cost of the asset relating to the future site restoration and reclamation provision rather than calculating the asset since inception date. The change in methodology is expected to give rise to an increase to the Fund’s Future Site Restoration and Reclamation provision of approximately $7.6 million (pre-tax) and is expected to decrease the Fund’s annual reclamation expense in 2010 by approximately $0.1 million.

Property, Plant and Equipment IFRS provides a policy choice for an entity to either apply a historical cost model or a revaluation model in valuing property, plant and equipment. The Fund expects to use the historical cost model to value property, plant and equipment.

IFRS 1 provides an optional exemption on first-time adoption to measure an item of property, plant and equipment at its fair value and use that fair value as its deemed cost. The Fund does not plan to take the IFRS optional exemption, and will continue to use the cost under Canadian GAAP as of the Effective Date.

Under IFRS, where part of an item of property, plant and equipment has a cost that is significant in relation to the cost of the item as a whole, it must be componentized and depreciated separately from the remainder of the item. Canadian GAAP is similar to these requirements. The Fund does not expect the impact of componentization or our other policy choices related to property, plant and equipment to have a material effect on its consolidated financial statements.

Revenue Recognition Some differences between IFRS and Canadian GAAP exist in relation to the measurement and timing for the recognition of revenue. These differences do not apply to the Fund’s current revenue streams, therefore, there are no expected differences to the Fund’s revenue recognition on transition to IFRS.

Income Taxes Changes in accounting policies under IFRS noted above will impact the corresponding future tax asset or liability.

Financial Instruments Under IFRS, the Fund will continue to assess the effectiveness of hedge relationships quantitatively and hedge ineffectiveness will be recognized in net earnings. The Fund does not expect differences to the Fund’s accounting for financial instruments on transition to IFRS.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

As at December 31, 2010, an evaluation of the effectiveness of the issuer’s disclosure controls and procedures (as such term is defined under the rules adopted by the Canadian securities regulatory authorities) was carried out by management, under the supervision of, and with the participation of, the Manager’s chief executive officer (“CEO”) and chief financial officer (“CFO”).

Based upon that evaluation, the CEO and CFO concluded that as at such date, the Fund’s disclosure controls and procedures were appropriately designed and were operating effectively such that information relating to the Fund required to be disclosed by the Fund in the reports which the Fund file or submit to such regulatory authorities (a) is recorded, processed, summarized and reported within the time periods specified under applicable securities laws, and (b) is accumulated and communicated to the Fund’s management, including the CEO and CFO, to allow timely decisions regarding disclosure. Although the Fund’s disclosure controls and procedures were operating effectively as at December 31, 2010, there can be no assurance that the Fund’s disclosure controls and procedures will detect or uncover all failures of persons within the Fund and its subsidiaries to disclosure material information otherwise required to be set forth in the annual regulatory filings.


INTERNAL CONTROLS OVER FINANCIAL REPORTING

During 2010, the Fund assessed the design and effectiveness of internal controls over financial reporting. The design of internal controls over financial reporting was evaluated as defined in Multilateral Instrument 52-109 – Certification of Disclosure on Issuers’ Annual and Interim Filings. Based on the results of this evaluation, the CEO and CFO concluded that as at December 31, 2010 the internal controls over financial reporting were appropriately designed and were operating effectively to provide reasonable assurance that the Fund’s financial reporting is reliable and that its consolidated financial statements were prepared in accordance with Canadian GAAP and no material weaknesses were identified through their evaluation.

Management also concluded that during the year ended December 31, 2010, no changes were made to internal controls over financial reporting that would have materially affected, or would be reasonably likely to materially affect those controls.

RISKS AND UNCERTAINTIES

Where appropriate, the Fund has included comments on risks and uncertainties throughout the MD&A. The following are additional risks and uncertainties that have not been included elsewhere in the document. The Fund is also subject to certain risks and uncertainties that are common in the zinc processing industry and the market environment generally and that may affect future performance, events, results and operations. The risks and uncertainties included here are not exhaustive. The Fund operates in a very competitive and rapidly changing environment. New risk factors may emerge from time to time and it is not possible for the Fund to predict all such risk factors, nor can it assess the impact of all such risks factors on the Fund’s business. In addition, historical trends discussed elsewhere in this MD&A should not be used to anticipate events, performance, results or trends in future periods.

Operational Risks The Processing Facility is dependent upon the continuing supply of zinc concentrate. Currently, Xstrata Canada is obligated to supply zinc concentrate based on the terms set out in the Supply and Processing Agreement. During the occurrence of an event of force majeure, the obligations of Xstrata Canada will be suspended to the extent that such obligations cannot be performed as a result of such force majeure. If the Fund is not able to secure a supply of zinc concentrate on favourable terms because of the termination of the contract in 2017, or during a force majeure situation, or if Xstrata Canada fails to fulfill all of its obligations under the Supply and Processing Agreement, its cash realized from operations may decline, which could in turn have a material adverse effect on the Fund’s business, cash flows and results of operations.

The current economic conditions facing the Fund’s markets, the credit environment and changes in laws applicable to income funds present the Fund with some potential challenges. The Board, on the advice of its Independent Committee and with the assistance of financial and legal advisors, continues to explore and evaluate a number of options on behalf of the Fund as it seeks to restore the distribution at sustainable levels and to maximize Unitholder value while pursuing a responsible long-term financing plan for the Fund. The Trustees and the Fund currently intend to pursue a business plan, operating plan, distribution policy and capital structure which account for:• the need for the Processing Facility to make such investment

as is necessary to remain competitive;• the need to secure suitable zinc concentrate supplies

on a long-term commercial basis;• the need for the Fund to remain financially viable and

protect Unitholders’ equity interests to the end of the life of the Supply and Processing Agreement and beyond;

• the need for the Fund to secure its long-term future and protect the interests of all affected stakeholders, including Unitholders, employees, suppliers, customers and the communities of Salaberry-de-Valleyfield, Québec; and

• the need for the Fund to make adequate allowances for employee, environmental and closure obligations and responsibilities.



However, there can be no assurance that the Fund’s business plan, operating plan, distribution policy and/or capital structure will be able to take into account all of the above objectives or do so on a successful basis.

At normal operating levels, the Processing Facility purchases approximately 1,200 million kilowatt hours per year from Hydro-Québec at the market price charged to industrial users. During 2010, the Fund’s electricity costs were approximately $54.3 million (2009 – $49.0 million). Increases in energy costs could adversely affect cash realized from operations. Changes in the Processing Facility’s electricity costs are currently partially offset by adjustments to the processing fee in the following year. There can be no assurance that a material increase in such electricity costs can be offset by adjustments to the processing fee in the future. In addition, the interruption or unavailability of such electricity could have a material adverse impact upon the operations of the Processing Facility, which could in turn have a material adverse effect on the business, cash flows and results of operations of the Fund.

Business Risks Demand for the Processing Facility’s products is a function of world industrial production growth, the development of new uses and markets, and substitution. Demand for our products is also impacted by general business and economic conditions and the condition of financial and credit markets.

The Fund only has a fixed storage capacity for sulphuric acid at the Processing Facility (approximately 37,000 tonnes). The availability of storage facilities outside of the Processing Facility is limited due to the special material requirements for such storage facilities. In a market where sulphuric acid sales have significantly slowed and the Fund is not able to secure additional storage capacity, the Fund’s ability to produce zinc and sulphuric acid may be reduced.

The global zinc market has fundamentally changed in recent years. Factors that have the potential to positively and/or negatively impact the Fund’s business in the future include the increasing influence of demand from China and India as industrialization and urbanization continues in their economies, the growth in low cost smelting capacity in China and the decline in mined zinc from traditional North American sources that may see North American smelters increasingly dependent on seaborne zinc concentrate for their supply. The Fund must be prepared to adjust to these issues and, in particular, their impact on the availability of feed sources and treatment charges upon the termination of the Supply and Processing Agreement. The Fund’s failure or inability to adjust to such issues, or to do so in a manner that is satisfactory or successful, may have a material adverse effect on the Fund’s business, results of operations and financial condition.

On January 1, 2011, the specified flow-through entity legislation became effective and income funds are no longer able to make distributions to unitholders without the imposition of entity level taxation. The Fund has the option of either remaining as a taxable income trust or converting to a corporation. However under both scenarios, the cash realized from operations will be negatively impacted by additional income tax payable. The Trustees are considering the tax and other implications of conversion while also considering the implications to Unitholders of remaining as a trust.

The Processing Facility is dependent upon key customers that are relatively close to the Processing Facility. In 2010, the Processing Facility’s 10 largest customers accounted for approximately 68% (2009 – 72%) of its direct or indirect sales (on a volume basis), with its largest customer accounting for 22% (2009 – 19%). The loss of a significant customer may have a materially adverse effect on the Fund’s financial position and cash realized from operations.

In 2010, the Processing Facility sold more than 98% (2009 – 98%) of its zinc to customers in the United States and Canada. If the Processing Facility lost certain customers in the United States and Canada, there is a risk that it would be forced to find alternative markets. This could increase distribution costs, thereby adversely affecting future cash realized from operations.

A portion of the Processing Facility’s Net Revenues results from the premiums paid for value-added products, such as zinc shapes, zinc shot and zinc powder. Changes in the supply and demand for these products can cause premiums to fluctuate, impacting upon the Fund’s cash realized from operations. In 2010, each 0.1 cent US change in the zinc premium impacted the Fund’s annualized sales and cash realized from operations by US $0.6 million (2009 – US $0.5 million). See also “Forward-Looking Information” below.

The Processing Facility is dependent upon local transportation companies to deliver its product to its customers. Changes in the rates charged to make these deliveries or a major disruption in service, could increase distribution costs or adversely impact the Processing Facility’s ability to satisfy its obligations to its customers, thereby adversely impacting cash realized from operations and potentially exposing the Fund and its business to additional liabilities.


A portion of the Processing Facility’s Net Revenues results from sale of byproducts, such as sulphuric acid and copper in cake, as well as from the sale of zinc metal. Changes in the demand and supply of these products can cause them to fluctuate, impacting upon the Fund’s cash, results of operations and business.

Access to Credit The Operating Trust’s Bridge Facility matures on June 2, 2011, subject to a further 6-month extension and, accordingly, the Fund’s future business and operating plans, strategy, viability depends on its ability to secure a long-term refinancing alternative. The availability of such refinancing will depend on a variety of factors, many of which are beyond the Fund’s control, including the ability or willingness of Xstrata Canada and/or its affiliates to provide any credit support that the lenders may require. In addition, unfavourable financial market conditions, a material default or breach of a bank covenant that results in the Fund’s existing Bridge Facility being withdrawn, decreases in sales, a deterioration in market or economic conditions, any material disruption to the Processing Facilities processing and production activities or in its business strategy, among other things, could result in diminished availability of refinancing alternatives or increase the associated costs thereof. There can be no assurance that the Operating Trust will be successful in securing a long-term refinancing or on terms that are similar to those of the existing Bridge Facility or acceptable to the Board.

