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Business and Significant Accounting Policies

3 Months Ended

Mar. 31, 2012

Business and Significant Accounting Policies

1. Business and Significant Accounting Policies

Business

Solitario Exploration & Royalty Corp. (“Solitario”) is a development stage company which is developing its Mt. Hamilton project located in Nevada. See “Recent Developments” below. In addition Solitario has a focus on the acquisition of precious and base metal properties with exploration potential and the development or purchase of royalty interests. In addition to its Mt. Hamilton project, 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. Although Solitario intends to develop the Mt. Hamilton project, Solitario has never developed a mineral property. At March 31, 2012, Solitario's mineral properties are located in the United States, Mexico, Brazil, Bolivia and Peru.

The accompanying interim condensed consolidated financial statements of Solitario for the three months ended March 31, 2012 and 2011 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, 2012.

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, 2011. 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

Mt. Hamilton feasibility study

In December 2010 Solitario signed the Limited Liability Company Operating Agreement of Mt. Hamilton LLC, (the “MH Agreement”), and formed Mt. Hamilton LLC (“MH-LLC”), the owner of the Mt. Hamilton project. Solitario announced on February 22, 2012 the completion of a feasibility study on its Mt. Hamilton project (the “Feasibility Study”), prepared by SRK Consulting (US), Inc. of Lakewood, Colorado (“SRK”). As a result of the completion of the Feasibility Study, pursuant to the MH Agreement, Solitario earned an 80% interest in MH-LLC, became a development-stage company (but not a company in the “Development Stage”) and reported mineral reserves at its Mt. Hamilton project. See Note 7, “Mineral Properties” below.

Investment in Kinross

Solitario has a significant investment in Kinross Gold Corporation (“Kinross”) at March 31, 2012, which consists of 820,000 shares of Kinross common stock. During the three months ended March 31, 2012 Solitario sold 30,000 shares of Kinross for net proceeds of $353,000 and recorded a gain on sale of $332,000. Solitario sold 105,000 shares of Kinross for net proceeds of $1,648,000 and recorded a gain on sale of $1,568,000 during the three months ended March 31, 2011. As of March 31, 2012, Solitario has no covered calls or any other derivative arrangements outstanding against its holdings of Kinross shares. As of March 31, 2012, Solitario has borrowed $2,792,000 in margin loans against its holdings of Kinross shares. The short-term margin loans are discussed below under, “Short-term debt.” As of May 4, 2012, Solitario owns 805,000 shares of Kinross common stock which have a value of approximately $6.75million based upon the market price of $8.39 per Kinross share. Solitario’s investment in Kinross common stock represents a significant concentration of assets, with the inherent risk that entails. Any significant fluctuation in the market value of Kinross common shares could have a material impact on our liquidity and capital resources.

Employee stock compensation plans

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 months ended March 31, 2012 and March 31, 2011, Solitario recorded $174,000 of stock option expense for the amortization of grant date fair value with a credit to additional paid-in-capital.

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.

There were no new options granted during the three months ended March 31, 2012 and 2011. During the three months ended March 31, 2012 no options were exercised. During the three months ended March 31, 2011 options for 18,100 shares were exercised for proceeds of $36,000, with 10,000 of those options exercised at a price of Cdn$1.55 per share and 8,100 shares exercised at a price of Cdn$2.40 per share.

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 months ended March 31, 2012 and 2011. Potentially dilutive shares related to outstanding common stock options of 2,433,400 and 2,565,900 during the three months ended March 31, 2012 and 2011, 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 during 2010, Solitario acquired warrants to purchase 1,666,666 shares of Ely common stock at Cdn$0.25 per share for a period of two years. Warrants for 833,333 shares expire on August 26, 2012 and the remaining warrants for 833,333 shares expire on October 19, 2012. As of March 31, 2012 and December 31, 2011, Solitario has recorded $139,000 and $73,000, respectively for the fair value of the warrants received from Ely as a current asset. Solitario recorded an unrealized gain on derivative instrument of $66,000 and $56,000, respectively, in the statement of operations for a net gain related to the Ely warrants for the three months ended March 31, 2012 and 2011.

International Lithium Corp.

