**Exhibit 1.3**

 

**Management’s Responsibility forFinancial Statements**

 

The accompanying consolidated financialstatements have been prepared by management in accordance with Canadiangenerally accepted accounting principles (GAAP). Financial statements includecertain amounts based on estimates and judgments. When an alternative methodexists under Canadian GAAP, management has chosen that which it deems mostappropriate in the circumstances in order to ensure that the consolidatedfinancial statements are presented fairly, in all material respects, inaccordance with Canadian generally accepted accounting principles. Thefinancial information presented elsewhere in the annual report is consistentwith that in the consolidated financial statements.

 

The Company maintains adequate systems ofinternal accounting and administrative controls. Such systems are designed toprovide reasonable assurance that transactions are properly authorized andrecorded, the Company’s assets are appropriately accounted for and adequatelysafeguarded and that the financial information is relevant and reliable.

 

The Board of Directors of the Company isresponsible for ensuring that management fulfills its responsibilities forfinancial reporting, and is ultimately responsible for reviewing and approvingthe consolidated financial statements and the accompanying management’sdiscussion and analysis. The Board of Directors carries out this responsibilityprincipally through its Audit Committee.

 

The Audit Committee is appointed by the Boardof Directors and all of its members are non-management directors. The AuditCommittee meets periodically with management and the external auditors todiscuss internal controls, auditing matters and financial reporting issues, andto satisfy itself that each party is properly discharging its responsibilities.The Audit Committee also reviews the consolidated financial statements,management’s discussion and analysis, the external auditors’ report, examinesthe fees and expenses for audit services, and considers the engagement orreappointment of the external auditors. The Audit Committee reports itsfindings to the Board of Directors for its consideration when approving theconsolidated financial statements for issuance to the shareholders.KPMG LLP, the external auditors, have full and free access to the AuditCommittee.

 

Toronto, Canada

March 18, 2008

 

 
| /s/  **James D. Excell**        |   | /s/  **G. Fraser B. Sinclair**                      |
|--------------------------------------|--------|----------------------------------------------------------|
| **James D. Excell**President and CEO |   | **G. Fraser B. Sinclair**Vice President Finance, and CFO |

 

25

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| **KPMG** LLP                      |   |                     |
|-----------------------------------|--------|--------------------------|
| **Chartered Accountants**         |   | Telephone (416) 228-7000 |
| Yonge Corporate Centre            |   | Telefax (416) 228-7123   |
| 4100 Yonge Street, Suite 200 |   | www.kpmg.ca              |
| North York, ON M2P 2H3            |   |                     |

 

**Auditors’ Report**

 

To the Shareholders of North AmericanPalladium Ltd.

 

We have audited the consolidated balancesheets of North American Palladium Ltd. (“the Company”) as at December 31,2007 and 2006 and the consolidated statements of operations, comprehensive lossand deficit, cash flows and shareholders’ equity for each of the years in thethree-year period ended December 31, 2007. These financial statements arethe responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance withCanadian generally accepted auditing standards. With respect to theconsolidated financial statements for the year ended December 31, 2007, wealso conducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require thatwe plan and perform an audit to obtain reasonable assurance whether thefinancial statements are free of material misstatement. An audit includes examining,on a test basis, evidence supporting the amounts and disclosures in thefinancial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation.

 

In our opinion, these consolidated financialstatements present fairly, in all material respects, the financial position ofthe Company as at December 31, 2007 and 2006 and the results of itsoperations and its cash flows for each of the years in the three-year periodended December 31, 2007 in accordance with Canadian generally acceptedaccounting principles.

 

We have also audited, in accordance with thestandards of the Public Company Accounting Oversight Board(United States), the Company’s internal control over financial reportingas of December 31, 2007, based on the criteria established in InternalControl-Integrated Framework issued by the Committee of SponsoringOrganizations of the Treadway Commission (COSO), and our report dated March 28,2008 expressed an unqualified opinion on the effectiveness of the Company’sinternal control over financial reporting.

 

/s/ KPMG LLP

KPMG LLP

Chartered Accountants, Licensed PublicAccountants

 

Toronto, Canada,

March 28, 2008.

 

26

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

** **

To theShareholders and Board Directors of North American Palladium Ltd.

 

We have auditedNorth American Palladium Ltd. (the Company”)’s internal control over financialreporting as of December 31, 2007, based on the criteria established in Internal Control—Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission (COSO).The Company’s management is responsible for maintaining effective internalcontrol over financial reporting and for its assessment of the effectiveness ofinternal control over financial reporting, included in the accompanyingManagement Discussion and Analysis**.** Ourresponsibility is to express an opinion the Company’s internal control overfinancial reporting based on our audit.

 

We conducted ouraudit in accordance with the standards of the Public Company AccountingOversight Board (United States). Those standards require that we plan andperform the audit to obtain reasonable assurance about whether effectiveinternal control over financial reporting was maintained in all materialrespects. Our audit included obtaining an understanding of internal controlover financial reporting, assessing the risk that a material weakness exists,and testing and evaluating the design and operating effectiveness of internalcontrol based on the assessed risk. Our audit also included performing suchother procedures as we considered necessary in the circumstances. We believethat our audit provides a reasonable basis for our opinion.

 

A company’sinternal control over financial reporting is a process designed to providereasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance withgenerally accepted accounting principles. A company’s internal control overfinancial reporting includes those policies and procedures that (1) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (3) provide reasonable assurance regarding preventionor timely detection of unauthorized acquisition, use, or disposition of thecompany’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

27

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In our opinion,the Company****maintained, in allmaterial respects, effective internal control over financial reporting as of December 31,2007, based on the criteriaestablished in Internal Control—Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission (COSO). We also haveconducted our audits on the consolidated financial statements in accordance with Canadian generally acceptedauditing standards. With respect to the year ended December 31, 2007, wealso have conducted our audit in accordance with the standards of the PublicCompany Accounting Oversight Board (United States).  Our report dated March 28, 2008******expressed an unqualified opinion on those**consolidated**financialstatements.

 

/s/ KPMG LLP

 

CharteredAccountants, Licensed Public Accountants

Toronto, Canada

 

March 28,2008

 

28

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**Consolidated Balance Sheets**

(expressed in thousands of Canadian dollars)

 
| ** **                                                                                 | ** ** | **December 31** | ** **  |
|--------------------------------------------------------------------------------------------|------------|----------------------|-------------|
| ** **                                                                                 | ** ** | **2007**             | ** **  | **2006** | ** ** |
| **ASSETS**                                                                                 |       |                 |        |   |   |
| **Current Assets**                                                                         |       |                 |        |   |   |
| Cash and cash equivalents                                                                  | ** ** | **$**                | **74,606**  |   | $ | 3,153 |   |
| Concentrate awaiting  settlement, net – Note 3                              | ** ** | **79,087**           |        | 82,050 |   |
| Taxes recoverable                                                                          | ** ** | **62**               |        | 145 |   |
| Inventories –  Note 4                                                       | ** ** | **17,873**           |        | 14,164 |   |
| Crushed and broken  ore stockpiles                                                    | ** ** | **8,072**            |        | 7,134 |   |
| Other assets                                                                               | ** ** | **2,563**            |        | 2,602 |   |
|                                                                                       | ** ** | **182,263**          |        | 109,248 |   |
| Mining interests,  net – Note 5                                             | ** ** | **114,464**          |        | 146,617 |   |
| Mine restoration  deposit – Note 6                                          | ** ** | **8,272**            |        | 8,041 |   |
| Crushed and broken  ore stockpiles                                                    | ** ** | **375**              |        | 289 |   |
| Deferred financing  costs – Note 7                                          | ** ** | **—**           |        | 962 |   |
|                                                                                       | ** ** | **$**                | **305,374** |   | $ | 265,157 |   |
| **LIABILITIES AND SHAREHOLDERS’  EQUITY**                                             |       |                 |        |   |   |
| **Current Liabilities**                                                                    |       |                 |        |   |   |
| Accounts payable and  accrued liabilities                                                  | ** ** | **$**                | **20,757**  |   | $ | 21,526 |   |
| Future mining tax  liability – Note 19                                      | ** ** | **168**              |        | 149 |   |
| Current portion of  obligations under capital leases – Note 8               | ** ** | **1,672**            |        | 2,104 |   |
| Current portion of  convertible notes payable – Note 9                      | ** ** | **25,710**           |        | 22,148 |   |
| Current portion of  long-term debt– Note 10                                      | ** ** | **5,918**            |        | 6,662 |   |
| Kaiser-Francis credit  facility– Note 11                                         | ** ** | **—**           |        | 5,827 |   |
|                                                                                       | ** ** | **54,225**           |        | 58,416 |   |
| Mine restoration obligation –  Note 2                                            | ** ** | **8,878**            |        | 8,211 |   |
| Obligations under capital  leases – Note 8                                  | ** ** | **1,824**            |        | 4,111 |   |
| Convertible notes  payable – Note 9                                         | ** ** | **—**           |        | 23,062 |   |
| Long-term debt –  Note 10                                                   | ** ** | **3,957**            |        | 10,992 |   |
| Future mining tax  liability – Note 19                                      | ** ** | **539**              |        | 381 |   |
|                                                                                       | ** ** | **69,423**           |        | 105,173 |   |
| **Shareholders’ Equity**                                                              |       |                 |        |   |   |
| Common share capital and  purchase warrants – Note 13                       | ** ** | **443,986**          |        | 339,743 |   |
| Stock options                                                                              | ** ** | **1,673**            |        | 1,269 |   |
| Equity component of  convertible notes payable, net of issue costs – Note 9 | ** ** | **6,044**            |        | 12,336 |   |
| Contributed surplus                                                                        | ** ** | **6,292**            |        | — |   |
| Deficit                                                                                    | ** ** | **(222,044**         | **)**       | (193,364 | ) |
| Total shareholders’ equity                                                            | ** ** | **235,951**          |        | 159,984 |   |
|                                                                                       | ** ** | **$**                | **305,374** |   | $ | 265,157 |   |