Borrowing Risks As at December 31, 2010, the Fund had approximately $191.5 million of indebtedness, the majority of which represents funds drawn under its existing Bridge Facility.

The Fund is subject to the risks associated with a long-term refinancing of the Bridge Facility, including the risks that cash flow from operations will be insufficient to meet required payments of principal and interest, the risk that the existing Bridge Facility will not be able to be refinanced or that the terms of such refinancing will not be as favourable to the Fund. In addition, the Fund is subject to the risk that its interest expense may increase on any refinancing of existing indebtedness or on its current Bridge Facility that bears interest at floating rates if interest rates increase, which could have a material adverse effect on the results of operations of the Fund.

The Fund’s Bridge Facility arrangements contain certain covenants and representations and warranties, the breach of which could result in a default and the acceleration of maturity of the existing Bridge Facility. The Fund and various of its subsidiaries and affiliates have granted security interests over all of their assets to secure indebtedness owing under Bridge Facility. If the Fund is not able to meet its debt service obligations, it risks the loss of some or all of its assets. For further details concerning the Fund’s Bridge Facility and the risks and uncertainties relating thereto, see “Liquidity and Capital Resources” above.

Reliance on the Fund Administrator and Manager The Fund is dependent upon Xstrata Canada for the operation and maintenance of the Processing Facility. The Fund is also dependent upon Xstrata Canada as its principal supplier of zinc concentrate to the Processing Facility and as its exclusive sales agent for the purchase of additional zinc concentrate and the sale of zinc metal and byproducts and related hedging and derivative arrangements, all pursuant to the Supply and Processing Agreement. The Supply and Processing Agreement expires in May 2017, or earlier in certain circumstances, unless extended. Upon termination, the Partnership will be required to establish replacement arrangements for the operation of the Processing Facility.

The Fund is also dependent upon the Manager, a subsidiary of Xstrata Canada, for administration and management of the Fund and the Operating Trust. The failure of Xstrata Canada, the Manager or their affiliates to perform their obligations pursuant to and in accordance with the Administration Agreement, Management Services Agreement, O&M Agreement, or the Supply and Processing Agreement, or the termination or expiration of any of such agreements, is likely to have a material adverse impact on the Fund and its business, operations and financial condition.

In addition, the obligations under the Bridge Facility are currently supported by security provided by Xstrata Canada, the Manager and other wholly-owned indirect subsidiaries of Xstrata Canada. This security includes certain limited recourse and unconditional guarantees, general security agreements and pledges provided by these parties. Additionally, the Manager and Xstrata Canada have provided consents to the assignment of the Administration Agreement, Management Services Agreement, O&M Agreement and Supply and Processing Agreement, as applicable, in which they have each limited their ability to terminate such agreements, even in the event of the insolvency of the Fund, the Operating Trust or the Partnership, as applicable. No independent obligation exists that would require Xstrata Canada and the other parties noted above to provide an identical or similar security package as is currently provided with respect to a refinancing of the



Bridge Facility. A lack of support from Xstrata Canada and the Manager (and related provision of security) could have a material adverse effect on the available credit, if any, and related terms, conditions and covenants that may be extended to or required from Operating Trust and the Fund by any lenders as part of a long-term refinancing.

Distributions Are Not Guaranteed and May Fluctuate with the Fund’s Performance Pursuant to the terms of the Bridge Facility, the Fund is prohibited from making any cash distributions to its Unitholders. Even in the absence of such contractual restrictions, cash distributions are not guaranteed and may fluctuate with the Fund’s performance. The Fund depends on income generated from the sale of zinc products produced from the Processing Facility to make such distributions. There can be no assurance regarding the amount of revenue generated by the Fund. The amount of distributable income will depend upon numerous other factors, including the profitability of the business, fluctuations in working capital, interest rates, capital expenditures, actual and contingent liabilities, including environmental remediation and closure obligations, and other factors which may be beyond the control of the Fund. If the Trustees determine that it would be in the best interests of the Fund, they may reduce for any period the distributable income to be distributed to the Unitholders.

Impact of the US/Canadian Dollar Exchange Rate A portion of the Processing Facility’s Net Revenues is impacted by the US/ Canadian dollar exchange rate. Since the inception of the Fund, the Canadian dollar has generally strengthened against the US dollar, negatively impacting the Fund’s net earnings and cash available for distribution. In 2010, a one-cent Canadian appreciation in the average Canadian/US exchange rate would have negatively impacted the Fund’s annual cash realized from operations by approximately $0.6 million (2009 – $0.5 million). The further strengthening of the Canadian dollar relative to the US dollar may have a material adverse effect on the Fund’s cash flows and results of operations.

Employee Relations Good labour relations are fundamental to the Fund’s ongoing success. The Processing Facility has 606 employees, 420 of whom are represented by the United Steel Workers of America, Local 6486. The last labour disruption was in 1986. Improved labour relations have translated into eight consecutive collective agreements without a strike. The current four-year collective agreement expires on October 31, 2011.

A labour disruption, such as a strike or lockout, could have negative material effect on the Fund’s financial position, cash realized from operations and its business. In addition, the Fund is reliant upon the efforts and abilities of its current senior management team, namely the CEO and CFO, and its Trustees. If the Fund were to lose the benefit of these senior managers’ or Trustees’ experience and skills, the Fund could be adversely affected.

Environment, Health and Safety The Processing Facility’s operations are subject to stringent laws governing air emissions, discharges into water, waste, hazardous materials and workers’ health and safety, among other things. As such, there is a significant risk of environmental, health and safety liabilities. The Processing Facility has obtained the necessary permits and other approvals relating to the protection of the environment and workers’ health and safety. Compliance with applicable laws and future changes to them is material to the Processing Facility’s operation. Future legislation and regulations could necessitate additional expenses, capital expenditures, financial assurance and restrictions on the operation of the Processing Facility, the extent of which cannot be predicted.

The Fund has a comprehensive environmental management system, which consists of an environmental policy, as well as implementation codes and procedures including codes of practice, job descriptions, operating procedures, rules and responsibilities, employee training, public and employee communications, emergency preparedness, hazard analysis and audits.

Interest Rates As at December 31, 2010, all of the Fund’s $194.7 million indebtedness bears interest at floating rates (December 31, 2009 – $93.6 million), which exposes the Fund to financial risks as a result of interest rate fluctuations and the potential volatility of these rates.


Hedging Activities Through the hedging intended by the terms of the Supply and Processing Agreement and other hedging arrangements the Fund enters into from time to time (as discussed above under “Financial Instruments and Other Instruments”), the Fund attempts to manage its exposure to fluctuations in zinc market prices. Although hedging activities may protect a company against fluctuations in commodity prices, they can also limit the price that can be realized on zinc or zinc byproducts that are subject to forward sales and call options where the market price of zinc exceeds the price in a forward sale or call option contract. In addition, the Fund’s ability to hedge against such fluctuations may also be limited by factors outside of its control, such as pursuant to any covenants that may be required in connection with any long-term refinancing. There can be no assurance that the Fund’s hedging activities will be successful or will protect the Fund against possible adverse effects resulting from fluctuations in the price of zinc concentrate and byproducts.

Legal Proceedings The nature of the Fund’s business subjects it to regulatory investigations, claims, lawsuits and other proceedings in the ordinary course of business.

The nature or results of these legal proceedings cannot be predicted with certainty. There can be no assurance that these matters will not have a material adverse effect on the business or results of operations in any future period, and a substantial adverse judgement could have a material adverse impact on the Fund’s business, financial condition, liquidity and results of operations.

For further information concerning legal proceedings, see the section entitled “Commitments and Contingencies – Litigation” above.

Price and Volatility of Priority Units The market price of Priority Units of the Fund has experienced fluctuations which may not necessarily be related to the operating performance, underlying asset values or prospects of the Fund. It may be anticipated that any market for Priority Units will be subject to market trends generally and changes or disruptions in securities markets or credit markets generally, and the value of the Priority Units on the TSX may be adversely affected by such volatility.

Restrictions on Certain Unitholders and Liquidity of Units The Trust Indentures of the Fund and the Operating Trust impose restrictions on non-resident Unitholders who are prohibited from beneficially owning more than 49% of the Units. This restriction may limit the rights of certain Unitholders, including non-residents of Canada, to acquire Units, to exercise their rights as Unitholders and to initiate and complete take-over bids in respect of the Units. As a result, these restrictions may limit the demand for Units from certain Unitholders and thereby adversely affect the liquidity and market value of the Units held by the public.

Redemption Right It is anticipated that the redemption right attached to Units will not be the primary mechanism for holders of Units to liquidate their investments. Cash redemptions are subject to limitations under the Trust Indenture of the Fund and are currently restricted under the Bridge Facility. Notes which may be distributed in specie to Unitholders in connection with a redemption will not be listed on any stock exchange. No established market is expected to develop in such notes and they may be subject to resale restrictions under applicable securities laws.

Insurance Coverage While the Fund maintains insurance against certain risks, the nature of these risks is such that liability could exceed policy limits or could be excluded from coverage. There are also risks against which the Fund cannot insure or against which it may elect not to insure for various reasons. The potential costs associated with any liabilities not covered by insurance, or in excess of insurance coverage, or compliance with applicable laws and regulations may cause substantial delays and require significant capital outlays, adversely affecting the future business, assets, prospects, financial condition and results of operations of the Fund.

Disclosure and Internal Controls Disclosure controls and procedures and internal controls over financial reporting are procedures designed to provide reasonable assurance that transactions are properly authorized, assets are safeguarded against unauthorized or improper use, and transactions are properly recorded and reported. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance with respect to the reliability of financial reporting and financial statement preparation. Any failure in the Fund’s disclosure controls and procedures and/or internal controls over financial reporting may have a material adverse impact on the Fund, its financial condition or its results of operations.



OUTLOOK

The survey of the ISM Purchasing Manager’s Index was reported at 60.8 in January 2011, which was better than analysts had expected. A reading above 50 indicates that the economy is expanding while readings under 50 indicate that the economy is contracting. The manufacturing sector grew at the highest level since May 2004 when the index registered 61.4. Stronger growth in United States manufacturing was also supported by the ISM New Orders Index which rose to 67.8. Automotive sales in January were at a pace of 12.62 million units per year which is 17% higher than January 2010. However residential and non-residential construction continues to be weak. In spite of slow construction activity, zinc demand is expected to steadily build during the first half of 2011 as customers experience better order levels and rebuild their inventories as the general outlook improves.

