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Business and Significant Accounting Policies

6 Months Ended

Jun. 30, 2011

Business and Significant Accounting Policies

1. Business and Significant Accounting Policies

Business

Solitario Exploration & Royalty Corp. (“Solitario”) is an exploration stage company with a focus on the acquisition of precious and base metal properties with exploration potential and the development or purchase of royalty interests. Solitario acquires and holds a portfolio of exploration properties for future sale, joint venture or to create a royalty prior to the establishment of proven and probable reserves. In August 2010, Solitario signed a Letter of Intent to earn up to an 80% interest in the Mt. Hamilton project located in Nevada from Ely Gold & Minerals, Inc. (“Ely”). Solitario has been working on the exploration and potential development of the Mt. Hamilton project. However, Solitario has never developed a mineral property. Solitario is exploring on other mineral properties that may be developed in the future by Solitario or through a joint venture. Solitario has been actively involved in mineral exploration since 1993. At June 30, 2011, Solitario's mineral properties are located in the United States, Mexico, Brazil, Bolivia and Peru. Solitario was incorporated in the state of Colorado on November 15, 1984.

The accompanying interim condensed consolidated financial statements of Solitario for the six months ended June 30, 2011 and 2010 are unaudited and are prepared in accordance with accounting principles generally accepted in the United States of America. They do not include all disclosures required by generally accepted accounting principles for annual financial statements, but in the opinion of management, include all adjustments, consisting only of normal recurring items, necessary for a fair presentation. Interim results are not necessarily indicative of results, which may be achieved in the future or for the full year ending December 31, 2011.

These financial statements should be read in conjunction with the financial statements and notes thereto which are included in Solitario’s Annual Report on Form 10-K for the year ended December 31, 2010. The accounting policies set forth in those annual financial statements are the same as the accounting policies utilized in the preparation of these financial statements, except as modified for appropriate interim financial statement presentation.

Recent developments

Equity financing

On April 13, 2011, Solitario sold 3,400,000 shares of its common stock in an underwritten public offering at a price to the public of $2.50 per share. In connection with the underwritten public offering, on May 9, 2011, the underwriter exercised its option to purchase an additional 510,000 shares at $2.50 per share to cover over-allotments. The total number of shares sold in the public offering and the over-allotment were 3,910,000 shares (the “Offering”) for net proceeds of approximately $8,937,000 after underwriter’s commission of six percent and offering costs. The Offering was made pursuant to a shelf registration statement on Form S-3 previously filed with the Securities and Exchange Commission (the “SEC”) on March 18, 2011, which was declared effective on March 29, 2011. A prospectus supplement relating to the Offering has been filed with the SEC and is available on the SEC's website located at www.sec.gov.

Stock option liability

On January 1, 2011, Solitario changed its accounting for stock options to equity accounting from liability accounting in accordance with the adoption of the Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) No. 2010-13, “Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades” (“ASU 2010-13”). ASU 2010-13 addresses the classification of a share-based payment award with an exercise price denominated in the currency of a market in which the underlying equity security trades. FASB Accounting Standards Codification (“ASC”) Topic 718 was amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity’s equity securities trade shall not be considered to contain a market, performance or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies for equity classification. In accordance with ASU 2010-13, this change has been made on a prospective basis as of January 1, 2011 with a reduction to stock option liability of $2,775,000, an increase to additional paid-in-capital of $1,240,000 and a reduction in accumulated deficit of $992,000, net of deferred taxes of $543,000. See “Employee stock compensation plans” below.