 

Commitments – Notes 1 and 15

Contingencies – Note 6 and 18

Subsequent events – Note 21

 

See accompanying notes to the consolidatedfinancial statements

 

On Behalf of the Board

 

 
| /s/  **André J. Douchane** |   | /s/  **Gregory J. Van Staveren** |
|--------------------------------------|--------|---------------------------------------|
| **André J. Douchane**Director   |   | **Gregory J. Van Staveren**

Director |

 

29

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**Consolidated Statements ofOperations, Comprehensive Loss and Deficit**

(expressed in thousands of Canadian dollars,except share and per share amounts)

 
| ** **                                                                                     | ** ** | **Year ended December 31** | ** **   |
|------------------------------------------------------------------------------------------------|------------|---------------------------------|--------------|
| ** **                                                                                     | ** ** | **2007**                        | ** **   | **2006** | ** ** | **2005** | ** ** |
| **Revenue – before pricing adjustments**                                             | ** ** | **$**                           | **201,367**  |   | $ | 145,819 |   | $ | 85,233 |   |
| Pricing adjustments:                                                                           |       |                            |         |   |   |   |   |
| Commodities                                                                                    | ** ** | **8,756**                       |         | 11,674 |   | 7,727 |   |
| Foreign exchange                                                                               | ** ** | **(14,191**                     | **)**        | 1,707 |   | (354 | ) |
| **Revenue – after pricing adjustments –  Note 16**                    | ** ** | **195,932**                     |         | 159,200 |   | 92,606 |   |
| ** **                                                                                     | ** ** | ** **                      |         |   |   |   |   |
| **Operating expenses**                                                                         |       |                            |         |   |   |   |   |
| Production costs, excluding amortization and asset retirement costs                            | ** ** | **125,065**                     |         | 112,458 |   | 99,322 |   |
| Smelter treatment, refining and freight costs                                                  | ** ** | **22,444**                      |         | 15,438 |   | 15,777 |   |
| Amortization – Note 5(b)                                                        | ** ** | **46,908**                      |         | 30,103 |   | 18,297 |   |
| Administrative                                                                                 | ** ** | **7,773**                       |         | 6,734 |   | 6,616 |   |
| Exploration                                                                                    | ** ** | **12,138**                      |         | 11,831 |   | 7,927 |   |
| Loss on disposal of equipment                                                                  | ** ** | **—**                      |         | 194 |   | — |   |
| Asset retirement costs                                                                         | ** ** | **1,010**                       |         | 554 |   | 476 |   |
| Total operating expenses                                                                       | ** ** | **215,338**                     |         | 177,312 |   | 148,415 |   |
| **Loss from mining operations**                                                                | ** ** | **(19,406**                     | **)**        | (18,112 | ) | (55,809 | ) |
| ** **                                                                                     | ** ** | ** **                      | ** **   |   |   |   |   |
| **Other income (expenses)**                                                                    |       |                            |         |   |   |   |   |
| Interest and other financing costs – Note 17                                    | ** ** | **(18,633**                     | **)**        | (15,647 | ) | (952 | ) |
| Foreign exchange gain (loss)                                                                   | ** ** | **8,422**                       |         | (1,759 | ) | 268 |   |
| Total other income (expenses)                                                                  | ** ** | **(10,211**                     | **)**        | (17,406 | ) | (684 | ) |
| **Loss before taxes**                                                                          | ** ** | **(29,617**                     | **)**        | (35,518 | ) | (56,493 | ) |
| Income and mining tax recovery – Note 19                                        | ** ** | **(937**                        | **)**        | (1,409 | ) | (2,882 | ) |
| **Net loss and comprehensive loss for the year**                                               | ** ** | **(28,680**                     | **)**        | (34,109 | ) | (53,611 | ) |
| Deficit, beginning of year                                                                     | ** ** | **(193,364**                    | **)**        | (159,255 | ) | (105,644 | ) |
| Deficit, end of year                                                                           | ** ** | **$**                           | **(222,044** | **)** | $ | (193,364 | ) | $ | (159,255 | ) |
| Net loss per share                                                                             |       |                            |         |   |   |   |   |
| Basic                                                                                          | ** ** | **$**                           | **(0.51**    | **)** | $ | (0.65 | ) | $ | (1.03 | ) |
| Diluted – Note 13(f)                                                            | ** ** | **$**                           | **(0.51**    | **)** | $ | (0.65 | ) | $ | (1.03 | ) |
| Weighted average number of shares outstanding – basic                                | ** ** | **55,792,203**                  |         | 52,562,939 |   | 52,006,548 |   |
| Weighted average number of shares outstanding – diluted –  Note 13(f) | ** ** | **55,792,203**                  |         | 52,562,939 |   | 52,006,548 |   |

 

See accompanying notes to the consolidatedfinancial statements

 

30

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**Consolidated Statements of CashFlows**

(expressed in thousands of Canadian dollars)

 
| ** **                                                                           | ** ** | **Year ended December 31** | ** **  |
|--------------------------------------------------------------------------------------|------------|---------------------------------|-------------|
| ** **                                                                           | ** ** | **2007**                        | ** **  | **2006** | ** ** | **2005** | ** ** |
| **Cash provided by (used in)**                                                       |       |                            |        |   |   |   |   |
| **Operations**                                                                       |       |                            |        |   |   |   |   |
| Net loss for the year                                                                | ** ** | **$**                           | **(28,680** | **)** | $ | (34,109 | ) | $ | (53,611 | ) |
| Operating items not involving cash                                                   |       |                            |        |   |   |   |   |
| Accretion expense relating to convertible notes payable                              | ** ** | **12,947**                      |        | 10,090 |   | — |   |
| Amortization                                                                         | ** ** | **46,908**                      |        | 30,103 |   | 18,297 |   |
| Amortization of deferred financing costs                                             | ** ** | **751**                         |        | 1,090 |   | 43 |   |
| Interest on convertible notes settled in shares                                      | ** ** | **2,644**                       |        | 1,974 |   | — |   |
| Accrued interest on mine restoration deposit                                         | ** ** | **(231**                        | **)**       | (194 | ) | (74 | ) |
| Unrealized foreign exchange loss (gain)                                              | ** ** | **10,779**                      |        | (822 | ) | (33 | ) |
| Asset retirement costs                                                               | ** ** | **1,010**                       |        | 554 |   | 476 |   |
| Future income tax recovery – Note 19                                  | ** ** | **(937**                        | **)**       | (739 | ) | (3,286 | ) |
| Stock based compensation and employee benefits                                       | ** ** | **1,637**                       |        | 1,771 |   | 1,728 |   |
| Loss on disposal of equipment                                                        | ** ** | **—**                      |        | 194 |   | — |   |
|                                                                                 | ** ** | **46,828**                      |        | 9,912 |   | (36,460 | ) |
| Changes in non-cash working capital – Note 20(a)                      | ** ** | **(21,352**                     | **)**       | (43,701 | ) | 28,187 |   |
|                                                                                 | ** ** | **25,476**                      |        | (33,789 | ) | (8,273 | ) |
| **Financing Activities**                                                             |       |                            |        |   |   |   |   |
| Issuance of common shares and warrants, net of issue costs –  Note 13 | ** ** | **75,318**                      |        | 3,955 |   | 3,200 |   |
| Repayment of long-term debt                                                          | ** ** | **(12,016**                     | **)**       | (6,566 | ) | (6,798 | ) |
| Repayment of obligations under capital leases                                        | ** ** | **(1,979**                      | **)**       | (2,278 | ) | (2,253 | ) |
| Mine restoration deposit                                                             | ** ** | **—**                      |        | (600 | ) | (1,200 | ) |
| Issuance of convertible notes                                                        | ** ** | **—**                      |        | 41,037 |   | — |   |
| Increase in long-term debt and credit facility                                       | ** ** | **—**                      |        | 8,111 |   | — |   |
| Deferred financing costs                                                             | ** ** | **—**                      |        | (2,364 | ) | — |   |
|                                                                                 | ** ** | **61,323**                      |        | 41,295 |   | (7,051 | ) |
| **Investing Activities**                                                             |       |                            |        |   |   |   |   |
| Additions to mining interests                                                        | ** ** | **(15,346**                     | **)**       | (19,384 | ) | (35,415 | ) |
| Proceeds on disposal of mining interests                                             | ** ** | **—**                      |        | — |   | 15 |   |
|                                                                                 | ** ** | **(15,346**                     | **)**       | (19,384 | ) | (35,400 | ) |
| Increase (decrease) in cash and cash equivalents                                     | ** ** | **71,453**                      |        | (11,878 | ) | (50,724 | ) |
| Cash and cash equivalents, beginning of year                                         | ** ** | **3,153**                       |        | 15,031 |   | 65,755 |   |
| Cash and cash equivalents, end of year                                               | ** ** | **$**                           | **74,606**  |   | $ | 3,153 |   | $ | 15,031 |   |
|                                                                                 | ** ** | ** **                      |        |   |   |   |   |
| **Cash and cash equivalents consisting of:**                                         |       |                            |        |   |   |   |   |
| Cash                                                                                 | ** ** | **$**                           | **4,444**   |   | $ | 3,153 |   | $ | 15,031 |   |
| Short-term investments                                                               | ** ** | **70,162**                      |        | — |   | — |   |
|                                                                                 | ** ** | **$**                           | **74,606**  |   | $ | 3,153 |   | $ | 15,031 |   |