The trend of improving sulphuric acid market fundamentals has continued from 2010 into 2011. It is supported by continued growth in industrial demand, strong demand from non-industrial markets such as copper leaching and fertilizer, as well as continued improvements in United States Gulf sulphur prices.

The Fund’s estimates for 2011 production, sales, processing fee and capital expenditures are as follows:

Production: 265,000 tonnesSales: 265,000 tonnes Processing fee: 38.9 cents per poundCapital expenditures: $27 million

The Fund’s ability to meet the targets identified above is subject to various risks, uncertainties and assumptions, some of which are discussed under “Risks and Uncertainties” above and can be found in the “Forward-Looking Information” below.

FORWARD-LOOKING INFORMATION

This MD&A, including sections entitled “Overview”, “Key Performance Drivers”, “Distribution Policy”, “Liquidity and Capital Resources”, “Contractual Obligations”, “Transactions with Related Parties”, “Critical Accounting Estimates and Changes in Accounting Policy”, “Commitments and Contingencies”, “Convergence to International Financial Reporting Standards (“IFRS”)”, “Risks and Uncertainties” and “Outlook”, contains forward-looking statements and forward-looking information within the meaning of applicable securities laws. Amongst others, the Fund has made forward-looking statements for 2011 expected targets and performance, production, sales, the processing fee and capital expenditures, the Fund and the Operating Trust’s future refinancing plans and business plans and operation of the Processing Facility, future liabilities and obligations of the Fund, the dependence upon the continuing supply of zinc concentrates and competition relating thereto, anticipated trends in zinc concentrate supply and demand, smelting capacity, acid market demand and supply, and treatment charges, future conversion, structuring and other strategic options available to the Fund, and the anticipated financial and operating results of the Fund and distributions to Unitholders. The Fund provides this information because they are the key drivers of the business. Readers are cautioned that this information may not be appropriate for other reasons.

These statements and information are based, among others, on the Fund’s current assumptions, expectations, estimates, objectives, plans and intentions regarding projected revenues and expenses, the economic and industry environments in which he Fund operates or which could affect the Fund’s activities, the Fund’s ability to attract and retain clients and consumers as well as the Fund’s operating costs, raw materials and energy supplies which are subject to a number of risks and uncertainties.

Forward-looking information involves known and unknown risks, uncertainties and other factors, which may cause the actual events, results or performance to be materially different from any future events, results or performance expressed or implied by the forward-looking information. Examples of such risks, uncertainties and other factors include, but are not limited to: (1) the Fund’s ability to operate at normal production levels; (2) the dependence upon the continuing supply of zinc concentrates (terms of the Supply and Processing Agreement); (3) the demand for zinc metal, sulphuric acid and copper in cake; (4) the ability to manage sulphuric acid inventories; (5) changes to the supply and demand for specific zinc metal


products and the impact on the Fund’s realized premiums; (6) the ability of the Fund to continue to service customers in the same geographic region; (7) general business and economic conditions and the condition of financial and credit markets; (8) legislation governing the operation of the Fund including, without limitation, air emissions, discharges into water, waste, hazardous materials, workers’ health and safety, and many other aspects of the Fund’s operations, as well as the impact of current legislation and regulations on expenses, capital expenditures, taxation and restrictions on the operation of the Processing Facility; (9) reliance on Xstrata Canada and certain of its affiliates for the management, operation and maintenance of the Processing Facility, the Fund and the Operating Trust and credit support in connection with the Bridge Facility and any refinancing of the Bridge Facility; (10) loan default and refinancing risk associated with the Bridge Facility and refinancing alternatives relating thereto; (11) the sensitivity of the Fund’s Net Revenues to reductions in realized zinc metal prices including premiums, copper prices, sulphuric acid prices; the strengthening of the Canadian dollar vis-à-vis the US dollar; and increasing transportation and distribution costs; (12) the impact of month prior pricing; (13) the sensitivity of the Fund’s production costs to increases in electricity rates, other energy costs, labour costs and operating supplies used in its operations, the sensitivity of the Fund’s interest expense to increases in interest rates; (14) changes in recoveries and capital expenditure requirements; (15) the negotiation of collective agreements with its unionized employees; (16) transportation disruptions; (17) potential negative financial impact from regulatory investigations, claims, lawsuits and other proceedings; and (18) the other general risks and uncertainties set out in the Fund’s continuous disclosure documents on file with the Canadian Securities Regulatory Authorities.

Forward-looking statements can generally be identified by the use of words such as “anticipates”, “believes”, “plans”, “intends”, “estimates”, “are expected”, “is forecast”, “approximately” or variations of such words and phrases, or statements that certain actions, events or results “may”, “could”, “would”, “might” or “will” be taken, occur or be achieved. or words and expressions of similar nature. Forward-looking information involves known and unknown risks, uncertainties and other factors, which may cause the actual events, results or performance to be materially different from any future events, results or performance expressed or implied by the forward-looking information. As a result, the Fund cannot guarantee that any forward-looking statements will materialize. Assumptions, expectations and estimates made in the preparation of forward-looking statements and risks that could cause the Fund’s actual events, results or performance to differ materially from the Fund’s current expectations are discussed throughout this document and in our other continuous disclosure materials available on SEDAR at www.sedar.com. Forward-looking information contained in this MD&A is based on management’s current estimates, expectations and assumptions, which management believes are reasonable as of the current date. You should not place undue importance on forward-looking information and should not rely upon this information as of any other date. Except as required by law, the Fund does not undertake to update these forward-looking statements, whether written or oral, that may be made from time to time by the Fund or on the Fund’s behalf.


The accompanying consolidated financial statements of the Noranda Income Fund (the “Fund”) have been prepared by management in accordance with Canadian generally accepted accounting principles. Financial statements are not precise, since they include certain amounts based on estimates and judgements. When alternative methods exist, management has chosen those which it deems most appropriate in the circumstances in order to ensure that the consolidated financial statements are presented fairly, in all material respects, in accordance with generally accepted accounting principles.

Management maintains adequate systems of internal accounting and administrative controls, consistent with reasonable cost. Such systems are designed to provide reasonable assurance that the financial information is relevant and reliable, and that the Fund’s assets are appropriately accounted for and adequately safeguarded.

The board of trustees ensures that management fulfils its responsibilities for financial reporting and internal control through an audit committee. This committee meets periodically with management and the external auditors to discuss internal controls, auditing matters and financial reporting issues, and to satisfy itself that each party is properly discharging its responsibilities. The committee reviews the consolidated financial statements, and reports to the board of trustees. The external auditors have full and direct access to the audit committee.

Management’s Statement of Responsibility

Mario Chapados Michael BoonePresident and Chief Vice-President and Chief Executive Officer Financial OfficerCanadian Electrolytic Canadian Electrolytic Zinc Limited Zinc LimitedThe Noranda Income The Noranda Income Fund’s Manager Fund’s Manager

February 16, 2011


To the unitholders of the Noranda Income Fund:We have audited the accompanying consolidated financial statements of the Noranda Income Fund, which comprise the consolidated balance sheets as at December 31, 2010 and 2009, and the consolidated statements of earnings (loss) and deficit and comprehensive income (loss) and cash flows for the years then ended, and a summary of significant accounting policies and other explanatory information.

Management’s responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with Canadian generally accepted accounting principles, and for such internal control as management determines is necessary to enable the preparation of consolidated financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditors consider internal control relevant to the entity’s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements.

We believe that the audit evidence we have obtained in our audits is sufficient and appropriate to provide a basis for our audit opinion.

Opinion In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Noranda Income Fund as at 31 December 2010 and 2009 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.

Emphasis of matter We draw attention to Note 1 to the consolidated financial statements which describes uncertainty upon the Fund’s ability to continue as a going concern. Our opinion is not qualified in respect of this matter.

Independent Auditors’ Report

Ernst & Young, LLPChartered AccountantsMontréal, Canada

February 16, 2011

1 CA auditor permit no. 20871

1


Consolidated Balance Sheets

December 31 ($ thousands) 2010 2009

(note 1)

Assets (note 6)

Current assets:

Cash and cash equivalents $ 2,899 $ 2,895

Accounts receivable

Trade 76,692 77,126

Xstrata Canada (note 15) 34,203 8,270

Commodity hedging instruments (note 12) 3,478 4,409

Commodity financial instruments (note 12) 2,159 –

Inventories (note 4) 78,555 110,875

Prepaids and other assets 2,891 949

Future tax asset (note 9) 242 –

201,119 204,524

Long-term commodity hedging instrument (note 12) 377 1,110

Property, plant and equipment (note 5) 285,739 295,756

487,235 501,390

Liabilities And Equity

Current liabilities:

Accounts payable and accrued liabilities

Trade 18,495 16,254

Xstrata Canada (note 15) 47,556 72,477

Commodity financial instruments (note 12) – 3,587

Firm commitments (note 12) 3,499 4,112

Bank and other loans (note 6) 191,455 207,886

261,005 304,316

Long-term firm commitments (note 12) 379 1,111

Future tax liability (note 9) 14,137 13,147

Future site restoration and reclamation (note 7) 9,460 9,006

Ordinary Unitholders’ interest (note 10) 55,917 48,619

Priority Unitholders’ Interest:

Priority Unitholders’ equity (note 11) 209,272 191,273

Deficit (62,935) (66,082)

146,337 125,191

487,235 501,390

[See accompanying notes] Going concern uncertainty (note 1)

Commitment and contingencies (note 8)

On behalf of the Board of Trustees of the Noranda Operating Trust:

John J. SwidlerTrustee

Barry TissenbaumTrustee


Consolidated statements of earnings (loss) and deficit and comprehensive income (loss)


(note 1)Revenues

Sales (note 15, 16) $ 659,146 $ 483,175 Transportation and distribution costs (16,141) (14,321)

643,005 468,854

Raw material purchase costs (note 15) 371,559 253,276

Revenues less raw material purchase costs 271,446 215,578

Other expenses

Production (note 15) 177,278 165,716

Selling, general and administration (note 15) 23,751 17,609

Foreign exchange gain (1,240) (9,605)

Commodity financial instruments (gain) loss (note 12) (5,746) 2,957

Commodity hedging loss (gain) (note 12) 319 (224)

Amortization of property, plant and equipment 33,709 36,021

Reclamation (note 7) 692 (3,595)

228,763 208,879

Earnings before interest, non-controlling interest and income tax 42,683 6,699

Interest expense, net (note 6) 13,491 11,104

Earnings (loss) before non-controlling interest and income tax 29,192 (4,405)

Ordinary Unitholders’ non-controlling interest in earnings (loss) 7,298 (1,101)

Earnings (loss) before income tax 21,894 (3,304)

Future income tax expense (note 9) 748 –

Net earnings (loss) and comprehensive income (loss) 21,146 (3,304)