Investment in Ely and the Mt. Hamilton joint venture

On August 26, 2010, Solitario signed a Letter of Intent (“LOI”) with Ely to make certain equity investments into Ely and to joint venture Ely’s Mt. Hamilton gold project, which was wholly-owned by DHI-Minerals (US) Ltd. (“DHI-US”), an indirect wholly-owned subsidiary of Ely. On August 26, 2010 and October 19, 2010, Solitario made private placement investments of Cdn$250,000 each in Ely securities. Solitario received a total of 3,333,333 shares of Ely common stock and warrants to purchase a total of 1,666,667 shares of Ely common stock (the “Ely Warrants”) for an exercise price of Cdn$0.25 per share, which expire two years from the date of purchase. The private placements were pursuant to the LOI. On November 12, 2010 Solitario made an initial contribution of $300,000 for a 10% membership interest in, upon the formation of, Mt. Hamilton LLC (“MH-LLC”) which was formed in December 2010. The terms of the joint venture are set forth in the Limited Liability Company Operating Agreement of MH-LLC between Solitario and DHI-US (the “MH Agreement”). MH-LLC owns 100% of the Mt. Hamilton Gold project. Pursuant to the MH Agreement, Solitario may earn up to an 80% interest in MH-LLC, and indirectly, the Mt. Hamilton project, by completing various staged commitments. See a more complete discussion of Ely and MH-LLC in Note 12 to the consolidated financial statements, “Ely Gold investment and the Mt. Hamilton Joint Venture” in Item 8 “Financial Statements and Supplementary Data” of our Annual Report on Form 10-K for the year ended December 31, 2010.

Royalty buy-down

On May 17, 2011, MH-LLC and Solitario entered into an agreement with an underlying royalty holder on its Mt. Hamilton property whereby Solitario delivered, for the benefit of MH-LLC, 344,116 shares of its common stock, with a fair market value of $1,000,000 based upon a 20-day weighted average quoted stock price, and $1,520,000 of cash, to reduce the future net smelter royalty (the “Royalty Buy-down”) from a maximum royalty of 8% to a maximum royalty of 6%. MH-LLC retains its existing right to further reduce the net smelter royalty at Mt. Hamilton by an additional 5%, to an ultimate royalty of 1%, as further discussed in Note 12 to the consolidated financial statements, “Ely Gold investment and the Mt. Hamilton Joint Venture” in Item 8 “Financial Statements and Supplementary Data” of our Annual Report on Form 10-K for the year ended December 31, 2010. As part of the Royalty Buy-down transaction, Solitario agreed to loan to DHI-US, the non-controlling member of MH-LLC, $504,000 for DHI-US’s mutually agreed 20% share of the total purchase price contributed by Solitario to MH-LLC to fund the Royalty Buy-down. This loan is unsecured; bears interest at 6% per annum and the loan and any accrued interest thereon will only be repaid from 80% of DHI-US share of distributions from MH-LLC, if any. Solitario has recorded the loan of $504,000 as an offset to the non-controlling interest in MH-LLC, as the loan represents a claim on DHI-US’s share of the future distributions from MH-LLC. During the three and six months ended June 30, 2011, Solitario accrued $4,000 of interest on the $504,000 loan as an offset to DHI-US’s noncontrolling interest in the equity section of the consolidated balance sheet.

Kinross common stock

Solitario has a significant investment in Kinross Gold Corporation (“Kinross”) at June 30, 2011, which consists of 855,000 shares of Kinross common stock. As of June 30, 2011, none of these shares are subject to the Kinross Collar, discussed below under "Derivative instruments." During the three and six months ended June 30, 2011 Solitario sold 20,000 and 125,000 shares of Kinross for net proceeds of $316,000 and $1,964,000 and recorded a gain on sale of $302,000 and $1,870,000, respectively. Solitario sold 40,000 shares of Kinross common shares during the three and six months ended June 30, 2010 for net proceeds of $730,000 and recorded a gain on sale of $553,000.. On April 12, 2011, the final tranche of the Kinross Collar due on that date expired, and the remaining 100,000 shares under the Kinross Collar were released. The Kinross Collar has expired as of that date and no shares are subject to the Kinross Collar. No shares were delivered to UBS under the Kinross Collar and no cash was paid or received upon termination of the Kinross Collar. As of August 1, 2011, we own 855,000 shares of Kinross, which have a value of approximately $14.2 million based upon the market price of $16.58 per Kinross share. Any significant fluctuation in the market value of Kinross common shares could have a material impact on Solitario's liquidity and capital resources.