 

Supplementary information –Note 20(b), (c) (d) and (e)

 

See accompanying notes to the consolidatedfinancial statements

 

31

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**Consolidated Statements ofShareholders’ Equity**

(expressed in thousands of Canadian dollars,except share amounts)

 
| ** **                                             | ** ** | **Number  of shares** | ** ** | **Capital  stock** | ** ** | **Stock  options** | ** ** | **Warrants** | ** ** | **Equity  component  of  convertible  notes  payable** | ** ** | **Contributed  surplus** | ** ** | **Deficit** | ** ** | **Total  shareholders’  equity** | ** ** |
|--------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|--------------------|------------|--------------|------------|--------------------------------------------------------|------------|--------------------------|------------|-------------|------------|---------------------------------------|------------|
| Balance,  December 31, 

2006                     |       | 52,947,693            |       | $                  | 331,705    |               | $          | 1,269        |       | $                                                      | 8,038      |                     | $          | 12,336      |       | $                                     | —     |   | $ | (193,364 | ) | $ | 159,984 |   |
| Common shares  issued:                                 |       |                  |       |               |       |               |       |         |       |                                                   |       |                     |       |        |       |                                  |       |
| For principal  repayments on convertible notes payable |       | 3,120,997             |       | 26,180             |       | —             |       | —       |       | (6,292                                                 | )          | 6,292                    |       | —      |       | 26,180                                |       |
| For interest  payments on convertible notes payable    |       | 341,528               |       | 2,644              |       | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | 2,644                                 |       |
| Private  placement of flow-through shares (net)        |       | 550,000               |       | 5,686              |       | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | 5,686                                 |       |
| Tax effect of  flow-through shares                     |       | —                |       | (1,114             | )          | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | (1,114                                | )          |
| Pursuant to unit  offering, net of issue costs         |       | 18,666,667            |       | 64,461             |       | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | 64,461                                |       |
| Warrants Issued:                                       |       |                  |       |               |       |               |       |         |       |                                                   |       |                     |       |        |       |                                  |       |
| Pursuant to unit  offering, net of issue costs         |       | —                |       | —             |       | —             |       | 5,155        |       | —                                                 |       | —                   |       | —      |       | 5,155                                 |       |
| Stock options  exercised                               |       | 5,000                 |       | 17                 |       | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | 17                                    |       |
| Fair value of  stock options exercised                 |       | —                |       | 10                 |       | (10                | )          | —       |       | —                                                 |       | —                   |       | —      |       | —                                |       |
| Stock-based  compensation expense                      |       | 138,685               |       | 1,204              |       | 414                |       | —       |       | —                                                 |       | —                   |       | —      |       | 1,618                                 |       |
| Net loss for the  year ended December 31, 2007    |       | —                |       | —             |       | —             |       | —       |       | —                                                 |       | —                   |       | (28,680     | )          | (28,680                               | )          |
| Balance,  December 31,

2007                      |       | 75,770,570            |       | $                  | 430,793    |               | $          | 1,673        |       | $                                                      | 13,193     |                     | $          | 6,044       |       | $                                     | 6,292      |   | $ | (222,044 | ) | $ | 235,951 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

32

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**Consolidated Statements ofShareholders’ Equity**

(expressed in thousands of Canadian dollars,except share amounts)

 
| ** **                                                                | ** ** | **Number  of shares** | ** ** | **Capital  stock** | ** ** | **Stock  options** | ** ** | **Warrants** | ** ** | **Equity  component  of  convertible  notes  payable** | ** ** | **Contributed  surplus** | ** ** | **Deficit** | ** ** | **Total  shareholders’  equity** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|--------------------|------------|--------------------|------------|--------------|------------|--------------------------------------------------------|------------|--------------------------|------------|-------------|------------|---------------------------------------|------------|
| Balance, December 31, 2005                                           |       | 52,197,217            |       | $                  | 325,592    |               | $          | 874          |       | $                                                      | —     |                     | $          | —      |       | $                                     | —     |   | $ | (159,255 | ) | $ | 167,211 |   |
| Common shares issued:                                                     |       |                  |       |               |       |               |       |         |       |                                                   |       |                     |       |        |       |                                  |       |
| For interest payments on convertible notes payable                        |       | 242,158               |       | 1,974              |       | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | 1,974                                 |       |
| Private placement shares (net)                                            |       | 270,000               |       | 3,045              |       | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | 3,045                                 |       |
| Tax effect of flow-through shares                                         |       | —                |       | (1,067             | )          | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | (1,067                                | )          |
| Warrants Issued:                                                          |       |                  |       |               |       |               |       |         |       |                                                   |       |                     |       |        |       |                                  |       |
| Pursuant to terms of Series I convertible notes, net of issue  costs |       | —                |       | —             |       | —             |       | 6,238        |       | 9,750                                                  |       | —                   |       | —      |       | 15,988                                |       |
| Pursuant to terms of Series II convertible note, net of issue  costs |       | —                |       | —             |       | —             |       | 1,800        |       | 2,586                                                  |       | —                   |       | —      |       | 4,386                                 |       |
| Warrants exercised                                                        |       | —                |       | —             |       | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | —                                |       |
| Stock options exercised                                                   |       | 130,755               |       | 910                |       | —             |       | —       |       | —                                                 |       | —                   |       | —      |       | 910                                   |       |
| Fair value of stock options exercised                                     |       | —                |       | 166                |       | (166               | )          | —       |       | —                                                 |       | —                   |       | —      |       | —                                |       |
| Stock-based compensation expense                                          |       | 107,563               |       | 1,085              |       | 561                |       | —       |       | —                                                 |       | —                   |       | —      |       | 1,646                                 |       |
| Net loss for the year ended December 31, 2006                        |       | —                |       | —             |       | —             |       | —       |       | —                                                 |       | —                   |       | (34,109     | )          | (34,109                               | )          |
| Balance, December 31, 2006                                           |       | 52,947,693            |       | $                  | 331,705    |               | $          | 1,269        |       | $                                                      | 8,038      |                     | $          | 12,336      |       | $                                     | —     |   | $ | (193,364 | ) | $ | 159,984 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

33

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**Notes to theConsolidated Financial Statements**

**for the years endedDecember 31, 2007, 2006 and 2005**

(expressed in thousands of Canadian dollars, except pershare amounts and metal prices)

 

**1. NATUREOF OPERATIONS**

 

North AmericanPalladium Ltd. (“NAP” or “the Company”) is a Canadian company in thebusiness of exploring and mining Platinum Group Metals (“PGMs”) and certainbase and precious metals. Its principal asset is the Lac des Iles mine locatedin the Thunder Bay District in Ontario. The Company also has a number of basemetal exploration projects located in Canada and an advanced PGM explorationproject located in Finland in which it is earning an interest in under anagreement signed on March 24, 2006. The Company operates in one operatingsegment, mining.

 

The Company’sfinancial position and operating results are directly affected by the marketprice of the PGMs in relation to the Company’s production costs. Theprices of PGMs (palladium, platinum) and by-product metals (gold, copperand nickel) fluctuate widely and are affected by numerous factors beyond theCompany’s control.

 

**Arctic Platinum Project**

 

On March 24,2006, the Company entered into an agreement with Gold Fields Limited to furtherexplore and develop a mining operation at the Arctic Platinum Project (“APP”)located in Finland. The APP includes several advanced stage PGM Projects. TheCompany has been granted an option to earn up to a 50% interest and, in certaincircumstances, a 60% interest in APP, in which event a joint venture will be formedand the Company will become the project operator. In order to exercise theoption, the Company must spend US$12,500, complete a feasibility study and makea production decision as well as issue to Gold Fields, approximately7.3 million shares or approximately 9.2 million shares, subject toadjustment, to earn a 50% or 60% interest respectively on or before August 31,2008. As at December 31, 2007, the Company has incurred $12,758(US$11,670) in expenditures on the APP and these costs have been charged toexploration expense.

 

**Shebandowan Project**

 

On December 3,2003, the Company entered into an option and joint venture agreement with ValeInco Limited (formerly Inco Limited and CVRD Inco Limited) on theHaines-Conacher property which surrounds the past producing Shebandowan mine.The agreement was subsequently amended on March 31, 2006 to include themine. The nickel, copper and PGM Shebandowan Project is located approximately100 km southwest of the Lac des Iles mine. Successive diamond drillingprograms in 2005 and 2006 were carried out on three relatively shallowmineralized zones known as the West, Road and “D” zones. A Technical Report incompliance with National instrument 43-101 on Shebandowan West zone,disclosing the results of a mineral resource estimate by an independentQualified Person was filed on October 26, 2007. On December 10, 2007,the Company announced that it has exercised its option to form an operatingjoint venture with Vale Inco Limited over the Shebandowan property.