Deficit, beginning of year (66,082) (52,091)

Distributions to Priority Unitholders (note 11) (17,999) (10,687)

Deficit, end of year (62,935) (66,082)

Net earnings (loss) per Priority Unit (basic and diluted) $ (0.56) $ (0.09)

Weighted average number of Priority Units outstanding

(basic and fully diluted) 37,497,975 37,497,975

[See accompanying notes]


Consolidated statements of cash flows


(note 1)Cash realized from (used for) operations:

Net earnings (loss) $ 21,146 $ (3,304)

Items not affecting cash:

Amortization of property, plant and equipment 33,709 36,021

Reclamation (note 7) 692 (3,595)

Ordinary Unitholders’ non-controlling interest in earnings (loss) 7,298 (1,101)

Future income tax recovery 748 –

Mark-to-market (gain) loss on commodity financial instruments (note 12) (2,484) 2,957

Mark-to-market loss (gain) on hedging financial instruments (note 12) 319 (224)

Change in fair value of embedded derivatives (note 12) 2,501 4,290

Accretion on bank and other loans (note 6) 720 255

Write-down of inventory 1,144 –

Loss from sale of assets 1,385 1,356

Site restoration expenditures (note 7) (238) (205)

66,940 36,450

Net change in non cash working capital items:

Accounts receivable (25,499) (16,293)

Inventories 29,887 (31,850)

Prepaid expenses and other assets (1,942) 1,161

Accounts payable and accrued liabilities (28,443) 38,912

(25,997) (8,070)

40,943 28,380

Cash realized from (used for) investment activities:

Purchases of property, plant and equipment (24,194) (23,964)

Proceeds from government assistance 234 – Proceeds from sale of property, plant and equipment 172 7

(23,788) (23,957)

Cash realized from (used for) financing activities:

Distributions – Priority Unitholders (note 11) – (13,874)

– Ordinary Unitholders (note 10) – (2,125)

Bank debt issued (note 6) 527,283 297,263

Bank debt repaid (note 6) (387,184) (286,247)

Deferred financing fees paid (3,750) –

Senior secured notes repaid (note 6) (153,500) –

(17,151) (4,983)

Change in cash and cash equivalents during the year 4 (560)

Cash and cash equivalents, beginning of year 2,895 3,455

Cash and cash equivalents, end of year 2,899 2,895

Supplemental cash flow information:

Cash interest paid 18,488 11,375

Cash taxes paid – –

[See accompanying notes]


NOTE 1. NATURE AND DESCRIPTION OF THE NORANDA INCOME

FUND AND GOING CONCERN UNCERTAINTY

The Noranda Income Fund (the “Fund”) was created in 2002, initially to acquire from Noranda Inc., which changed its name to Xstrata Canada Corporation (“Xstrata Canada”) after being subsequently acquired by Xstrata Plc (“Xstrata”), indirectly through the Noranda Operating Trust (the “Operating Trust”) and the Noranda Income Limited Partnership (the “Partnership”), the CEZinc processing facility (the “Processing Facility”) in Salaberry-de-Valleyfield in Québec. The Processing Facility produces refined zinc metal and various byproducts from zinc concentrates.

Xstrata is a global diversified mining group, listed on the London and Swiss stock exchanges.

The Fund’s consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”) on a going concern basis, which presumes the Fund will continue in operation for the foreseeable future and will be able to realize its assets and discharge its liabilities and commitments in the ordinary course of business for the foreseeable future.

The use of these principles may not be appropriate. As at December 31, 2010, the Fund has a working capital

deficiency of $59.9 million mainly because of the Fund’s debt expiring in 2011. This compares to a working capital deficiency of $99.8 million as at December 31, 2009. The Fund needs to renew its current debt or raise additional capital or debt to supplement or replace its existing bridge facility (“Bridge Facility”) which matures on June 2, 2011, and is subject to an extension of 6 months at the option of the Fund at similar terms and conditions, in order to have sufficient liquidity to meet its obligations over the next 12 months.

There are a number of factors that support the Fund’s ability to refinance its debt which is due in 2011. They include:• In 2010, the Fund received support from its lending

syndicate in order to extend its secured revolving operating line of credit (the “Revolving Facility”) to December 3, 2010 (note 6).

• In December 2010, the Fund obtained a Bridge Facility in the amount of $250 million that matures on June 2, 2011, and is subject to an extension of 6 months, at the option of the Fund at similar terms and conditions (note 6).

• The Fund addressed the economic challenges that it faced, including the suspension of distributions, and the reduction in inventories and production costs.

• The Fund returned to full production in 2010 which improved the economics of the business.

• The Fund has a track record of being able to generate positive cash flow from operations, including $40.9 million in 2010, $28.4 million in 2009, $122.3 million in 2008, $67.9 million in 2007 and $20.2 million in 2006. The cash flow from operations before the net change in non-cash working capital items for the same five periods was $66.9 million in 2010, $36.5 million in 2009, $77.3 million in 2008, $81.8 million in 2007 and $73.2 million in 2006.

The Fund also faces several risks that may have a material impact on its liquidity and its capacity to refinance its debt. While the Fund believes it has developed planned courses of action and identified other opportunities to mitigate liquidity risks, there is no assurance that the Fund will be able to achieve any or all of the opportunities it has identified, if needed, to obtain sufficient liquidity. There is uncertainty as to whether sufficient capital would be made available either from the Fund’s current lenders or other parties. The Fund’s inability to further extend or refinance its Bridge Facility may require it to seek additional funding sources. The Fund is currently in discussions with a number of lenders and exploring financing alternatives with the expectation of finalizing a refinancing before the expiry of the Bridge Facility. The refinancing may be done at less favourable terms than what currently exist, it may restrict future distributions and it may require that a portion of the debt be paid down. Due to these circumstances, there is uncertainty upon the Fund’s ability to continue as a going concern.

These consolidated financial statements do not give effect to any adjustments to the amounts and classifications of assets and liabilities which might be necessary should the Fund not be successful in its efforts to renew its current debt or obtain new sources of financing. Such adjustments could be material.

Significant agreements Pursuant to a 15 year Supply and Processing Agreement signed on May 3, 2002, between Xstrata Canada and the Partnership, Xstrata Canada is obligated to sell to the Processing Facility, except in certain circumstances, all of its zinc concentrate requirements up to 550,000 tonnes of zinc concentrate annually at a concentrate price (based on the price of zinc metal on the London Metal Exchange (“LME”)) for “Payable zinc metal” contained in the concentrate less a processing fee initially set at $0.352 per pound of that “Payable zinc metal”. The processing fee is the processing fee in the previous year adjusted annually (i) upward by 1% and (ii) upward or downward by 10% of the year-over-year percentage change in the average cost of electricity per megawatt hour for the Processing Facility. The processing fee for 2010 was $0.385 (2009 – $0.38) per pound. “Payable zinc metal” in respect of a quantity of concentrate is equal to 96% of the assayed zinc metal content of that concentrate under the Supply and Processing Agreement.

Notes to Consolidated Financial Statements December 31, 2010 [$ thousands except as otherwise indicated]



Under the Supply and Processing Agreement, Xstrata Canada acts as the exclusive agent for the Partnership to arrange the sale of zinc metal and byproducts and related hedging and derivative arrangements.

Under the terms of an administration agreement between the Fund and Canadian Electrolytic Zinc Limited (the “Manager”), a wholly owned subsidiary of Xstrata Canada, a management services agreement between the Operating Trust and the Manager and an operating and management agreement between the Manager and the Partnership, the Manager provides administrative services to the Fund and management services to the Operating Trust and the Partnership, respectively. The initial terms of these agreements end on May 2, 2017 and will automatically renew thereafter for a five year term, unless terminated in accordance with the terms. Upon the termination of the operating and management agreement, the Partnership will acquire the Manager from Xstrata Canada.

Distributions As a result of the amendments to the Revolving Facility and the Bridge Facility, the Fund is currently restricted from making cash distributions to unitholders (note 6). When not restricted by its financing arrangement, or otherwise, the Fund’s policy is to make distributions to unitholders equal to cash flows from operations before variations in working capital and such reserves for operating and capital expenditures as may be considered appropriate by the board of trustees. The Fund determines the cash available for distribution on a monthly basis for the unitholders of record of the Fund on the last business day of each calendar month and these distributions are to be paid on or about 25 days thereafter.

In addition, the Fund is required by its Trust Indentures to distribute on December 31, of each year amounts equal to its taxable income and net capital gains for the year. Such distributions are to be made in cash, unless the Fund is restricted from distributing cash or sufficient cash it not available, in which case such distributions are to be satisfied in whole or in part by the issuance of additional Priority Units having a value equal to the amount of cash which is unavailable for distribution. Following such an “in-kind” distribution, the Priority Units are automatically consolidated such that each certificate representing a number of units prior to the in-kind distribution of additional units is deemed to represent the same number of units after the distribution of additional units and the consolidation). On December 17, 2010, the board of trustees of the Operating Trust approved an In-Kind Distribution of $0.48 per unit to the Fund’s Priority

Unitholders on record as at December 31, 2010. It was also settled on that date. The amount of the In-Kind Distribution was equal to the entire amount of the Fund’s estimated taxable income for the purposes of the Income Tax Act for 2010, since no cash distribution had been paid to Priority Unitholders during the year.

Cash distributions on Ordinary Units of the Partnership are subordinated to distributions on Priority Units of the Fund until 2017 except upon the occurrence of certain events. Each Ordinary Unit is entitled to receive a cash distribution on a monthly basis in an amount that is equal to the monthly cash distribution paid to each Priority Unit, provided each Priority Unit is first paid an amount that is equal to the monthly cash distribution of not less than $0.08333 per Priority Unit (the “Base Distribution”) before any amount is paid to the holder of the Ordinary Units. If, notwithstanding the subordination of the Ordinary Units, the cash available for distribution is not sufficient to make the Base Distribution on the Priority Units in a month, the amount of the deficiency shall not accumulate and will not be paid to holders of the Priority Units. If the cash available for distribution in a month is not sufficient to make a distribution on the Ordinary Units that is equal to the distribution on the Priority Units, the amount of the deficiency will accumulate and be paid to holders of the Ordinary Units if there is excess cash available for distribution, above the Base Distribution, in a subsequent month. Any accumulated distribution deficiency related to the Ordinary Units is not accrued by the Fund until such time, as excess cash is available for distribution above the Base Distribution and a cash distribution is approved by the board of trustees. In the event of an exchange of Ordinary Units on a one-to-one basis for Priority Units after May 2, 2017 (note 10), any accumulated distribution deficiency related to the Ordinary Units prior to the exchange is not accrued by the Fund until such time as excess cash is available for distribution above the Base Distribution is available and a cash distribution is approved by the board of trustees. Subsequent to the exchange, there will be no further accumulation of the distribution deficiency. As at December 31, 2010, the accumulated distribution deficiency was $2.5 million.


NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

These consolidated financial statements have been prepared in accordance with Canadian GAAP and within the framework of the following significant accounting policies.

Principles of consolidationThe consolidated financial statements of the Fund include the accounts of the Fund and those of the Operating Trust and the Partnership. All significant intercompany transactions and balances have been eliminated.

Use of estimates The preparation of these consolidated financial statements in conformity with Canadian GAAP requires management to make estimates and assumptions. These estimates affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. Significant estimates include, but are not limited to, inventory valuation, amortization, income taxes, revenue recognition, impairment of long-lived assets and future site restoration and reclamation. Actual results could differ from these estimates.

Foreign currency translation Foreign currency denominated monetary assets and liabilities are translated at the exchange rate prevailing at the year end, and revenues and expenses at average rates of exchange during the year. Exchange gains and losses arising on the translation of the accounts are included in the consolidated statements of earnings (loss) and deficit and comprehensive income (loss).

Cash equivalents Cash and cash equivalents consist of cash and highly-liquid, short-term investments that are readily convertible to known amounts of cash. They are not subject to a significant risk of change in value. The Fund considers these highly-liquid, short-term investments, with a maturity on acquisition of less than three months, to be cash equivalents. Due to the short-term and liquid nature of these financial assets, the Company has elected to classify them as held for trading. As at December 31, 2010, cash equivalents included an overnight deposit in the amount of $2.8 million with a Canadian chartered bank maturing as at January 4, 2011 at a rate of 0.95% (December 31, 2009 – no overnight deposits).

Inventories Finished goods, raw materials and work-in-process inventories are valued at the lower of average cost or net realizable value. Inventories of spare parts are valued at the lower of average cost or replacement value on a first-in and first-out basis.

Revenue recognition Revenues from the sale of refined metals, copper in cake and sulphuric acid are recorded at the time of sale, when the rights and obligations of ownership pass to the buyer, which generally occurs upon shipment. For a portion of the Fund’s sales contracts, final prices for metals are set based on the prevailing spot metal prices on a specified future date based on the date the products are delivered. The Fund records revenues under these contracts based on the forward prices at the time of the sale. At each subsequent balance sheet date, the prices are adjusted to the then current forward price. Price changes for shipments which are awaiting final pricing at year end could have a material effect on future revenues. As at December 31, 2010, there was $7.5 million (2009 – $6.2 million) in revenues that were awaiting final pricing, comprising 331 tonnes of zinc and 915 tonnes of copper in cake (2009 – 1,199 tonnes of zinc and 465 tonnes of copper in cake).

Property, plant and equipment Property, plant and equipment are recorded at cost, less any applicable government assistance. Amortization of property, plant and equipment is based on the estimated service lives of the assets, calculated on the straight-line basis at the following annual rates:

Computers and software 4 years Automobiles and trucks 4 years Mobile equipment 10 years Buildings and plant equipment 10–40 years Anodes1 3.5 years 1 Included in buildings and plant equipment

Assets under construction are not amortized until put into use.

In 2010, the Fund reviewed and increased the useful life of certain property, plant and equipment, based on experience with these assets, to better reflect their use in time. These changes were applied prospectively from January 1, 2010. The impact on amortization expense in 2010 was as follows:

Reduction in Previous Revised Amortization Useful Lives Useful Lives Expense – 2010

Building and plant equipment 10–25 years 10–40 years $ 4,295



Future site restoration and reclamation The fair value of the future liability for an asset retirement obligation is recognized in the period in which it is incurred and is included within future site restoration and reclamation, with an offsetting amount being recognized as an increase in the carrying amount of the corresponding asset. The asset amortizes over its estimated useful life and the liability accretes to its future value until the obligation is completed.

Transaction costs and financing feesTransaction costs for financial instruments classified as other than held for trading are recognized as an expense and included in interest expense in the period they are incurred, except to the extent that they are related to the establishment of a loan facility that has a duration longer than two years. In such cases, they are capitalized and amortized using the effective interest method over a period that corresponds with the term of the loan facility. Financing fees are capitalized and amortized using the effective interest method over a period that corresponds with the term of the financial instrument.

Income taxes The Fund follows the liability method of accounting for future income taxes and the related recommendations of Emerging Issues Committee (“EIC”) – 167, Future Income Tax Liabilities – Income Trusts and Other Specified Investment Flow Throughs. Under the liability method, future income tax assets and liabilities are determined based on differences between the accounting basis and the tax basis of the assets and liabilities, and are measured using the substantively enacted tax rates and laws expected to apply when these differences reverse. The effect of a change in income tax rates on future tax liabilities and assets is recognized in income in the period in which the change occurs.

As the Fund is an unincorporated trust, it was entitled to deduct from income, for tax purposes, distributions paid or payable to unitholders. Consequently, it is expected that the Fund will not be liable for tax under Part 1 of the Income Tax Act (Canada) in 2010. The deductibility of distributions to the unitholders in 2010 represents an exemption from future income taxes relating to temporary differences, as the Fund is committed to continue to distribute to its unitholders all or virtually all of its taxable income that would otherwise be taxable in the Fund.

In June 2007, the Federal Government substantially enacted tax legislation relating to the taxation of existing income and royalty trusts, at effective rates similar to Canadian corporations beginning in 2011. These changes are effective January 1, 2011 for existing trusts and will result in taxation of distributions, if any, at a rate of 28.4% in 2011.

Comprehensive income Comprehensive income is the change in the Fund’s net assets that results from transactions, events and circumstances from sources other than the Fund’s unitholders. It includes items that would not normally be included in the net earnings such as: unrealized gains or losses on available for sale investments; and gains and losses designated as cash flow hedges.

Impairment of long-lived assets Property, plant and equipment and other long-lived assets are regularly reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Impairment is assessed by comparing the carrying amount of an asset to be held and used with the sum of the undiscounted cash flows expected from its use and disposal. If such assets are considered impaired, the impairment loss to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value, generally determined on a discounted cash flow basis. Any impairment results in a write-down of the asset and a charge to net earnings (loss) during the year.

Exchangeable securities issued by subsidiaries of income trusts The Ordinary Units issued by Noranda Income Limited Partnership, of which the Fund indirectly owns 100% of the Partnership Units, are exchangeable securities that contain a subordination feature. Under the Canadian Institute of Chartered Accountants’ (“CICA”) EIC-151, Exchangeable Securities Issued by Subsidiaries of Income Trusts, these Ordinary Units are required to be presented as a non-controlling interest.


Government assistance Grant amounts from government assistance programs are reflected as reductions in the cost of the assets or in the expenses to which they relate at the time which the assistance becomes receivable and when there is reasonable assurance that the assistance will be received. For the year ending December 31, 2010, the Fund received $0.2 million, which was recorded as a reduction of production costs and $0.2 million, which was recorded as a reduction of the related plant equipment (2009 – $0.04 million and nil, respectively). There are no ongoing obligations related to the assistance, which is subject to audit by the government agency.

Financial instruments The Fund recognizes a financial asset or financial liability only when the entity becomes a party to the contractual provisions of the financial instrument. Financial assets and liabilities should, with certain exceptions, be initially measured at fair value. After initial recognition, the measurement of each financial instrument will vary depending on their classification: financial assets and financial liabilities held for trading, available-for sale financial assets, held-to maturity investments, loans and receivables and other financial liabilities.

The Fund has classified its cash and cash equivalents as held for trading and its accounts receivable as loans and receivables. Accounts payable, distributions payable and debt are classified as other financial liabilities.

CICA Handbook Section 3855 also requires that under certain conditions, an embedded derivative be separated from its host contract and be accounted for as a derivative. An embedded derivative causes some or all of the cash flows that otherwise would be required by the contract to be modified according to a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, a credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract.

The Fund has separated and recorded at fair value the embedded derivatives resulting from the provisional pricing feature in the concentrate payables as set out in the Supply and Processing Agreement. Under the terms of this agreement, final prices for purchases of concentrate are set based on LME prices prevailing on a specified future date after shipment (“quotational pricing”). The Fund accounts for changes in the fair value of unsettled concentrate payable amounts resulting from quotational pricing with reference to forward LME rates for the remaining quotational period through gains or losses recorded in raw material purchases costs and corresponding adjustments in accounts payable and accrued liabilities.

Hedges The Fund has determined that its derivatives which were contracted in connection with its inventory management hedging program do not meet the hedging requirements. As a result, and in accordance with Section 3855, these derivatives have been recognized on the balance sheet as a commodity financial instrument with the change in their fair values at each reporting period recognized as a gain or a loss.

The Fund periodically uses commodity forward contracts to hedge the effect of price changes relating to its firm fixed commitments on the commodities it sells. Hedge accounting is permitted under Section 3865 when there is a high degree of correlation between price movements in the derivative instrument and the item designated as being hedged. The relationship between the Fund’s firm fixed sales commitments and the commodity forward contracts purchased to hedge these commitments permits the use of hedge accounting under Section 3865.

At the inception of the hedge, the Fund documents the hedging relationship and the risk management objective and strategy for undertaking the hedge. Such hedges are expected to be highly effective and this effectiveness is tested at each reporting period. Hedge accounting is discontinued prospectively when the derivative no longer qualifies as an effective hedge, or the derivative is terminated or sold upon the sale or early termination of the hedged item.

NOTE 3. CHANGES IN ACCOUNTING POLICIES

The CICA issued Handbook Sections 1582, Business Combinations, which replaces Section 1581, Business Combinations; Section 1601, Consolidations; Section 1602, Non-controlling Interests; and Section 1625, Comprehensive Revaluation of Assets and Liabilities. These standards were effective for the Fund’s interim and annual financial statements beginning on January 1, 2011, with earlier application permitted.

These standards (CICA 1582, 1601 and 1602) were harmonized with the converged IASB and the FASB standards on business combinations and with their guidance on accounting for non-controlling interests. In conjunction with these changes, amendments were made to CICA 1625 and CICA 3251 to remove guidance no longer applicable and to make these standards consistent with the business combinations standards.



NOTE 4. INVENTORIES

2010 2009

Spare parts $ 8,794 $ 8,603Raw materials 18,150 28,322Work-in-process 14,385 24,335Finished products 37,226 49,615 $ 78,555 $ 110,875

During 2010, $582.5 million (2009 – $455.0 million) of inventory was expensed including amortization related to property, plant and equipment of $33.7 million (2009 – $36.0 million). During the three month period ending June 30, 2010, a write-down from cost to net realizable value of $1.1 million was recorded in raw material purchase costs. As at December 31, 2010, raw materials, work-in-process and finished products are all carried at cost.

