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Business and Significant Accounting Policy

6 Months Ended

Jun. 30, 2012

Business and Significant Accounting Policy

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 June 30, 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 and six months ended June 30, 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.

Sandstorm royalty sale

On June 11, 2012, MH-LLC completed the sale of a 2.4% net smelter returns royalty (“NSR”) on the Mt. Hamilton project to Sandstorm Gold, Ltd (“Sandstorm”) for US$10.0 million. MH-LLC received an upfront payment of US$6.0 million upon signing the agreement and will receive US$4.0 million on January 15, 2013, which Solitario has recorded as a current asset as of June 30, 2012. As part of the agreement, MH-LLC will have the option, for a period of 30 months from June 11, 21012 to repurchase up to 100% of the NSR for US$12 million, provided that MH-LLC enters into a gold stream agreement with Sandstorm that has an upfront deposit of greater than US$30 million. In addition, MH-LLC has provided Sandstorm with a right of first refusal on any future royalty or gold stream financing for the Mt. Hamilton project. Pursuant to the Agreement, Solitario is jointly and severally liable for all obligations of MH-LLC to Sandstorm. See Note 7, “Mineral Properties,” below for further discussion of the Sandstorm royalty sale.

Private placement to related parties

On June 26, 2012, Christopher Herald, President and Chief Executive Officer of Solitario, and James Maronick, Chief Financial Officer of Solitario, agreed to purchase shares of the Company’s common stock at a price of $1.22 per share, with Mr. Herald agreeing to purchase 180,000 shares and Mr. Maronick agreeing to purchase 45,000 shares. The purchase of the shares was unanimously approved by Solitario’s Board of Directors and was also unanimously approved by Solitario’s Audit Committee of the Board of Directors. The price of the shares was the last closing price of Solitario’s common shares as quoted on the NYSE MKT (formerly NYSE Amex) on June 25, 2012. Solitario received total proceeds of $274,500.

Investment in Kinross

Solitario has a significant investment in Kinross Gold Corporation (“Kinross”), which consisted of the following at June 30, 2012 and December 31, 2011:

(in thousands)	6/30/2012	12/31/2011
Shares	670	850
Fair value
Current assets	$1,365	$4,361
Long term assets	$4,096	$5,329

During the three and six months ended June 30, 2012 and 2011, Solitario sold the following shares of Kinross:

(in thousands)	Three months ended June 30		Six months ended June 30
	2012	2011	2012	2011
Shares sold	150	20	180	125
Proceeds	$1,238	$316	$1,591	$1,964
Gain on sale	$1,132	$302	$1,464	$1,870

As of June 30, 2012, Solitario has borrowed $3,123,000 in short-term margin loans, which are primarily secured by its investment in Kinross. The short-term margin loans are discussed below under “Short-term debt.” As of August 6, 2012, Solitario owns 670,000 shares of Kinross common stock which have a value of approximately $5.2 million based upon the market price of $7.75 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

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’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, 2012, Solitario recorded $174,000 and $348,000, respectively, of stock option expense for the amortization of grant date fair value with a credit to additional paid-in capital. Solitario recorded the same stock option expense during the three and six months ended June 30, 2011.

There were no new options granted during the three and six months ended June 30, 2012 and 2011. During the three and six months ended June 30, 2012 no options were exercised. 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, respectively. 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.

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, 2012 and 2011. Potentially dilutive shares related to outstanding common stock options of 2,433,400 during the three and six months ended June 30, 2012 and 2,475,900 during the three and six months ended June 30, 2011 were excluded from the calculation of diluted loss per share because the effects were anti-dilutive.

Derivative instruments

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 sheets as of June 30, 2012 and December 31, 2011:

(in thousands)	Derivative Instruments
	Balance Sheet Location	June 30, 2012	December 31, 2011
Derivatives not designated as hedging instruments under ASC 815
Ely investment warrants	Other current assets	$ 23	$ 74
International Lithium Corp warrants	Other current assets	1	4

The following amounts are included in (loss) gain on derivative instruments in the condensed consolidated statement of operations for the three months and six ended June 30, 2012 and 2011:

	Three months ended		Six months ended
(in thousands)	June 30, 2012	June 30, 2011	June 30, 2012	June 30, 2011
Derivatives not designated as hedging instruments under ASC 815	Gain(loss)	Gain(loss)	Gain(loss)	Gain(loss)
Ely investment warrants	$(117)	$ 17	$ (51)	$73
International Lithium Corp warrants	(3)	-	(3)	-
Kinross collar	-	-	-	(2)
Total derivatives	$(120)	$ 17	$ (54)	$ 71

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 and six months ended June 30, 2012, there were no reclassifications in financial assets or liabilities between Level 1, 2 or 3 categories. During the six months ended June 30, 2011, Solitario reclassified its investment in 1,666,666 shares of 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.

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, 2012:

(in thousands)	Level 1	Level 2	Level 3	Total
Assets
Marketable equity securities	$6,104	$ -	$ -	$6,104
Other current assets – Ely warrants	-	23	-	23
Other current assets - ILC warrants	-	1	-	1

Solitario recorded a royalty sale receivable of $4,000,000 in current assets in connection with the Sandstorm royalty sale discussed above. The determination of the initial fair value of $4,000,000 was categorized as Level 3, as there was no market data available and Solitario determined the fair value based upon its assumptions of the likelihood of payment of the receivable by Sandstorm as discussed below in Note 7, “Mineral Properties.”

(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 statements of operations. The following tables summarize Solitario’s marketable equity securities and accumulated other comprehensive income related to its marketable equity securities:

(in thousands)	June 30, 2012	December 31, 2011
Marketable equity securities at fair value	$6,104	$10,361
Cost	860	988
Accumulated other comprehensive income for unrealized holding gains	5,244	9,373
Deferred taxes on accumulated other comprehensive income for unrealized holding gains	1,956	3,496
Accumulated other comprehensive income	$3,288	$5,877

Solitario has classified $1,365,000 and $4,361,000, respectively, of marketable equity securities as current, as of June 30, 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 June 30,		Six months ended June 30,
	2012	2011	2012	2011
Gross cash proceeds	$1,238	$ 316	$1,591	$1,964
Cost	106	14	127	94
Gross gain on sale included in earnings during the period	1,132	302	1,464	1,870
Deferred taxes on gross gain on sale included in earnings	(422)	(113)	(546)	(698)
Reclassification adjustment to unrealized gain in other comprehensive income for net gains included in earnings	(710)	(189)	(918)	(1,172)
Gross unrealized holding (loss) gain arising during the period included in other comprehensive loss.	(1,579)	117	(2,665)	(3,170)
Deferred taxes on unrealized holdings loss (gain) included in other comprehensive loss	589	(44)	994	1,183
Net unrealized holding (loss) gain	(990)	73	(1,671)	(1,987)
Other comprehensive (loss) income from marketable equity securities	$(1,700)	$(116)	(2,589)	$(3,159)

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, 2012 and 2011, respectively. Any payments received for the sale of property interests without reserves are recorded as a reduction of the related property’s capitalized cost. Proceeds which exceed the capitalized cost of the property without reserves are recognized as revenue. Payments received on the sale of properties with reserves are recognized as revenue to the extent the proceeds exceed the proportionate basis in the assets sold. Gain on the sale of a mineral property revenue stream is deferred to the extent there is a guarantee for the future revenue stream until such time as the potential funding obligation for the guarantee is reduced or released.

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.