 

**2. BASIS OF PRESENTATION AND SUMMARY OFSIGNIFICANT ACCOUNTING POLICIES**

 

Theseconsolidated financial statements have been prepared in accordance withCanadian generally accepted accounting principles. All amounts are in Canadiandollars unless otherwise noted. The more significant accounting policies aresummarized as follows:

 

**Basis of Consolidation**

 

Theseconsolidated financial statements include the accounts of the Company and itswholly-owned subsidiaries, Lac des Iles Mines Ltd. (“LDI”), North AmericanPalladium Finland Ltd. (“NAPFL”), and North American Palladium ArcticServices Ltd. (“NAPFS”). The Company’s exploration activities in respectof the Shebandowan project are conducted through a joint venture, effective December 6,2007, which the Company accounts for using the proportionate consolidationmethod. All inter-company balances and transactions have been eliminated.

 

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**Revenue and Concentrate Awaiting Settlement**

 

Revenue fromthe sale of palladium and by-product metals is recognized net of royalties uponthe delivery of concentrate to the smelter, which is when title transfers andthe rights and obligations of ownership pass. The Company’s metals are soldunder contracts that provide for final prices that are determined by quotedmarket prices in a period subsequent to the date of sale. Variations from theprovisionally priced sales are recognized as revenue adjustments as they occuruntil the price is finalized. Provisional pricing is based upon market pricesin the month of recognition. Concentrate awaiting settlement at the smelter isnet of estimated treatment and refining costs which are subject to finalassay adjustments.

 

Although theCompany sold its metals during 2007 to a limited number of customers, it is noteconomically dependent upon them as there are other markets throughout theworld for the Company’s metals.

 

**Concentrate, Crushed and Broken OreStockpiles and Supplies Inventories**

 

Concentrateand crushed and broken ore stockpiles are valued at the lower of averageproduction cost (including an allocation of the amortization of productionrelated assets) and net realizable value. Crushed and broken ore stockpilesrepresent coarse ore that has been extracted from the mine and is available forfurther processing. Stockpile tonnages are verified by periodic surveys. Theamount of stockpiled ore that is not expected to be processed within one yearis shown as a long-term asset. Supplies inventory is valued at the lower ofaverage direct acquisition cost and replacement cost.

 

**Mining Interests**

 

Plant andequipment are recorded at cost with amortization generally provided either onthe unit-of-production method over the proven and probable reserves to whichthey relate or on a straight-line basis over their estimated useful lives,ranging from three to seven years. The Company capitalizes interest on majorprojects where direct indebtedness has occurred. During 2007 interest in theamount of $nil was capitalized (2006 – $188).

 

The Companyleases certain equipment under capital leases. These leases are capitalizedbased on the lower of fair market value and the present value of future minimumlease payments. The corresponding liabilities are recorded as obligations undercapital leases. This equipment is being amortized on the same basis asdescribed above.

 

Mining leasesand claims and royalty interests are recorded at cost and are amortized on theunit-of-production method over the proven and probable reserves.

 

Explorationcosts relating to properties are charged to earnings in the year in which theyare incurred. When it is determined that a mining property can be economicallydeveloped as a result of established proven and probable reserves, futuredevelopment and exploration expenditures are capitalized. Determination as toreserve potential is based on the results of feasibility studies, whichindicate whether production from a property is economically feasible. Uponcommencement of commercial production of a development project these costs are amortizedusing the unit-of-production method over the proven and probable reserves.Capitalized exploration costs, net of salvage values, relating to a propertythat is later abandoned or considered uneconomic for the foreseeable future,are written off in the period the decision is made.

 

**Impairment of Long-lived Assets**

 

Each year, theCompany reviews mining plans for the remaining life of each property.Significant changes in the mine plan can occur as a result of miningexperience, new discoveries, changes in mining methods and rates, processchanges, investments in new equipment and technology and other factors. Basedon year-end ore reserves and the current mine plan, the Company reviewsannually its accounting estimates and makes adjustments accordingly.

 

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The Companyassesses long-lived assets for impairment whenever events or changes incircumstances indicate the carrying amount of an asset may not be recoverable.When the carrying value of a long-lived asset is less than its net recoverablevalue as determined on an undiscounted basis, an impairment loss is recognizedto the extent that its fair value, measured as the discounted cash flows overthe life of the asset is less than the carrying value. Future cash flows areestimated based on quantities of recoverable minerals, expected palladium andother commodity prices and expected foreign exchange rates (consideringcurrent, historical and expected future prices and foreign exchange rates andrelated factors), production levels and cash costs of production and capitaland reclamation expenditures, all based on detailed life-of-mine plans andprojections. The term “recoverable minerals” refers to the estimated amount ofpalladium and other commodities that will be obtained from proven and probablereserves after taking into account losses during mining, ore processing andconcentrate treatment. Assumptions underlying future cash flow estimates aresubject to risk and uncertainty. Any differences between significantassumptions and market conditions such as metal prices, exchange rates,recoverable metal, and/or the Company’s operating performance could have amaterial effect on the Company’s ability to recover the carrying amounts of itslong-lived assets resulting in possible additional impairment charges.

** **

**Asset Retirement Obligations**

 

Assetretirement obligations are recognized when incurred and recorded as liabilitiesat fair value. The amount of the liability is subject to re-measurement at eachreporting period. The liability is accreted over time through periodic chargesto earnings. In addition, the asset retirement obligation is capitalized aspart of mining interests and amortized over the estimated life of the mine.Total undiscounted cash flows required to settle the obligations are estimatedto be approximately $7,800 the majority of which is to be paid at the end ofthe mine life, which is currently expected in 2010. A credit adjusted risk-freerate of 4% has been utilized to determine the obligation recorded on thebalance sheet. The estimated asset retirement obligation may change materiallybased on future changes in operations, costs of reclamation and closureactivities, and regulatory requirements.

 

The followingis a reconciliation of the changes in the asset retirement obligation duringthe year:

 
| ** **                      | ** ** | **2007**  | ** ** | **2006** | ** ** |
|---------------------------------|------------|-----------|------------|----------|------------|
| Balance,  beginning of the year |       | **8,211** |       | $        | 7,894      |   |
| Accretion  expense              |       | **667**   |       | 317      |       |
| Balance at  the end of year     |       | **$**     | **8,878**  |     | $          | 8,211 |   |
|                                 |            |           |            |          |            |  |  |

 

**Stock-Based Compensation Plans**

 

The Companyhas a stock-based compensation plan which is described in note 13 (e) anda Restricted Share Unit Plan (“RSU”) which is described in note 13 (g).The Company recognizes as an expense the cost of stock-based compensation basedon the estimated fair value of new stock options granted to employees anddirectors. The fair value of each RSU, being the fair market value of theCompany’s common shares at the grant date, is recorded as a liability on theCompany’s consolidated balance sheet over the vesting period. The value of theRSU liability is adjusted to reflect changes in the market value of the Company’scommon shares at each period end.

 

**Translation of Foreign Currency**

 

The reportingand functional currency of the Company is the Canadian dollar. Accordingly, theCompany translates monetary assets and liabilities denominated in foreigncurrency at the rate of exchange prevailing at the consolidated balance sheetdates, non-monetary assets and liabilities denominated in foreign currency atthe rate in effect at the date the transaction occurred and revenues andexpenses denominated in foreign currency at the exchange rate in effect duringthe applicable accounting period. All resulting foreign exchange gains andlosses are recorded in the consolidated statements of operations, comprehensiveloss and deficit.

 

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**Income Taxes**

 

The Companyfollows the asset and liability method of accounting for income taxes. Underthis method, future tax assets and liabilities are determined based ondifferences between the financial reporting and tax bases of assets andliabilities and are measured using the substantively enacted tax rates and lawsthat will be in effect when the differences are expected to reverse. The effecton future tax liabilities and assets of a change in tax rates is recognized inincome in the period that the change occurs. The Company provides a valuationallowance for future tax assets when it is more likely than not that someportion or all of the future tax assets will not be realized.

 

**Cash and cash equivalents**

 

Cash and cashequivalents includes cash on account less outstanding cheques, demand depositsand short-term guaranteed investments with original maturities of three monthsor less and are stated at fair value.

 

**Deferred Financing Costs**

 

Deferredfinancing costs represents the costs of negotiating and securing the Company’slong-term debt facilities. Effective January 1, 2007, the Company recordsall transaction costs for financial assets and financial liabilities as areduction of the related asset or liability and the effective interest ratemethod is now used to amortize these costs to operations. As at January 1,2007, the Company adjusted the carrying value of the related long-term debt andthe convertible note payable using the effective interest method. The impactwas a decrease in the carrying value of the convertible notes payable of $855and a decrease in the long-term debt of $107 and a decrease in deferredfinancing costs of $962.