NOTE 5. PROPERTY, PLANT AND EQUIPMENT

Accumulated Net Book 2010 Cost Amortization Value

Plant equipment1 $ 722,049 $ 483,453 $ 238,596Buildings 140,086 97,691 42,395Mobile equipment 2,495 2,151 344Computers and software 3,295 2,709 586Automobiles and trucks 403 384 19Land 3,799 – 3,799 $ 872,127 $ 586,388 $ 285,7391 Includes $6,515 of plant equipment in progress that was not being amortized as at

December 31, 2010.

Accumulated Net Book 2009 Cost Amortization Value

Plant equipment2 $ 709,337 $ 459,892 $ 249,445Buildings 140,846 99,132 41,714Mobile equipment 2,746 2,428 318Computers and software 3,191 2,738 453Automobiles and trucks 417 390 27Land 3,799 – 3,799 $ 860,336 $ 564,580 $ 295,7562 Includes $15,003 of plant equipment in progress that was not being amortized as at

December 31, 2009.

NOTE 6. BANK AND OTHER LOANS

2010 2009

Bridge Facility – Revolving Facility Tranche $ 64,730 $ – Bridge Facility – Term Loan Tranche 130,000 – Revolving Facility – 54,631 A-1 Notes – 114,500 A-2 Notes – 39,000 194,730 208,131 Deferred financing fees (3,275) (245) $ 191,455 $ 207,886

2010On April 19, 2010, the Fund completed an amendment with a syndicate of Canadian chartered banks to extend the maturity date of its Revolving Facility from May 3, 2010 to November 3, 2010.

On October 27, 2010, the Fund completed an amendment with a syndicate of Canadian chartered banks to further extend the maturity date of its Revolving Facility from November 3, 2010 to December 3, 2010.

On December 2, 2010, the Fund obtained a Bridge Facility for an amount of $250 million from a syndicate of lenders. The Bridge Facility is comprised of a $130 million term loan tranche (“Term Loan Tranche”) that was used to partly repay all of the outstanding Notes in the amount of $153.5 million that matured on December 20, 2010 and a $120 million operating line of credit (“Revolving Facility Tranche”) intended to refinance the Revolving Facility that matured on December 3, 2010, to finance general corporate purposes including working capital and to repay the remaining $23.5 million of the Notes mentioned above. The Bridge Facility enables the Fund along with the independent committee of the board of trustees of the Operating Trust to continue working with its independent financial advisors, TD Securities Inc. to continue to pursue long-term refinancing alternatives.

The terms of the Revolving Facility Tranche are substantially the same as the terms of the previous Revolving Facility. The Term Loan Tranche is subject to certain adjustments to include a quarterly reduction of this portion of the Bridge Facility and any repayments permanently reduce the amount available on the Term Loan Tranche.

The maturity of the Bridge Facility is June 2, 2011, subject to a further extension of six months at the option of the Fund at similar terms and conditions, and mandatory principal repayments in certain circumstances. The credit agreement governing the Bridge Facility contains covenants that restrict the Fund in several respects, including the ability to make cash distributions or redeem or repurchase units.


Under the Revolving Facility Tranche, the amount available to be drawn varies on a monthly basis and will continue to be based on 65% of the Fund’s eligible inventory and 80% of the Fund’s eligible accounts receivable (both as defined in the credit agreement) from the previous month. The monthly calculation is subject to a maximum available to be drawn of $120 million. The amount available to be drawn based on the Fund’s December 31, 2010 balance sheet was $112 million.

Borrowings under the Revolving Facility Tranche are available by way of Canadian prime rate advances, US base rate advances, bankers’ acceptances, US dollar Libor advances and Canadian and US dollar letters of credit. The Revolving Facility Tranche bears interest at rates that vary with the Canadian prime rate, US base rate, the bankers’ acceptance rate, or Libor rates plus applicable margins between 3.5% and 4.5%.

Borrowings under the Term Loan Tranche are available by way of Canadian prime rate advances or bankers’ acceptance and bear interest at Canadian prime rate plus applicable margins between 3.5% and 4.5%.

As at December 31, 2010, $50 million (Cdn$49.7 million) was payable in US Dollars, and the effective interest rate on the Bridge Facility was 5.5%.

The lenders required, as a condition to the refinancing, that Xstrata Canada reaffirm its credit support, as provided in the past in connection with the Revolving Facility. In consideration for the credit support, the Operating Trust paid Xstrata Canada a fee of US$0.4 million (note 15).

The assets of the Partnership, the Operating Trust and the Manager are pledged as collateral against the Bridge Facility. The Fund has provided covenants to its lenders. All of the covenants were complied with during 2010.

2009On November 16, 2009, the Operating Trust, completed an amendment with a syndicate of Canadian chartered banks to its Revolving Facility. The amended Revolving Facility matured on May 3, 2010. The amount available to be drawn on the Revolving Facility varied on a quarterly basis and was based on 65% of the Fund’s eligible inventory and 80% of the Fund’s eligible accounts receivable (both as defined in the Revolving Facility agreement) from the previous quarter-end. The maximum available to be drawn at any time was $200 million and the minimum available to be drawn was $55 million.

Borrowings under the Revolving Facility bore interest at rates that varied with the prime rate, the bankers’ acceptance rate or Libor rates plus applicable margins between 3.5% and 4.5%.

On December 19, 2003, the Operating Trust completed the issue of $153.5 million Notes pursuant to a private placement. The Notes had a term of seven years and matured on December 20, 2010. The Notes were comprised of $114.5 million fixed-rate notes (“A-1 Notes”) with a coupon of 6.529% payable quarterly, and $39 million floating rate notes (“A-2 Notes”) at a rate of the three-month Canadian Dollar Offer Rate (“CDOR”) plus 1.94%.

The assets of the Partnership, the Operating Trust and the Manager were pledged as collateral against the Revolving Facility and the Notes.

Interest expense, net 2010 2009

Interest expense $ 12,796 $ 10,865 Accretion on long-term debt 720 255 Interest income (25) (16) $ 13,491 $ 11,104

NOTE 7. FUTURE SITE RESTORATION AND RECLAMATION

The Fund has used a discount rate of 8% to determine the fair value of the liability of its future site restoration and reclamation expenditures. The liability accretes to its future value until the obligation is completed. The majority of the estimated future site restoration and reclamation expenditures currently recorded relate to the reclamation of residue ponds at the Processing Facility. The estimated future site restoration and reclamation expenditures may vary based on changes in operations, cost of restoration and reclamation activities and regulatory requirements.

During the second quarter of 2009, a review of the site restoration and reclamation expenditures was completed by the Fund, including work from a third-party engineering firm. The results indicated that the Fund expects to reduce its future site restoration and reclamation liabilities because of a reduction in the expected future reclamation spending. This, in turn, reduced the present value of future site restoration and reclamation liabilities. The revisions are subject to approval by the Québec Minister of Natural Resources.

The sources of the reduced reclamation spending came from: 1. The Fund identified opportunities to recycle some of

the residues on site, therefore, reducing the amount of residues that need to be treated; and

2. The life of some of the residues ponds was extended, thereby deferring the timing of some of the expenditures for the projects.



Although the ultimate amount to be incurred is uncertain, the liability for future site restoration and reclamation on an undiscounted basis is estimated to be approximately $37.8 million. The cash flows required to settle the liability are expected to be incurred from now until 2046.

Future Site Restoration and Reclamation Continuity 2010 2009

Opening balance $ 9,006 $ 12,806 Accretion of reclamation expense 708 1,020 Site restoration expenditures (238) (205)Change in estimates (16) (4,615)Closing balance $ 9,460 $ 9,006

The Fund’s operations are affected by federal, provincial and local laws and regulations concerning environmental protection. The Fund’s provisions for future site restoration and reclamation are based on known requirements. It is not currently possible to estimate the impact on operating results, if any, of future legislative or regulatory developments.

NOTE 8. COMMITMENTS AND CONTINGENCIES

a) Operating leases and purchase commitments As at December 31, 2010, the Fund had commitments under operating leases requiring annual rental payments as follows:

2011 $ 1,004 2012 548 2013 189 2014 29 2015 and thereafter – $ 1,770

As at December 31, 2010, the Fund had purchase commitments requiring payments as follows:

2011 $ 10,195 2012 2,394 2013 934 $ 13,523

Included in the above is $5.0 million of purchase commitments to related parties. Certain agreements for operating costs require the Fund to make minimum purchases, or be subject to penalties.

b) Manager’s pension plan As discussed in Note 1, upon the termination of the operating and management agreement, the Partnership will acquire the Manager from Xstrata Canada. If this occurs, the Partnership will establish a pension plan for the employees of the Manager. Pension plan assets and liabilities will be transferred into the newly established pension plan, subject to obtaining regulatory approvals.

As at December 31, 2010, the estimated liability of the Manager’s pension plan was $124.5 million (2009 – $106.5 million). There are currently $117.7 million (2009 – $104.5 million) of assets within the Manager’s pension plan.

The cost of providing benefits through defined benefit pension plans and post-retirement benefit plans is actuarially determined. Cost and obligation estimates depend on management’s assumptions about future events, which are used by the actuaries in calculating such amounts. These assumptions include discount rates, the expected return of plan assets and future compensation increases. In addition, actuarial consultants utilized subjective factors, such as withdrawal and mortality rates. Actual results may differ materially from those estimates based on these assumptions.

c) Litigation In August 2004, the Processing Facility was served with a class action motion presentable before the Québec Superior Court, subsequent to an accidental discharge of sulphur trioxide. In June 2008, the Québec Superior Court dismissed the motion to institute a class action. The plaintiff appealed the decision. In August 2009, the Québec Court of Appeal dismissed the appeal.

In December 2009, the Processing Facility was served with a new motion for leave to institute a class action. The Processing Facility brought several motions to have the motion for leave to form the class action dismissed. The Québec Superior Court dismissed the Processing Facility’s motions in December 2010. The Processing Facility will appeal the decisions on those motions before the Québec Court of Appeal in February, 2011. The motion for leave to form a class action is expected to be heard by the Québec Superior Court in late March 2011, pending the decision of the Québec Court of Appeal.

The Manager continues to maintain that the class action suit is unfounded.


d) Appropriation of land The Fund is currently in discussion with Québec’s Ministry of Natural Resources regarding land that the Fund is currently using. This land was appropriated by the provincial government a number of years ago. The Fund’s cash payment, if any, cannot be determined.

e) Guarantees Some of the Fund’s inceptive agreements, specifically those related to the acquisition of the Processing Facility and the debt, include indemnification provisions in which the Fund may be required to make payments to Xstrata or lenders for breach of fundamental representations and warranty terms in the agreement. As at December 31, 2010, the Fund does not believe these indemnification provisions would require any material cash payments by the Fund.