Employee stock compensation plans

Solitario accounts for its stock options under the provisions of ASC 718 Compensation – Stock Compensation. Pursuant to ASC 718, as of January 1, 2011, Solitario classifies its stock options as equity options in accordance with ASU 2010-13. Previously, Solitario had classified its stock options as liabilities as they are priced in Canadian dollars and Solitario’s functional currency is United States dollars and Solitario’s common stock trades on both the NYSE Amex Equities (“NYSE-Amex”) and the Toronto Stock Exchange (“TSX”). Prior to January 1, 2011, Solitario recorded a liability for the fair value of the vested portion of outstanding options based upon a Black-Scholes option pricing model.

Solitario’s outstanding options on the date of grant have a five year term, and vest 25% on date of grant and 25% on each of the next three anniversary dates. Solitario recognizes stock option compensation expense on the date of grant for 25% of the grant date fair value, and subsequently, based upon a straight line amortization of the unvested grant date fair value of each of its outstanding options. During the three and six months ended June 30, 2011 Solitario recorded $175,000 and $349,000 of stock option expense for the amortization of grant date fair value with a credit to additional paid-in-capital.

Prior to January 1, 2011, Solitario recorded a stock option liability for the vested fair value of each option grant on the measurement date by multiplying the estimated fair value determined using the Black-Scholes model by the percent vesting of the option on the measurement date. During the three and six months ended June 30, 2010, Solitario recognized $636,000 and $645,000, respectively, in stock option compensation expense.

On June 27, 2006 Solitario’s shareholders approved the 2006 Stock Option Incentive Plan (the “2006 Plan”). Under the terms of the 2006 Plan, the Board of Directors may grant up to 2,800,000 options to Directors, officers and employees with exercise prices equal to the market price of Solitario’s common stock at the date of grant.

Solitario granted 2,065,000 options on May 5, 2010, with a grant fair value of $2,449,000 based upon a Black Scholes option pricing model resulting in a weighted average fair value of $1.19 per share.

At December 31, 2010, the fair value of $2,775,000 for Solitario’s outstanding options on that date, granted under the 2006 Plan, was determined utilizing the following assumptions and a Canadian dollar to United States dollar exchange rate of 0.99994.

Fair Value at December 31, 2010

Grant Date	5/5/10			5/19/09
Plan	2006 Plan			2006 Plan
Option price (Cdn$)	$	2.40		$	1.55
Options outstanding		2,065,000			519,000
Expected Life		4.4 yrs			3.4 yrs
Expected volatility		62	%		66	%
Risk free interest rate		1.6	%		1.1	%
Weighted average fair value	$	2.24		$	2.54
Portion of vesting at measurement date		41.6	%		64.6	%
Fair value of outstanding vested options	$	1,924,000		$	851,000

There were no new options granted during the first three and six months of 2011. During the three and six months ended June 30, 2011, options for 90,000 and 100,000 shares, respectively, were exercised at a price of Cdn$1.55 per share for cash proceeds of $146,000 and $161,000. During the six months ended June 30, 2011, options for 8,100 shares were exercised at a price of Cdn$2.40 per share for cash proceeds of $20,000. No options were exercised during the three and six months ended June 30, 2010.

The following table summarizes the activity for stock options outstanding under the 2006 Plan as of June 30, 2011, with exercise prices equal to the stock price, as defined, on the date of grant and no restrictions on exercisability after vesting:

	Shares issuable on outstanding Options			Weighted average exercise Price (Cdn$)		Weighted average remaining contractual term in years		Aggregate intrinsic value(1)
2006 Plan
Outstanding, beginning of year		2,584,000		$	2.23
Granted		—
Exercised		(108,100	)	$	1.61
Forfeited		—
Outstanding at June 30, 2011		2,475,900		$	2.26		3.7	$	1,115,000
Exercisable at June 30, 2011		1,313,650		$	2.21		3.6	$	659,000

(1)The intrinsic value at June 30, 2011 based upon the quoted market price of Cdn$2.70 per share for our common stock on the TSX and an exchange ratio of 1.02379 Canadian dollars per United States dollar.