 

**Basic and Diluted Loss Per Share**

 

Basic loss percommon share is computed by dividing the loss for the period by the weightedaverage number of common shares outstanding during the reporting period.Diluted loss per common share is computed using the treasury stock methodwhereby the weighted average number of shares outstanding is increased toinclude additional common shares from the assumed exercise of stock options,convertible notes and common share purchase warrants (equity instruments), ifdilutive. The number of additional common shares is calculated by assuming thatoutstanding equity instruments were exercised and that proceeds from suchexercises were used to acquire shares of common stock at the average marketprice during the reporting period. These common equivalent shares are notincluded in the calculation of the weighted average number of sharesoutstanding for diluted loss per common share when the effect would beanti-dilutive.

 

**Flow-through shares**

 

The Companyfinances a portion of its exploration activities through the issue offlow-through shares. The Company renounces the deductions to investors andaccordingly records share issue costs related to the future tax liability ofthe temporary difference arising from the renunciation. As a result, sharecapital is reduced and future income tax liabilities are increased by theestimated tax benefits when renounced by the Company to the investors, exceptto the extent that the Company has unused tax benefits on loss carryforwardsand tax pools in excess of book value available for deduction against which avaluation allowance has been provided. In these circumstances, the future taxliability reduces the valuation allowance, if any, and the reduction isrecognized in earnings.

 

**Use of Estimates**

 

The preparationof financial statements requires management to make estimates and assumptionsthat affect the reported amount of assets and liabilities, and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenue and expenses during the year. Significantestimates and assumptions relate to recoverability of mining operations andmineral exploration properties. While management believes that these estimatesand assumptions are reasonable, actual results could vary significantly.

 

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**Derivative Financial Instruments**

 

From time totime the Company may enter into forward commodity sales contracts to hedge theeffect on revenues of changes in the price of metals it produces. Gains andlosses on derivative financial instruments used to mitigate metal price riskare recognized in revenue from metal sales over the term of the hedgingcontract. The Company had no outstanding forward commodity sales contracts as atDecember 31, 2007.

 

From time totime the Company may enter into foreign exchange forward sales contracts tomanage the effect of fluctuations in the value of committed U.S. dollardenominated revenues. The Company had no outstanding foreign exchange forwardsales contracts as at December 31, 2007.

 

The Companydoes not hold financial instruments or derivative financial instruments fortrading purposes.

 

**Adoption of New Accounting Standards**

 

In July 2006,the Accounting Standards Board issued a replacement of The Canadian Instituteof Chartered Accountants’ Handbook (“CICA Handbook”) Section 1506,Accounting Changes (“Section 1506”). The new standard allows for voluntarychanges in accounting policy only when they result in the financial statementsproviding reliable and more relevant information, requires changes inaccounting policy to be applied retrospectively unless doing so isimpracticable, requires prior period errors to be corrected retrospectively andcalls for enhanced disclosures about the effects of changes in accountingpolicies, estimates and errors on the financial statements. Section 1506also requires disclosures of information relevant to assessing the possibleimpact of the application of a new GAAP standard on the Company’s financial statementsin the period of initial adoption. The adoption of Section 1506 effective January 1,2007 has had no impact on these consolidated financial statements.

 

**Financial Instruments**

 

As required byThe Canadian Institute of Chartered Accountants (“CICA”), on January 1,2007, the Company adopted CICA Handbook Section 1530, ComprehensiveIncome; Section 3251, Equity; Section 3855, FinancialInstruments – Recognition and Measurement; and Section 3861,Financial Instruments – Disclosure and Presentation. The adoption of thesenew standards resulted in changes in the presentation for financial instrumentsas described below. As required by the implementation of these new standards,the prior period consolidated financial statements have not been restated. Theprincipal changes in the accounting for financial instruments arising from theadoption of these accounting standards are described below.

 

**(a)****          Section 1530,Comprehensive Income**

 

Section 1530 requires a statement of comprehensive income, whichconsists of net income and other comprehensive income (“OCI”). OCI is a newrequirement to temporarily present certain gains and losses from changes infair value outside of net income. There has been no impact of thispronouncement for the year ended December 31, 2007, accordingly theCompany’s net income and comprehensive income are equal.

 

**(b)****          Section 3251,Equity**

 

Section 3251 describes the changes in how to report and discloseequity and changes in equity as a result of the new requirements of Section 1530,including the changes in equity for the period arising from OCI. Accumulatedchanges in OCI are included in the accumulated other comprehensive income (“AOCI”)and are presented in the consolidated statements of shareholders equity andcomprehensive income as a separate component of shareholders’ equity. TheCompany has no AOCI as a result of the adoption of this new accountingpronouncement, accordingly there is no impact on the consolidated financialstatements as a result of the adoption of this standard.

 

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**c)****              Section 3855,Financial Instruments – Recognition and Measurement Section 3861,Financial Instruments – Disclosure and Presentation**

 

Under the new standards, financial assets and financial liabilities areinitially recognized at fair value and their subsequent measurements aredependent on their classification as described below. Their classificationdepends on the purpose for which the financial instruments were acquired orissued, their characteristics and the Company’s designation of suchinstruments. The standards require that all financial assets be classifiedeither as held-for-trading, available for sale, held-to-maturity, or loans andreceivables. The standards require that all financial assets, including allderivatives, be measured at fair value with the exception of loans andreceivables, debt securities classified as held-to-maturity andavailable-for-sale financial assets that do not have quoted market prices inthe active market. Settlement date accounting continues to be used for allfinancial assets, except changes in fair value between the trade date andsettlement date are reflected in the consolidated statements of earnings forheld-for-trading financial assets, while changes in fair value between tradedate and settlement date are reflected in OCI for available-for-sale financialassets.

 

**Loans and receivables**

 

Loans andreceivables are non-derivative financial assets that are initially recognizedat fair value and thereafter are accounted for at cost or amortized cost.

 

**Other liabilities**

 

Otherliabilities are initially recorded at fair value and thereafter are recorded atcost or amortized cost using the effective interest method and include allliabilities, other than derivatives or liabilities to which the fair valuedesignation has been applied.

 

**Embedded derivatives**

 

Derivativesembedded in other financial instruments or contracts are separated from theirhost contracts and accounted for as derivatives when their economiccharacteristics and risk are not closely related to those of the host contract;the terms of the embedded derivatives are the same as those of thefree-standing derivatives; and the combined instrument or contract is notmeasured at fair value, with changes in fair value recognized in income. Theseembedded derivatives are measured at fair value with changes therein recognizedin the statement of earnings. As at December 31, 2007 and December 31,2006, the Company has separated the early repayment call and put options on theCompany’s convertible notes payable. The fair value of the early repayment andput option was determined to be nominal and therefore there was no impact onthe financial statements as a result of the bifurcation of these embeddedderivatives.

 

**Classification of financial instruments**

 

The followingis a summary of the accounting classification the Company has elected to applyto each of its significant categories of financial instruments outstanding asof January 1, 2007:

 

(i)                  Concentrate awaiting settlement, netis classified as held for trading;

 

(ii)               Other assets are classified as loans andreceivables; and

 

(iii)            All financial liabilities as otherfinancial liabilities.

 

**Future Accounting Standards**

 

*Financial Instruments – Recognition andMeasurement*

 

In December 2006,the CICA released new Handbook sections 3862, “Financial Instruments –Disclosures”, and 3863, “Financial Instruments – Presentation”,effective for fiscal years beginning on or after October 1, 2007. Section 3862,describes the required disclosures related to the significance of financialinstruments on the Company’s financial position and performance and the natureand extent of risks arising for financial instruments to which the entity isexposed and how the entity manages those risks. This section complementshandbook sections 3855, “Financial Instruments – Recognition andMeasurements”; 3863, “Financial Instruments – Presentation; and 3865, “Hedges”.Section 3863

37

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establishesstandards for presentation of financial instruments and non financialderivatives. This section complements handbook section 3861, “FinancialInstruments – Disclosure and Presentation”. The Company has not yetdetermined the effect these new standards will have on its financial positionand results of operations.

 

*Capital Disclosures*

 

In December 2006,the CICA released new Handbook section 1535, “Capital Disclosures”, whichestablishes standards for disclosing information about a Company’s capital andhow it is managed, to enable users of financial statements to evaluate theCompany’s objectives, policies and procedures for managing capital. Thissection will apply to interim and annual financial statements relating tofiscal years beginning on or after October 1, 2007. The Company has notyet determined the effect these new standards will have on its financialposition and results of operations.

 

*Inventories*

 

In June 2007,the CICA released new handbook section 3031, “Inventories,” effective forfiscal years beginning on or after January 1, 2008. Section 3031supersedes the existing CICA section 3030, “Inventories,”and provides additional guidance on the determination of cost and itssubsequent recognition as an expense, including any write-down to netrealizable value, and disclosures made within the financial statements. TheCompany has not yet determined the effect these new standards will have on itsfinancial position and results of operations.

 

**3. CONCENTRATE AWAITING SETTLEMENT**

 

Concentrateawaiting settlement is comprised of:

 
| ** **                             | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|
| Concentrate awaiting settlement, gross | ** ** | **$**      | **85,869** | ** ** | $          | 88,034 |   |
| Refining and smelter treatment charges | ** ** | **(6,782** | **)**      | (5,984     | )          |
| Concentrate awaiting settlement, net   | ** ** | **$**      | **79,087** | ** ** | $          | 82,050 |   |

 

The grossvalue of concentrate awaiting settlement represents the value of allPGMs and base metals from production shipped to and received by thethird-party smelter between May and December 2007, including125,802 ounces of palladium which was valued at the December 31, 2007London Metal Exchange (“LME”) afternoon price fix of US$364 (2006 –including 129,496 ounces of palladium valued at US$322). The LMEafternoon price fix as at March 18, 2008 was US$481.