The Fund indemnifies its directors and officers against claims reasonably incurred and resulting from the performance of their services to the Fund, and maintains liability insurance for its directors and officers.

No amounts have been recorded for the contingencies outlined under b) through e) above.

NOTE 9. INCOME TAXES

The Fund follows the liability method of accounting for future income taxes. Under the liability method, future income tax assets and liabilities are determined based on differences between the accounting basis and the tax basis of the assets and liabilities, and are measured using the currently substantively enacted tax rates and laws expected to apply when these differences reverse. The effect of a change in income tax rates on future tax liabilities and assets is recognized in income in the period in which the change occurs.

In June 2007, the Federal Government substantively enacted its tax legislation relating to the taxation of existing income and royalty trusts, at effective rates similar to Canadian corporations commencing in 2011. Prior to June 22, 2007, the Fund estimated the future income taxes on certain temporary differences between amounts recorded on its balance sheet for book and tax purposes at a nil effective tax rate. Under the legislation, the Fund has estimated the effective tax rate on post-2010 reversal of these temporary differences to be 28.4% in 2011 and 26.9% in 2012 and beyond. Temporary differences reversing before 2011 gave rise to nil future income taxes. The Fund has estimated its future income taxes based on its

best estimates of future results of operations, available capital cost allowance deductions and distributions and assuming no material changes to the Fund’s organizational structure. The Fund’s estimate of its future income taxes may vary based on actual results of the factors described above, and such variations may be material.

The components of the future tax asset and future tax liability are as follows:

2010 2009

Future Tax Asset – Current Debt issuance costs $ 242 $ –

Future Tax Liability – Long-Term Property, plant and equipment $ 27,216 $ 25,260 Future site restoration and reclamation (2,075) (1,834)Eligible capital property (11,004) (10,279) $ 14,137 $ 13,147

Taxable income and net capital gains for the year that are not distributed to unitholders in cash or in units are generally taxed in the Fund at the highest federal and provincial tax rates that are applicable to individuals.

NOTE 10. ORDINARY UNITHOLDERS’ INTEREST

The Partnership has 12,500,000 Ordinary Units outstanding, which are exchangeable into Priority Units. Ordinary Units are entitled to distributions from the Fund equivalent to distributions paid by the Fund on the Priority Units, provided that the holders of the Priority Units are first paid the Base Distribution of $0.08333 per unit, per month.

The Ordinary Units are entitled to a number of votes equal to the number of votes attached to a Priority Unit and vote with the Priority Unitholders as one class. Xstrata’s Ordinary Units are generally not transferable and are exchangeable for Priority Units on a one-for-one basis only after May 2, 2017, or earlier upon the occurrence of certain events, including but not limited to the Fund’s or the Partnership’s insolvency.



NOTE 11. PRIORITY UNITHOLDERS’ CAPITAL ACCOUNTS

Priority Unitholders’ Capital Accounts 2010 2009

37,497,975 units $ 209,272 $ 191,273

The equity of the Fund as at December 31, 2010 consisted of 37,497,975 Priority Units. Unitholders can redeem their units at a present formula price, to a maximum of $0.05 million per month, and subject to the Fund’s banking covenants on the Bridge Facility. Pursuant to the Fund’s Trust Indenture, an unlimited number of Priority Units are issuable. Each Priority Unit represents an equal, undivided beneficial interest in the Fund and in distributions from the Fund. Each Priority Unit is transferable and entitles the holder thereof to participate equally in distributions from the Fund and to one vote.

In 2010, a non-cash In-Kind Distribution of $18.0 million ($0.48 per unit) was declared to the Priority Unitholders and settled on December 31, 2010 through the issuance of Priority Units. Immediately following the issuance of these units, the Fund consolidated the units such that the number of Priority Units remained unchanged from the number outstanding prior to the non-cash In-Kind Distribution.

NOTE 12. DERIVATIVES AND HEDGES

a) Inventory management program The Fund purchases metal in the form of zinc concentrate to be processed eventually into refined zinc metal for sale to customers. As agent of the Fund, Xstrata Canada provides the hedging arrangements in the event that the structure of the Fund’s sales and purchase contracts does not minimize exposure to changes in zinc prices during the period in which the zinc is refined.

The derivatives associated with the Fund’s inventory management program do not meet the requirements for hedge accounting. As a result, these derivative financial instruments have been recognized on the consolidated balance sheets as either a commodity financial instrument asset or liability with the change in their fair value at each reporting period date recognized as a commodity financial instrument gain or a loss. As at December 31, 2010, the Fund had bought forward approximately 16 million pounds of zinc (2009 – sold 21 million pounds of zinc).

In 2010, the change in fair value of these derivatives was recorded as commodity financial instruments gain of $5.7 million which was recognized in the consolidated statement of earnings (loss) and deficit and comprehensive income (loss) in commodity financial instrument gain (2009 – commodity financial instrument loss of $3.0 million). As at December 31, 2010, the fair value of these positions, as determined with reference to quoted market prices (level 1), was a commodity financial instrument asset of $2.2 million (2009 – commodity financial instrument liability of $3.6 million).

b) Hedges of fixed firm commitments Certain customers request a fixed sales price instead of the LME average price in the month of shipment. Xstrata enters into commodity forward and futures contracts on behalf of the Fund that will allow the Fund to receive the LME average price in the month of shipment while customers pay the agreed-upon fixed price. Xstrata Canada accomplishes this by settling the futures contracts during the month of shipment, which generally results in the realization of the LME average price. In the event that the futures contracts have to be terminated early, due to the customer cancelling a fixed price order, Xstrata Canada has the right to charge the customer with the cost of settling the LME futures contract. A high degree of correlation between the changes in the fair value of the contracts and the fixed sales commitments permits hedge accounting to be used.

As at December 31, 2010, Xstrata Canada had futures contracts hedging approximately 23 million pounds of zinc (2009 – 28 million pounds) to be sold pursuant to firm commitments at fixed prices and delivery dates related to the Fund. As at December 31, 2010, the fair value of these contracts as determined with reference to pooled market prices (level 1) was recognized as a commodity hedging instrument asset of $3.5 million and a long-term commodity hedging instrument asset of $0.4 million (December 31, 2009 – commodity hedging instrument asset of $4.4 million and long-term commodity hedging instrument asset of $1.1 million) and the fair value of the firm fixed sales commitments was recognized as a firm commitment liability of $3.5 million and a long-term firm commitment liability of $0.4 million (December 31, 2009 – firm commitment liability of $4.1 million and a long-term firm commitment liability of $1.1 million).

The net change in fair value of these net positions, representing the ineffective portion of the hedge position for 2010 was recognized in the consolidated statement of earnings (loss) and deficit and comprehensive income (loss) as a commodity hedging loss of $0.3 million (2009 – gain of $0.2 million).


c) Embedded derivatives For the year ended December 31, 2010, the Fund recorded $2.5 million as an increase of raw material purchase costs related to the change in fair value, as determined with reference to pooled market prices (level 1) of the embedded derivatives resulting from the quotational pricing feature of its zinc concentrate payables (2009 – increase of $4.3 million).

NOTE 13. FINANCIAL INSTRUMENTS

Financial risk management The Fund’s activities expose it to a variety of financial risks, which include market risk, credit risk and liquidity risk. The Fund’s primary risk management objective is to protect the Fund’s balance sheet, earnings and cash flow in support of providing, when possible, stable monthly cash distributions at a sustainable level to unitholders.

From time-to-time, the Fund may use foreign exchange forward contracts and commodity price contracts to manage exposure to fluctuations in foreign exchange and metal prices. The Fund’s use of derivatives is based on established practices and parameters, which are subject to the oversight of the board of trustees.

Market risk The Fund purchases zinc concentrate, issues debt at fixed and floating rates, invests surplus cash, sells zinc, copper in cake and sulphuric acid in US dollars and purchases inputs in US dollars. These activities expose the Fund to market risk from changes in zinc prices, interest rates, and foreign exchange rates, which affect the Fund’s balance sheet, earnings and cash flows. The Fund uses derivatives as part of its overall risk management policy to manage certain exposures to market risk that result from these activities.

Interest rate risk As at December 31, 2010, the Fund had $194.7 million floating-rate debt outstanding, which subjects it to an interest rate price risk.

The Fund invests surplus cash in bank deposits and short-term money market securities, which due to their short-term nature, do not expose the Fund to material interest rate risks.

As at December 31, 2010, with other variables unchanged, a 1% change in the variable interest rates would have an insignificant impact on the net earnings of the Fund.

Foreign exchange risk The Fund’s foreign exchange risk arises primarily with respect to the US dollar. The Fund’s revenue and raw material purchase costs are exposed to foreign exchange risk as commodity sales and raw material purchase costs are denominated in US dollars. The majority of operating expenses, principally labour costs and energy costs are payable in Canadian dollars. The US dollar revenue exposure is higher than the US dollar raw material purchase cost exposure due to the realization of zinc metal premiums, the sale of copper in cake and sulphuric acid and zinc metal recovery gains in US dollars. As at December 31, 2010, there were no outstanding forward US dollar purchases.

The Fund also has exposure to the US dollar for its cash, account receivable, inventory, accounts payable and accrued liabilities and bank debt. The Fund attempts to manage the overall economic exposure to US dollar by matching US dollar assets to US dollar liabilities. This currency exposure is managed in part through US dollar overnight transactions. As at December 31, 2010, the Fund had bought forward US dollars with a notional amount of US$79.1 million and sold forward dollars with a notional amount of $79.1 million. An unrealized gain of $0.4 million related to these open positions was recorded in accounts receivable as at December 31, 2010.

Each US one-cent change in the value of the Canadian dollar as at December 31, 2010 impacted earnings before non-controlling interests by approximately $0.6 million.



Commodity price riskThe Fund is subject to price risk from fluctuations in market prices of commodities. The Fund uses future contracts to manage its exposure to fluctuations in commodity prices. The use of the future contracts is based on established practices and parameters.

The Fund’s commodity price risk associated with financial instruments primarily relates to changes in fair value caused by settlement adjustments to receivables and payables and other financial instruments, including firm commitments.

The following represents the financial instruments’ effect on the net earnings after-tax as at December 31, 2010 from a 10% change to metal prices, based on the December 31, 2010 LME forward prices:

Effect on Financial Price on Instruments on December 31, 2010 Change Net Earnings

Zinc US$ 1.10 per pound 10%/-10% $ (6,029)/6,029Copper US$ 4.37 per pound 10%/-10% $ 658/(658)

Credit risk The Fund invests surplus cash in bank deposits and short-term money market securities, sells its products to customers on standard market credit terms, and uses derivatives to manage its market risk exposures. These activities expose the Fund to counterparty credit risk that would result if the counterparty failed to meet its obligations in accordance with the terms and conditions of its contracts with the Fund.