Earnings per share

The calculation of basic and diluted earnings and loss per share is based on the weighted average number of common shares outstanding during the three and six months ended June 30, 2011 and 2010. Potentially dilutive shares are related to outstanding common stock options of 2,475,900 and 2,565,900 during the three and six months ended June 30, 2011 and 2010, respectively, were excluded from the calculation of diluted loss per share because the effects were anti-dilutive.

Derivative instruments

Ely Warrants

In connection with the equity investment in Ely on August 30, 2010, Solitario acquired warrants to purchase 833,333 shares of Ely common stock at Cdn$0.25 per share for a period of two years. On October 19, 2010, Solitario acquired warrants to purchase an additional 833,333 shares of common stock for two years from that date. In accordance with ASC 815, at December 31, 2010 Solitario did not classify the warrants acquired on October 19, 2010 as derivative instruments until January 18, 2011, or 31 days prior to the underlying shares being readily convertible to cash. Prior to that time, any gains and losses on those warrants were recorded in other comprehensive income. On January 18, 2011, Solitario transferred an unrecognized gain on derivative instrument of $114,000 for the warrants acquired on October 19, 2010 to gain on derivative instrument. In addition, as of June 30, 2011 Solitario has recorded $325,000 for the fair value of the warrants received from Ely as a long-term asset. Including the $114,000 gain on derivative instrument recorded on January 18, 2011, discussed above, Solitario has recorded total unrealized gain on derivative instrument in the statement of operations for the net gain related to the Ely warrants of $17,000 and $73,000, respectively, for the three and six months ended June 30, 2011.

Kinross Collar

On October 12, 2007 Solitario entered into a Zero-Premium Equity Collar (the "Kinross Collar") pursuant to a Master Agreement for Equity Collars and a Pledge and Security Agreement with UBS AG, London, England, an Affiliate of UBS Securities LLC (collectively "UBS"). Under the terms of the Kinross Collar, Solitario pledged 900,000 shares of Kinross common shares to be sold (or delivered back to Solitario with any differences settled in cash). On April 12, 2011, the remaining 100,000 shares under the Kinross Collar were released upon the expiration of the tranche of the Kinross Collar on that date. No shares were delivered to UBS under the Kinross Collar and no cash was paid or received upon termination of the final tranche of the Kinross Collar.

Solitario has not designated the Kinross Collar as a hedging instrument as described in ASC 815 Derivatives and Hedging and any changes in the fair market value of the Kinross Collar are recognized in the statement of operations in the period of the change. As of June 30, 2011 and December 31, 2010, Solitario recorded no value and $2,000, respectively, for the fair market value of the Kinross Collar in other current assets. Solitario recorded an unrealized loss of $2,000 during the six months ended June 30, 2011. Solitario recorded unrealized gains of $2,000 and $76,000, respectively, during the three and six months ending June 30, 2010 in gain on derivative instrument for the change in the fair market value of the Kinross Collar.

Covered Call Options

On November 13, 2009, Solitario sold a covered call option covering 40,000 shares of Kinross with a strike price of $22.00 expiring on May 22, 2010 (the “May 10 Kinross Call”) for $76,000. Solitario recorded a gain on derivative instrument of $4,000 and $42,000, respectively, during the three and six months ended June 30, 2010 for the change in the fair value of the May 10 Kinross Call. Solitario has not designated its covered calls as hedging instruments as described in ASC 815 and any changes in the fair market value of its covered calls are recognized in the statement of operations in the period of the change.

As of June 30, 2011, no shares of Kinross are subject to any hedging arrangements.