 

All of theconcentrate awaiting settlement is due from one domestic customer at December 31,2007 (2006 – two domestic customers). A reserve for doubtful accounts hasnot been established, as in the opinion of management, the amount due will befully realized.

 

**4. INVENTORIES**

 

Inventoriesconsist of the following:

 
| ** **  | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|-------------|------------|------------|------------|------------|------------|
| Concentrate | ** ** | **$**      | **3,026**  | ** ** | $          | 3,782 |   |
| Supplies    | ** ** | **14,847** | ** ** | 10,382     |       |
|        | ** ** | **$**      | **17,873** | ** ** | $          | 14,164 |   |

 

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**5.MINING INTERESTS**

 

**(a)****                                 ****Mininginterests are comprised of the following:**

 
| ** **                                                                 | ** ** | **2007**     | ** **  | **2006**   | ** ** |
|----------------------------------------------------------------------------|------------|--------------|-------------|------------|------------|
| Plant and equipment, at  cost                                              |       | **$**        | **368,339** | ** ** | $          | 362,151 |   |
| Underground mine  development, at cost                                     |       | **52,174**   | ** **  | 43,015     |       |
| Accumulated amortization  and impairment charges                           |       | **(319,388** | **)**       | (277,397   | )          |
|                                                                       |       | **101,125**  | ** **  | 127,769    |       |
| Equipment under capital  lease, at cost                                    |       | **14,076**   | ** **  | 14,076     |       |
| Accumulated amortization  and impairment charges                           |       | **(7,022**   | **)**       | (3,991     | )          |
|                                                                       |       | **7,054**    | ** **  | 10,085     |       |
| Mining leases and claims,  royalty interest, and development, at cost |       | **82,561**   | ** **  | 82,561     |       |
| Accumulated amortization  and impairment charges                           |       | **(76,276**  | **)**       | (73,798    | )          |
|                                                                       |       | **6,285**    | ** **  | 8,763      |       |
| Mining interests, net                                                      |       | **$**        | **114,464** | ** ** | $          | 146,617 |   |

 

**(b)****                                 ****Amortizationexpense is comprised of:**

 
| ** **                                                                         | ** ** | **2007**  | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------------------------------------------------------------|------------|-----------|------------|----------|------------|----------|------------|
| Capital assets (including plant and equipment, and equipment under  capital lease) |       | **$**     | **44,430** |     | $          | 28,422   |       | $ | 17,384 |   |
| Mining leases and claims, royalty interest, and development costs                  |       | **2,478** |       | 1,681    |       | 913      |       |
|                                                                               |       | **$**     | **46,908** |     | $          | 30,103   |       | $ | 18,297 |   |

 

(c)                                  As at December 31,each year, the Company tests its long-lived assets, including mineral interestsand plant and equipment for impairment, and reflects an impairment chargeif needed.

 

There was no impairmentcharge required for 2007 (2006 – $nil, 2005 – $nil).

 

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**6. MINE RESTORATION DEPOSIT**

 

The Company, in conjunction with the OntarioMinistry of Northern Development and Mines (the “Ministry”), hasestablished a trust fund (the “Fund”) pursuant to the Company’s mineclosure plan for eventual clean-up and restoration of the mine site. The mineclosure plan calls for a total amount of $7,802 to be accumulated inthe Fund.

 

Commencing in February 2001, the Fund, controlled by the Ministry,started to accumulate through monthly deposits of $100. At December 31,2007, the Company had $8,272 (2006 – $8,041) on deposit with the Ministryincluding accrued interest of $742. All current amounts required have beencontributed as at December 31, 2007. The funds on deposit bear interest atcurrent short-term deposit rates and will be returned to the Company once themine closure is completed. The estimated asset retirement obligation may changematerially based on future changes in operations, costs of reclamation andclosure activities, and regulatory requirements.

 

**7. DEFERRED FINANCING COSTS**

 
| ** **               | ** ** | **2007**   | ** ** | **2006** | ** ** |
|--------------------------|------------|------------|------------|----------|------------|
| Financing costs          |       | **$**      | **—** |     | $          | 1,610 |   |
| Accumulated amortization |       | **—** |       | (648     | )          |
|                     |       | **$**      | **—** |     | $          | 962 |   |

 

As at January 1, 2007, the Company adjusted the carrying value ofthe related long-term debt and the convertible note payable using the effectiveinterest method. The impact was a decrease in the carrying value of theconvertible notes payable of $855 and a decrease in the long-term debt of $107and a decrease in deferred financing costs of $962.

 

**8. OBLIGATIONS UNDER CAPITAL LEASES**

 

The following is a schedule of future minimum lease payments undercapital leases together with the present value of the net minimumlease payments:

 
| ** **                                                         | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|--------------------------------------------------------------------|------------|------------|------------|------------|------------|
| 2007                                                               |       | **$**      | **—** | ** ** | $          | 2,422 |   |
| 2008                                                               |       | **1,830**  | ** ** | 2,166      |       |
| 2009                                                               |       | **1,499**  | ** ** | 1,775      |       |
| 2010                                                               |       | **402**    | ** ** | 473        |       |
| Total minimum lease payments                                       |       | **3,731**  | ** ** | 6,836      |       |
|                                                               |       | ** ** | ** ** |       |       |
| Amounts representing  interest at rates from 3.5% – 6.8% |       | **(235**   | **)**      | (621       | )          |
| Present value of minimum  lease payments                           |       | **3,496**  | ** ** | 6,215      |       |
| Less current portion                                               |       | **(1,672** | **)**      | (2,104     | )          |
|                                                               |       | **$**      | **1,824**  | ** ** | $          | 4,111 |   |

 

**9. CONVERTIBLE NOTES PAYABLE**

 
| ** **                                                                   | ** ** | **2007**    | ** ** | **2006** | ** ** |
|------------------------------------------------------------------------------|------------|-------------|------------|----------|------------|
| Series I convertible  notes – maturing August 1, 2008    |       | **$**       | **17,011** |     | $          | 32,048 |   |
| Series II convertible  notes – maturing December 1, 2008 |       | **8,699**   |       | 13,162   |       |
|                                                                         |       | **25,710**  |       | 45,210   |       |
| Less current portion                                                         |       | **(25,710** | **)**      | (22,148  | )          |
|                                                                         |       | **$**       | **—** |     | $          | 23,062 |   |

 

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On March 29, 2006, the Company issued US$35,000 ($41,037)aggregate principal amount of Series I convertible notes (the “Series INotes”) due August 1, 2008 through a private placement of convertiblenotes and common share purchase warrants. The Offering was to Kaiser-FrancisOil Company (Kaiser-Francis) and an institutional investor (collectively the “Purchasers”).The Offering is governed by a securities purchase agreement dated March 24,2006 (the “SPA”) among the Company and the Purchasers.

 

The Series I Notes were initially convertible into2,873,563 common shares of the Company at any time by the holder atUS$12.18 per share. Warrants exercisable to purchase 1,436,782 commonshares were issued with the Series I Notes, each warrant being exercisableto purchase one common share at an exercise price of US$13.48 until March 29,2010 (see anti-dilution provisions below).

 

The Company, at its option, had the right to sell to Kaiser-Francis upto US$13,500 principal amount a Series II Note (a second tranche) onor before June 30, 2006, which would be used to repay the loan under theexisting Kaiser-Francis credit facility (refer to note 11). On June 23,2006, the Company exercised this right and issued to Kaiser-Francis US$13,500($15,176) aggregate principal amount a Series II Note, due December 1,2008. The Series II Note was initially convertible into1,108,374 common shares of the Company at any time by the holder atUS$12.18 per share. Warrants exercisable to purchase 554,187 common shareswere issued with the Series II Note, with each warrant being exercisableto purchase one common share at an initial exercise price of US$13.48 until June 23,2010 (see anti-dilution provisions below).

 

The convertible notes and the related Series I and Series IIWarrants contain “full ratchet” anti-dilution provisions. Under theseprovisions, if at any time prior to August 1, 2008 the Company issuessecurities (including common shares or warrants convertible into common shares)at a price per share (the “effective price”) less than a stated amount,the conversion/exercise price of the outstanding convertible notes and Series Iand Series II Warrants is reduced downward to equal the effective price,subject to a floor price of US$9.12 for the Series I Notes, US$6.67 forthe Series II Note, US$10.73 for the Series I Warrants and US$7.85for the Series II Warrants. On account of the unit offering that closed onDecember 13, 2007, the conversion price of the Series I Notes, the Series IINote, the Series I Warrants and the Series II Warrants decreased totheir respective floor prices.

 

The Series I and II Notes bear interest at a rate of 6.5% perannum payable bi-monthly. Series I and II Notes are repayable in nineequal installments commencing April 1, 2007 and August 1, 2007,respectively. The interest payments and/or repayment amounts may be paid toeach Purchaser, at the Purchaser’s option, in any combination of cash and/orcommon shares. If common shares are issued for interest payments or inrepayment of the convertible notes they will be issued at a 10% discount fromthe weighted average trading price of the common shares on the AMEX for thefive consecutive trading days immediately prior to applicable payment date. TheCompany has the right to defer any principal repayment in cash until a laterprincipal repayment date. There is no limit on the length of the deferral,other than it cannot be deferred later than the final maturity date. TheCompany must give five (5) business days prior notice of its intention todefer principal repayments. During 2007, the Purchasers elected to receivecommon shares in settlement of both their interest and principal repayments.