In May 2011 TNR Gold Corp. (“TNR”) completed a spin-out of a new entity, International Lithium Corp. (“ILC”). Solitario owned 1,000,000 shares of TNR at the time of the spin-out and received 250,000 shares of ILC and warrants to acquire 250,000 shares of ILC (the “ILC Warrants”) at a price of Cdn$0.375 per share for a period of two years. During the three months ended March 31, 2012, Solitario recorded no unrealized gain or loss on derivative instruments related to its ILC warrants.

Covered Call Options

From time to time Solitario has sold covered call options against its holdings of Kinross. The business purpose of selling covered calls is to provide additional income on a limited portion of shares of Kinross that Solitario may sell in the near term, which is generally defined as less than one year. As of March 31, 2012 and December 31, 2011, Solitario has no outstanding covered call options.

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.

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 March 31, 2012 and December 31, 2011:

(in thousands)	Derivative Instruments
	Balance Sheet Location	March 31, 2012	December 31, 2011
Derivatives not designated as hedging instruments under ASC 815
Ely investment warrants	Other current assets	$ 139	$ 74
ILC warrants	Other current assets	4	4

The following amounts are included in gain on derivative instruments in the condensed consolidated statement of operations for the three months ended March 31, 2012 and 2011:

(in thousands)	March 31, 2012	March 31, 2011
Derivatives not designated as hedging instruments under ASC 815	Gain(loss)	Gain(loss)
Ely investment warrants	$ 66	$ 56
Kinross collar	-	(2)
Total derivatives	$ 66	$ 54

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 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 Ely Warrants and ILC Warrants are carried at their 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 three months ended March 31, 2012 there were no reclassifications in financial assets or liabilities between Level 1, 2 or 3 categories. During the three months ended March 31, 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 March 31, 2011.

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 March 31, 2012:

(in thousands)	Level 1	Level 2	Level 3	Total
Assets
Marketable equity securities	$8,921	$ -	$ -	$8,921
Other current assets – Ely warrants	-	139	-	139
Other current assets - ILC warrants	-	4	-	4

(in thousands)	Level 1	Level 2	Level 3	Total
Assets
Marketable equity securities	$10,361	$ -	$ -	$10,361
Other current assets - Ely warrants	-	74	-	74
Other current assets - ILC warrants	-	4	-	4

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 $8,921,000 and $10,361,000 respectively, and cost of $966,000 and $$988,000 respectively, at March 31, 2012 and December 31, 2011. Solitario has accumulated other comprehensive income for unrealized holding gains of $7,955,000 and $9,373,000, respectively, net of deferred taxes of $2,967,000 and $3,496,000, respectively, at March 31, 2012 and December 31, 2011 related to our marketable equity securities. Solitario sold 30,000 shares of Kinross for proceeds of $353,000 and recorded a gain on sale of $332,000 during the three months ended March 31, 2012. Solitario sold 105,000 shares of Kinross stock during the three months ended March 31, 2011 for proceeds of $1,648,000 and recorded a gain on sale of $1,568,000. Solitario has classified $5,915,000 and $4,361,000, respectively, of marketable equity securities as current, as of March 31, 2012 and December 31, 2011, 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 March 31,
	2012	2011
Gross cash proceeds	$ 353	$ 1,648
Cost	21	80
Gross gain on sale included in earnings during the period	332	1,568
Deferred taxes on gross gain on sale included in earnings	(124)	(585)
Reclassification adjustment to unrealized gain in other comprehensive income for net gains included in earnings	(208)	(983)
Unrealized holding loss arising during the period included in other comprehensive income, net of tax of $405 and $1,226.	(681)	(2,060)

Revenue Recognition

Solitario records delay rental payments as revenue in the period received. Solitario did not receive any delay rental payments during the three months ended March 31, 2012 and 2011, respectively. 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, prior to earning an 80% interest in MH-LLC as a result of the completion of the Feasibility Study, MH-LLC was a variable interest entity as of December 31, 2011, of which Solitario was the primary beneficiary in accordance with ASC 810. Accordingly, Solitario consolidated MH-LLC in its consolidated financial statements at December 31, 2011 in accordance with ASC 810. Solitario has determined no separate presentation of assets or liabilities was necessary per ASC 810 at December 31, 2011, 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. As discussed in Note 1, as a result of the completion of the Feasibility Study, Solitario earned an 80% interest in MH-LLC on February 22, 2012. MH-LLC will no longer be accounted for as a variable interest entity, but will be subject to the consolidation method of accounting.