The following table provides a detail of the location and amount of the fair values of Solitario's derivative instruments presented in the condensed consolidated balance sheet as of June 30, 2011 and December 31, 2010:

(thousands)

Derivative Instruments

Balance Sheet Location

June 30, 2011

December 31, 2010

Derivatives not designated as hedging
instruments under ASC 815

Ely warrants

Long-term other assets

325

366

Kinross Collar

Current assets

—

The following amounts are included in gain on derivative instruments in the condensed consolidated statement of operations for the three and six months ended June 30, 2011 and 2010:

(thousands)	Three months ended June 30				Six months ended June 30
	2011		2010		2011			2010
Derivatives not designated as hedging instruments under ASC 815	Gain(loss)		Gain(loss)		Gain(loss)			Gain(loss)
Ely warrants	$	17	$	—	$	73		$	—
Kinross Collar		—		2		(2	)		76
May10 Kinross Call		—		4		—			42
Total derivatives	$	17	$	6	$	71		$	118

Fair Value

For certain of Solitario’s financial instruments, including cash and cash equivalents, payables and short-term debt, the carrying amounts approximate fair value due to their short term maturities. Solitario’s marketable equity securities and Ely warrants are carried at their estimated fair value primarily based on quoted market prices. The long-term debt associated with MH-LLC is carried at its estimated fair value based upon the discounted present value of the payments using an estimated discount rate and the Kinross Collar is carried at its estimated fair value based on a Black-Scholes option pricing model.

Solitario accounts for its financial instruments under ASC 820, "Fair Value Measurements." ASC 820 establishes a framework for measuring fair value and requires enhanced disclosures about fair value measurements. ASC 820 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. ASC 820 also requires disclosure about how fair value is determined for assets and liabilities and establishes a hierarchy for which these assets and liabilities must be grouped, based on significant levels of inputs as follows:

· Level 1: quoted prices in active markets for identical assets or liabilities;

· Level 2: quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability; or

· Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement. During the six months ended June 30, 2011, Solitario reclassified its investment in 1,666,666 shares Ely common shares, which were subject to a hold period as of December 31, 2010 from Level 2 to Level 1 as the shares were no longer subject to a hold period as of June 30, 2011. During the six months ended June 30, 2010 there was no reclassification in financial assets or liabilities between Level 1, 2 or 3 categories.

The following is a listing of Solitario’s financial assets and liabilities required to be measured at fair value on a recurring basis and where they are classified within the hierarchy as of June 30, 2011:

(thousands)	Level 1		Level 2		Level 3		Total
Assets
Marketable equity securities	$	14,751	$	—	$	—	$	14,751
Other assets – Ely warrants		—		325		—		325

(thousands)	Level 1		Level 2		Level 3		Total
Assets
Marketable equity securities	$	18,771		—		—	$	18,771
Marketable equity securities – Ely common stock		500		500		—		1,000
Kinross Collar derivative instrument		—		2		—		2
Other assets – Ely warrants		—		366		—		366

Items measured at fair value on a recurring basis:

Marketable equity securities: At June 30, 2011 the fair value of Solitario’s investment in Kinross, TNR and Ely marketable equity securities are based upon quoted market prices and are classified as Level 1 inputs. At December 31, 2010, the fair value of Solitario’s investment in Ely common stock, subject to a hold period, which expired in January 2011 for the shares of Ely common stock from the October 19, 2010 Ely investment, are based upon quoted market prices, which Solitario has not adjusted for the hold period due to the short remaining time period of the hold. However, these are classified as Level 2 inputs as of December 31, 2010 due to the restriction. The remaining marketable equity securities are classified as Level 1 inputs at December 31, 2010.

Ely warrants: The Ely warrants are not traded on any public exchange. Solitario determines the fair value of the Ely warrants using a Black-Scholes pricing model, using inputs, including share price, volatility of Ely common stock and discount rates that include an assessment of performance risk, that are readily available from public markets and for the hold period discussed above, therefore they are classified as Level 2 inputs as of June 30, 2011 and December 31, 2010.