 

Commencing June 29, 2007 for Series I and September 23,2007 for Series II, if the weighted average trading price of the commonshares for each of any 25 consecutive trading days is 150% or more of theinitial conversion price (as adjusted for any stock dividend or split, orsimilar transaction), the Company will have the right to force the Purchasersto convert all or any of the outstanding principal amount of the convertiblenotes at the conversion price.

 

Under Canadian GAAP, the components of the convertible notes must bebifurcated and accounted for separately as debt and equity instruments. Thewarrants are separable from the notes and are accounted for as an equityinstrument. The Series I proceeds received were allocated to the debt andequity components of the notes and to the initial warrants on a relative fairvalue basis as follows: US$20,558 to 

 

41

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the debt, US$8,808 to the equity componentand US$5,634 to the warrants. The Series II Note proceeds were allocatedas follows: US$9,578 to the debt, US$2,312 to the equity component and US$1,610to the warrants. In addition, a liability (the “Equity Premium”) wasrecognized for the holders’ option to receive common shares, in lieu of cash,at a 10% discount to the five day weighted trading price, as described above,for interest and principal payments. The Company accretes the carrying value ofthe convertible notes and the Equity Premium such that at each installmentpayment date, the carrying value of the notes and the Equity Premium will beequal to the face value of the notes and the liability related to the EquityPremium. The Company recorded accretion expense of $12,947 (2006 –$10,090), of which $3,245 (2006 – $2,523) represented the accretionrelating to the Equity Premium which was included in the carrying value of theconvertible notes payable as at December 31, 2007.

 

The fair value of the debt was determined based on the future paymentsof principal and interest for a debt instrument of comparable maturity andcredit quality, excluding any conversion option by the holder. The Series INotes carry an effective interest of 42%. The Series II Note carries aneffective interest rate of 28%.

 

The conversion option or equity component of the Notes was valued usinga Binomial model. The fair value of the warrants was determined based on theBlack-Scholes option pricing model. The models used in the valuation of thecomponents of the convertible debt contain certain subjective assumptions,changes of which can cause significant variation in the estimated fair value ofthe debt and equity components of the notes.

 

The issue costs of $2,364 have been allocated pro-rata to the debt($1,398) and equity components ($589) of the Series I and II Notesand to the associated warrants ($377) on a relative fair value basis. Thefinancing costs related to the debt components are being amortized over theterm of the convertible notes using the effective interest method.

 

As at December 31, 2007, the principal amount outstanding on the Series Iand Series II convertible notes was US$17,500 (2006 – US$35,000) andUS$9,000 (2006 – US$13,500) respectively.

 

**10. LONG-TERM DEBT**

 
| ** **                                                                                                                 | ** ** | **2007**   | ** ** | **2006**   | ** ** |
|----------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Equipment finance company credit facility consisting of $4,000 and  US$6,000 (2006 – $6,000 and US$10,000) loans |       | **$**      | **9,928**  | ** ** | $          | 17,654 |   |
| Less: financing costs  (net of amortization)                                                                          |       | **(53**    | **)**      | —     |       |
|                                                                                                                       |       | **9,875**  | ** ** | 17,654     |       |
| Less current portion                                                                                                       |       | **(5,918** | **)**      | (6,662     | )          |
|                                                                                                                       |       | **$**      | **3,957**  | ** ** | $          | 10,992 |   |

 

The Company’s long-term debt is comprised of a senior credit facilitywith an equipment finance company. The interest rate under the loan facility isLIBOR plus 2.50%, or 7.10% at December 31, 2007 (7.82% – 2006). Thesenior credit facility is repayable in equal quarterly installments over afive-year period with a final maturity of November 24, 2009. In return forgranting the loan, the lender received a first priority security in all of theCompany’s existing and future assets excluding its production leases andclaims. The credit facility allows in certain circumstances, full repayment ofoutstanding loans at any time during the term of the facility.

 

**11. KAISER-FRANCIS CREDIT FACILITY**

 

At the time the Company entered into its senior credit facility(note 10), certain terms under the US$20,000 non-revolving credit facilitywith Kaiser-Francis Oil Company (“Kaiser-Francis”) were amended. The final maturitydate was extended to June 30, 2006 from May 31, 2005 and the interestrate was reset based upon the 30 day LIBOR rate plus 2.50%. TheKaiser-Francis credit facility was repaid on June 23, 2006 pursuant to theterms of the Series II convertible note issued on that date (note 9).

 

42

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On October 12, 2006, the Company completed a transaction withKaiser-Francis for a US$5,000 short-term working capital loan maturing December 31,2006. The interest rate under the loan was the 30 day LIBOR rate plus2.50%. The Company paid a commitment fee of US$38 and amounts not drawn underthe loan were subject to a standby fee of 0.125% per annum. In connection withthe loan, the Company granted to Kaiser-Francis a first priority securityinterest in the inventory and receivables of the Company. On December 13,2006 the maturity date was extended to March 31, 2007, with no otherchanges in terms. The Company paid a commitment fee of US$25 for the extension.This loan was repaid in full from the proceeds of the first advance payment, inaccordance with the terms of the palladium and platinum purchase facility(note 15 (a)).

 

**12. RELATED PARTY TRANSACTIONS AND COMMITMENTS**

 

Kaiser-Francis is the major shareholder of the Company. In addition tothe related party transactions with Kaiser-Francis disclosed in note 11,the Company had the following related party transactions:

 

(a)                                  Under the termsof the Company’s convertible notes, the Company may not offer equity securitieswithout first offering to the noteholders a pre-emptive right to each tosubscribe for 12.5% of the total equity securities being offered. If eithernoteholder subscribes for less than its 12.5% share, the unused right shallthen be offered to the non-declining party, Kaiser-Francis or the institutionalinvestor, as the case may be. As a result of this provision of the agreement,Kaiser-Francis exercised the pre-emptive right and subscribed for 25% of theunit offering that closed on December 13, 2007.

 

(b)                                 In 2005, a nowformer director of the Company received a fee of $218 in connection with thenegotiations related to a Palladium Sales Contract entered into by the Companyin 2000. The contract was negotiated at arms-length prior to such personbecoming a director of the Company. The Palladium Sales Contract expired on June 30,2005, and no further fees are payable in connection with this contract.

 

**13. SHAREHOLDERS EQUITY**

 

**(a)****                                 ****AuthorizedCapital Stock**

 

The authorized capital stockof the Company consists of an unlimited number of common shares and anunlimited number of special shares, issuable in series, including10,000,000 Series “A” preferred shares.

 

**(b)****                                 ****Commonshare purchase warrants:**

 

The changes in issued commonshare purchase warrants for the year are summarized below:

 
| ** **                                                                       | ** ** | **2007**       | ** ** | **2006**   | ** ** |
|----------------------------------------------------------------------------------|------------|----------------|------------|------------|------------|
| ** **                                                                       | ** ** | **Shares**     | ** ** | **Amount** | ** ** | **Shares** | ** ** | **Amount** | ** ** |
| Balance beginning of year                                                        |       | **1,990,969**  | ** ** | **8,038**  |       |   |   |   |   |
| Issued pursuant to terms of Series I convertible notes, net of  issue costs |       | **—**     | ** ** | **—** |       | 1,436,782 |   | 6,238 |   |
| Issued pursuant to terms of Series II convertible note, net of  issue costs |       | **—**     | ** ** | **—** |       | 554,187 |   | 1,800 |   |
| Issued pursuant to unit offering, net of issue costs                             |       | **9,333,333**  | ** ** | **5,155**  |       |   |   |   |   |
| Balance, end of year                                                             |       | **11,324,302** | ** ** | **$**      | **13,193** |   | 1,990,969 |   | $ | 8,038 |   |
|                                                                                  |            |                |            |            |            |  |  |  |  |  |  |

 

On December 13, 2007the Company completed a public offering of 18,666,667 units at a price ofUS$4.00 per unit ($4.04 per unit) for total net proceeds of approximatelyUS$68,719 (issue costs US$5,919). Each unit consisted of one common share andone half of a common share purchase warrant of the Company. Each whole warrantwill entitle the holder to purchase one common share at a price of US$5.05 pershare at any time on or prior to December 13, 2009.

 

43

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In connection with the issueof the convertible notes, warrants to purchase 1,990,969 common shareswere issued and are outstanding as follows:

 
| **Number of Warrants** | ** ** | **Exercise Price** | ** ** | **Expiry Date** |
|-----------------------------|------------|-------------------------|------------|----------------------|
| 1,436,782                   |       | US$10.73                |       | March 29, 2010  |
|  554,187               |       | US$7.85                 |       | June 23, 2010   |

 

In connection with the issueof the unit offering, warrants to purchase 9,333,333 common shares wereissued and are outstanding as follows:

 
| **Number of Warrants** | ** ** | **Exercise Price** | ** ** | **Expiry Date**   |
|-----------------------------|------------|-------------------------|------------|------------------------|
| 9,333,333                   |       | US$5.05                 |       | December 13, 2009 |

 

**(c)****                                 ****GroupRegistered Retirement Savings Plan**

 

The Company has a groupregistered retirement savings plan, which all employees can participate in attheir option. The Company is required to make matching contributions to amaximum of $5 per employee per annum. The Company’s matching contribution canbe made either in cash or treasury shares of the Company. During 2007 theCompany contributed 138,685 shares with a fair value of $1,204,(2006 – 107,563 shares with a fair value of $1,085).