Accounts receivable credit risk is mitigated through established credit monitoring activities. These include conducting financial and other assessments to establish and

monitor a customer’s creditworthiness, setting customer limits, monitoring exposure against these limits, and in some instances moving the customer to cash-in-advance terms.

As at December 31, 2010, two customers (including Xstrata Canada and affiliated companies) represented 47% of the account receivable balance (2009 – 30% from one customer). As at December 31, 2010, $1.9 million of the accounts receivable – trade were fifteen days past due and the Fund had recorded an allowance for doubtful accounts of $0.4 million.

Surplus cash is only invested with counterparties meeting minimum credit quality requirements. Derivative transactions are executed only with approved high-quality counterparties under master netting agreements. The Fund monitors and manages its concentration of counterparty risk on an ongoing basis.

The Fund’s maximum exposure to counterparty credit risk at the reporting date is the carrying value of cash and cash equivalents, accounts receivables, firm commitments and commodity financial instruments.

Liquidity risk The Fund manages liquidity risk by maintaining adequate cash and cash equivalent balances, and by appropriately using the Fund’s Revolving Facility Tranche. The Fund continuously reviews both actual and forecasted cash flows to ensure that the Fund has appropriate Revolving Facility capacity.

Based on the balance sheet as at December 31, 2010, the Fund had $2.9 million of cash and cash equivalents and $47 million of unutilized Revolving Facility Tranche.

The following table summarizes the amount of contractual undiscounted future cash flow requirements for contractual obligations as at December 31, 2010:

Payments due by period

2012 and Contractual Obligations Total Q1 2011 Q2 2011 Q3 2011 Q4 2011 thereafter

Bridge Facility – Revolving Facility Tranche $ 64,730 $ – $ 64,730 $ – $ – $ – Bridge Facility – Term Loan Tranche 130,000 5,000 125,000 – – – Accounts payable and accrued liabilities 66,051 61,977 975 2,014 1,085 – Firm commitments 3,878 1,435 1,300 503 261 379 Total $ 264,659 $ 68,412 $ 192,005 $ 2,517 $ 1,346 $ 379


NOTE 14. CAPITAL RISK MANAGEMENT

The Fund’s objectives when managing capital is to ensure the Fund has the capital and capacity to support the Fund’s ability to continue as a going concern, and to enable the Fund to make sustaining and revenue generating capital expenditures. The Fund’s long-term objective is to maximize unitholder value and, when possible, provide stable monthly distributions at a sustainable level to unitholders (note 1). The Fund’s capital consists of unitholders’ interest and debt.

The Fund’s capital structure reflects the requirements of a company in the zinc processing industry that has long-term fixed processing fee supply contracts. The Fund expects to reduce the amount of debt within the capital structure as it moves closer to the end of the Supply and Processing Agreement (May 2, 2017). The Fund’s investment in working capital is directly correlated to the price of zinc and is funded by the Revolving Facility Tranche.

The Fund continually assesses the adequacy of our capital structure and capacity and makes adjustments within the context of the Fund’s strategy, economic conditions and the risk characteristics of the business.

The Fund monitors its capital using the measures that are consistent with the main covenants under the Bridge Facility. They require the Fund to maintain, at the end of each quarter, a leverage ratio, an interest coverage ratio, and a current ratio.

The leverage ratio at the end of each quarter, on a rolling four-quarter basis, is calculated by dividing the total debt at the end of the period by the Fund’s earnings before interest, taxes, depreciation and amortization (“EBITDA”) for the period, as defined in the credit agreement, and must be no greater than 4.25 to 1.

The interest coverage ratio at the end of each quarter, on a rolling four-quarter basis, is calculated by dividing the Fund’s EBITDA for the period by the total interest expense for that period net of the interest expense related to any subordinated loans, as defined in the credit agreement, and must be no less than 3 to 1.

The current ratio is calculated at the end of each quarter by dividing the current assets by the total of the non-debt current liabilities plus the Revolving Facility Tranche, as defined in the credit agreement, at the balance sheet date, and must be no less than 1 to 1.

The following provides a summary of the measures based on a rolling four-quarter basis as at December 31, 2010:

Twelve month period ending as at December 31, 2010

Leverage ratio 2.3Interest ratio 6.4Current ratio 1.5

NOTE 15. RELATED PARTY TRANSACTIONS

As discussed in Note 1, the Fund has entered into significant agreements with related parties:

As a result of the Supply and Processing Agreement, the Partnership in 2010 purchased $335.9 million of concentrate (2009 – $283.1 million) from Xstrata. In addition, Xstrata provided $1.2 million of sales agency services (2009 – $1.3 million). The sales agency services are provided on a cost recovery basis. As at December 31, 2010, the Partnership had a payable of $34.8 million to Xstrata Canada (2009 – $59.1 million) related to concentrate purchases. This amount is included in accounts payable and accrued liabilities.

As a result of the administration agreement between the Fund and the Manager, the management agreement between the Operating Trust and the Manager and an operating and management agreement between the Partnership and the Manager, Xstrata Canada had provided the following administration, management and operating services to the Fund for the periods:

Selling, General and Administration 2010 2009

Salary and benefits $ 6,886 $ 5,989 Support services 1,164 1,169 Operating and management agreement management fee 287 282 Total $ 8,337 $ 7,440

During 2010, the Fund’s production expenses included $60.6 million (2009 – $55.6 million) of salary and benefits provided by the Manager.

The support services, which include administration, management and operating services are provided on a cost recovery basis in addition to an annual management fee of $0.3 million in 2010 (2009 – $0.3 million). The annual management fee is adjusted upward by 2% per annum at the beginning of each calendar year.

As at December 31, 2010, the Fund, Operating Trust and the Partnership had a payable of $12.6 million (2009 – $13.1 million) related to the agreements. This amount was included in accounts payable and accrued liabilities.



In addition to the related party transactions above, the Partnership undertakes transactions with Xstrata Canada and affiliated companies at terms that reflect market rates. The following table summarizes the related party transactions for the years ended December 31, 2010 and 2009.

2010 2009

Sales Sales of zinc metal $ 72,135 $ 80,291 Sales of byproducts 21,455 27,449 Expenses Purchases of plant equipment, raw materials and operating supplies 8,914 4,221 Credit support from Xstrata Canada $ 402 $ –

Included in the accounts receivable as at December 31, 2010 was $34.2 million (2009 – $8.3 million) of amounts due from sales of zinc metal, copper in cake, and sulphuric acid. Included in accounts payable and accrued liabilities as at December 31, 2010 was $0.2 million (2009 – $0.3 million) of amounts due to related parties, excluding amounts due under agreements identified above.

All amounts due to and from related parties are non-interest bearing and are due in the ordinary course of business. All transactions with Xstrata Canada and affiliated companies are carried out in the normal course of operations, and are recorded at an agreed upon exchange amount.

NOTE 16. SEGMENTED INFORMATION

The Fund operates in one business segment; all sales are made from Canada and all assets are located in Canada.

Sales are attributed to customers based on their geographic location.

2010 2009

Canada $ 215,792 $ 133,506 United States 428,768 338,932Other 14,586 10,737 $ 659,146 $ 483,175

NOTE 17. REVENUE CONCENTRATION

Approximately 33% of the Fund’s zinc metal sales in 2010 were generated from two customers (2009 – 36% from two customers).

Transfer Agent and Registrar

Inquiries regarding change of

address, unit transfers, distributions

or lost certificates should be directed

to our Registrar and Transfer Agent:

Computershare Trust Company

of Canada

1500 University Street

Suite 700

Montréal, Québec

Canada H3A 3S8

Tel: 1-800-564-6253 (North America)

Email: [email protected]

Head Office

100 King Street West

First Canadian Place

Suite 6900, P.O. Box 403

Toronto, Ontario

Canada M5X 1E3

Tel: 416-775-1500

Fax: 416-775-1749

Email:

[email protected]

www.norandaincomefund.com

Processing Facility

Canadian Electrolytic Zinc Limited

860, Gérard-Cadieux Boulevard

Salaberry-de-Valleyfield, Québec

Canada J6T 6L4

Contact

Michael Boone

Vice President and Chief

Financial Officer

Canadian Electrolytic Zinc Limited

Noranda Income Fund’s Manager

Tel: 416-775-1561

Email: [email protected]

Auditors

Ernst & Young, LLP

Chartered Accountants

Montréal, Québec

Canadian Electrolytic

Zinc Limited,

Noranda Income

Fund’s Manager

Officers

Mario Chapados

President and

Chief Executive Officer

Michael Boone

Vice President and

Chief Financial Officer

Reid Bowlby

Vice President, Marketing

Ginette Berthel

Corporate Secretary

Noranda Operating Trust Trustees

Manuel Álvarez Dávila 3

Jean Pierre Ouellet 1, 2

François R. Roy 1, 2

Bob Sippel 3

John J. Swidler, Chair 1, 2

Barry Tissenbaum 1, 2

John Whyte 3

1 Member of the Audit Committee2 Member of the Governance and

Human Resources Committee3 Related to Xstrata Plc

Exchange Listing

TSX: NIF.UN

Annual Meeting of Unitholders

Will be held at 2:00 p.m. on June 14, 2011 at the TSX Broadcast & Conference Centre, The Exchange Tower, 130 King Street West, Toronto, Ontario M5X 1J2, in the Gallery Room.

Corporate Information

UNIT TRADING INFORMATION

Date Open High Low Close Volume Traded

2010 Q1 $ 2.54 $ 3.95 $ 2.40 $ 2.99 7,202,081

2010 Q2 $ 2.99 $ 3.00 $ 2.11 $ 2.49 6,202,044

2010 Q3 $ 2.45 $ 5.10 $ 2.30 $ 5.01 16,663,384

2010 Q4 $ 5.10 $ 5.45 $ 3.90 $ 4.62 7,572,397

2009 Q1 $ 4.20 $ 4.94 $ 2.25 $ 2.80 5,088,489

2009 Q2 $ 2.84 $ 3.16 $ 2.75 $ 2.82 2,804,401

2009 Q3 $ 2.85 $ 2.99 $ 1.53 $ 2.52 6,656,997

2009 Q4 $ 2.46 $ 3.45 $ 2.01 $ 2.55 12,544,914

100 King Street West

First Canadian Place

Suite 6900, P.O. Box 403

Toronto, ON M5X 1E3

Tel: 416-775-1500 Fax: 416-775-1749

www.norandaincomefund.com

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Cover Photo Credits

Casting operator inspects zinc jumbo

Casting operator verifies inventory

Laboratory analyst at work

Roaster operator loads H2SO4 rail car

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NIF - Noranda Income Fund · NIF.UN Noranda Income Fund Annual Report 2010. Contents Letter to...

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