Kinross Collar: The Kinross Collar between Solitario and UBS is a contractual hedge that is not traded on any public exchange. Solitario determines the fair value of the Kinross Collar using a Black-Scholes model using inputs, including the price of a share of Kinross common stock, volatility of Kinross common stock price that are readily available from public markets, and discount rates that include an assessment of performance risk, therefore, they are classified as Level 2 inputs. See Derivative instruments above.

During the three and six months ended June 30, 2011, Solitario did not change any of the valuation techniques used to measure its financial assets and liabilities at fair value.

Marketable equity securities

Solitario's investments in marketable equity securities are classified as available-for-sale and are carried at fair value, which is based upon quoted prices of the securities owned. The cost of marketable equity securities sold is determined by the specific identification method. Changes in market value are recorded in accumulated other comprehensive income within shareholders' equity, unless a decline in market value is considered other than temporary, in which case the decline is recognized as a loss in the consolidated statement of operations. Solitario had marketable equity securities with fair values of $14,751,000 and $19,771,000, respectively, and cost of $993,000 and $1,087,000, respectively, at June 30, 2011 and December 31, 2010. Solitario has accumulated other comprehensive income for unrealized holding gains of $13,759,000 and $18,684,000, respectively, net of deferred taxes of $5,132,000 and $6,969,000, respectively, at June 30, 2011 and December 31, 2010 related to our marketable equity securities. Solitario sold 20,000 shares and 125,000 shares, respectively, of Kinross stock during the three and six months ended June 30, 2011 for proceeds of $316,000 and $1,964,000, respectively, and recorded a gain on sale of $302,000 and $1,870,000, respectively. Solitario has classified $2,702,000 and $5,214,000, respectively, of marketable equity securities as current, as of June 30, 2011 and December 31, 2010, which represents Solitario's estimate of the portion of marketable equity securities that will be liquidated within one year.

The following table represents changes in marketable equity securities.

(in thousands)	Three months ended June 30,					Six months ended June 30,
	2011			2010		2011			2010
Gross cash proceeds	$316			$730		$1,964			$730
Cost		14			177		94			177
Gross gain on sale included in earnings during the period		302			553		1,870			553
Unrealized holding gain (loss) arising during the period included in other comprehensive income, net of tax of $18 and $1,199 for the three and six months ended June 30, 2011 and $11 and $(517) for the three and six months ended June 30, 2010		(31	)		19		(2,016	)		(869	)

Revenue Recognition

Solitario records delay rental payments as revenue in the period received. Solitario did not receive any delay rental payments during the three and six months ended June 30, 2011. Solitario received $747,000 of deferred noncontrolling shareholder payments from Anglo Platinum Limited (“Anglo) during the three and six months ended June 30, 2010. Any payments received for the sale of property interests are recorded as a reduction of the related property’s capitalized cost. Proceeds which exceed the capitalized cost of the property are recognized as revenue.

Variable interest entity

Pursuant to the terms of the MH Agreement, Solitario has determined that MH-LLC is a variable interest entity in accordance with ASC 810. Solitario has also determined that it is the primary beneficiary of MH-LLC. Accordingly, Solitario consolidates MH-LLC in its consolidated financial statements in accordance with ASC 810. Solitario has determined no separate presentation of assets or liabilities is necessary per ASC 810, as MH-LLC does not have any assets that can only be used to settle specific obligations or liabilities for which creditors do not have recourse to Solitario.

Recent accounting pronouncements

In April 2010, the FASB issued ASU 2010-13. ASU 2010-13 addresses the classification of a share-based payment award with an exercise price denominated in the currency of a market in which the underlying equity security trades. ASC Topic 718 was amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trade shall not be considered to contain a market, performance or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies for equity classification. In accordance with ASU 2010-13, this change has been made on a prospective basis as of January 1, 2011 with a reduction to stock option liability of $2,775,000, an increase to additional paid-in-capital of $1,240,000 and a reduction in accumulated deficit of $992,000, net of deferred taxes of $543,000. See “Employee stock compensation plans” above.