 

**(d)****                                 ****PrivatePlacement**

 

On February 27, 2007,the Company completed a private placement of 550,000 flow-through commonshares. The gross proceeds of $6,050 must be spent on Canadian explorationexpenses prior to December 31, 2008. As at December 31, 2007, theCompany has spent $628 on Canadian exploration expenses as defined in Section 66of the Income Tax Act (Canada).

 

On June 23, 2006, theCompany completed a private placement of 270,000 flow-through commonshares. The gross proceeds of $3,375 were spent on Canadian explorationexpenses as defined in Section 66 of the Income Tax Act (Canada) priorto December 31, 2007.

 

On April 21, 2005, theCompany completed a private placement of 213,000 flow-through commonshares. The gross proceeds of $2,503 were spent on Canadian explorationexpenses as defined in Section 66 of the Income Tax Act (Canada)prior to December 31, 2006.

 

Under the terms of theflow-through common share issues, the tax attributes of the relatedexpenditures are renounced to investors and the share capital is reduced andfuture income tax liabilities is increased by the estimated income tax benefitsrenounced by the Company to the investors. The tax attributes for the 2006expenditures were renounced in 2007, and those from 2005 were renouncedin 2006.

 

**(e)****                                 ****CorporateStock Option Plan**

 

The Company has adopted, andthe shareholders have approved, the Corporate Stock Option Plan (the “Plan”),under which eligible directors, officers, employees and consultants of theCompany are entitled to receive options to acquire common shares. The Plan isadministered by the Compensation Committee, a subcommittee of the Board ofDirectors, which determines the number of options to be issued, the exerciseprice (which may not be lower than the closing price of the Company’s commonshares on the Toronto Stock Exchange (“TSX”) on the day prior to the date ofgrant), expiration dates of each option, the extent to which each option isexercisable provided that the term of an option shall not exceed 10 yearsfrom the date of grant, as well as establishing a limited time period shouldthe optionee cease to be an “Eligible Person” as set forth in the conditions ofthe Plan. Options granted vest as to 1/3 on each of the first threeanniversary dates of the date of grant.

 

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The maximum number of commonshare options available for grant shall not exceed 2,700,000 beingapproximately 3.6% of the outstanding common shares or such greater number ofcommon shares as may be determined by the Board of Directors, and approved ifrequired, by the shareholders of the Company and by any relevant stock exchangeor other regulatory authority. As at December 31, 2007,532,757 options (2006 – 534,057 options) were available to begranted under the Plan.

 

The following summary setsout the activity in outstanding common share purchase options:

 
| ** **                          | ** ** | **2007**     | ** ** | **2006**                            | ** ** |
|-------------------------------------|------------|--------------|------------|-------------------------------------|------------|
| ** **                          | ** ** | **Shares**   | ** ** | **Weighted-Average Exercise Price** | ** ** | **Shares** | ** ** | **Weighted-Average Exercise Price** | ** ** |
| Outstanding, beginning of  year     |       | **360,133**  | ** ** | **$**                               | **10.24**  |   | 563,638 |   | $ | 10.43 |   |
| Granted                             |       | **132,500**  | ** ** | **9.05**                            |       | 65,000 |   | 8.15 |   |
| Exercised                           |       | **(5,000**   | **)**      | **3.42**                            |       | (130,755 | ) | 6.96 |   |
| Cancelled                           |       | **(131,200** | **)**      | **10.25**                           |       | (137,750 | ) | 13.15 |   |
| Outstanding, end of year            |       | **356,433**  | ** ** | **$**                               | **9.89**   |   | 360,133 |   | $ | 10.24 |   |
| Options exercisable at end  of year |       | **191,600**  | ** ** | **$**                               | **10.76**  |   | 166,432 |   | $ | 10.70 |   |

 

The following tablesummarizes information about the Company’s stock options outstanding at December 31, 2007:

 
| **Exercise Price** | ** ** | **Expiry Dates**       | ** ** | **Options Outstanding  at Dec. 31, 2007** | ** ** | **Options Exercisable  at Dec. 31, 2007** | ** ** |
|--------------------|------------|------------------------|------------|------------------------------------------------|------------|------------------------------------------------|------------|
| $ 4.75        |       | February 27, 2011 |       | 7,500                                          |       | 7,500                                          |       |
| $ 7.85        |       | August 26, 2014   |       | 30,000                                         |       | 10,000                                         |       |
| $ 8.12        |       | October 8, 2015   |       | 15,000                                         |       | —                                         |       |
| $ 8.40        |       | June 20, 2014     |       | 35,000                                         |       | 11,667                                         |       |
| $ 8.45        |       | April 1, 2015     |       | 40,000                                         |       | —                                         |       |
| $ 8.83        |       | December 14, 2013 |       | 10,000                                         |       | 6,667                                          |       |
| $ 8.87        |       | January 14, 2015  |       | 7,500                                          |       | —                                         |       |
| $ 9.03        |       | March 1, 2015     |       | 9,000                                          |       | —                                         |       |
| $10.00             |       | November 27, 2013 |       | 50,000                                         |       | 33,333                                         |       |
| $10.18             |       | April 15, 2015    |       | 30,000                                         |       | —                                         |       |
| $11.90             |       | June 23, 2012     |       | 122,433                                        |       | 122,433                                        |       |
|               |       |                   |       | 356,433                                        |       | 191,600                                        |       |

 

The fair value of optionsgranted in 2007 has been estimated at the date of grant using the Black-Scholesoption pricing model with the following weighted average assumptions: risk freeinterest rate of 3.97% (2006 – 4.05%; 2005 – 3.78%), expecteddividend yield of nil (2006 – nil; 2005 – nil), expected volatilityof 54% (2006 – 55%; 2005 – 55%), and expected option life of4 years (2006 – 4 years; 2005 – 4 years). Theestimated fair value of the options is expensed over the option’s vestingperiod, which is 3 years. The weighted average fair market value ofoptions granted in 2007 was $4.11 (2006 – $3.78; 2005 – $4.51).Compensation expense related to the Plan for the year ended December 31,2007 was $414 (2006 – $561; 2005 – $582).

 

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**(f)****                                   ****Reconciliation of the diluted number of shares outstanding:**

 
| ** **                                            | ** ** | **2007**       | ** **  | **2006**   | ** ** | **2005**   | ** ** |
|-------------------------------------------------------|------------|----------------|-------------|------------|------------|------------|------------|
| Net loss available to common shareholders             |       | **$**          | **(28,680** | **)**      | $          | (34,109    | )          | $ | (53,611 | ) |
| Weighted average number of shares outstanding         |       | **55,792,203** | ** **  | 52,562,939 |       | 52,006,548 |       |
| Effect of dilutive securities stock options           |       | **—**     | ** **  | —     |       | —     |       |
| Weighted average diluted number of shares outstanding |       | **55,792,203** | ** **  | 52,562,939 |       | 52,006,548 |       |
| Diluted net loss per share                            |       | **$**          | **(0.51**   | **)**      | $          | (0.65      | )          | $ | (1.03 | ) |

 

The effect of stock optionsand warrants has not been included in the determination of diluted loss pershare for 2007, 2006 or 2005, because to do so would be anti-dilutive.

 

At December 31, 2007,there were 14,794,088 (2006 – 6,172,671) equity instruments convertible tocommon shares. These have been excluded from the calculation of diluted netloss per share because to do so would have been anti dilutive. These equityinstruments could potentially dilute basic earnings per share inthe future.

 

**(g)****                                ****OtherStock-Based Compensation – Restricted Share Unit Plan**

 

Effective December 14,2005, the Company adopted an RSU plan under which eligible directors, officersand key employees of the Company are entitled to receive awards of restrictedshare units. Each restricted share unit means a unit equivalent in value to thefair market value of a common share of the Company on the date of the award.The RSU plan is administered by the Board of Directors, which will determineafter considering recommendations made by the compensation committee, thenumber and timing of restricted share units to be awarded and their vestingperiods, not to exceed three years. On each relevant full vesting date ofawarded restricted share units, the participant will receive a lump sum cashpayment equivalent to the market value of the equivalent number of commonshares. The value of each award is charged to compensation expense over theperiod of vesting and a corresponding liability is established on the balancesheet. The compensation expense and liability are adjusted to reflect thechanges in market value of the equivalent number of common shares during thevesting period.

 

As at December 31,2007, 10,001 (2006 – 33,333) restricted share units have been granted andare outstanding at a weighted average value of $8.72 (2006 – $9.09) perunit and $89 (2006 – $180) has been charged to compensation expense. Themarket value of the restricted share units as at December 31, 2007 is$3.64 (2006 – $8.87) per unit.

 

**14. FAIR VALUE OF FINANCIAL INSTRUMENTS**

 

The fair value of the obligations undercapital leases approximate their carrying value due to the interest rateimplicit in the leases approximating interest rates available at this time forsimilar lease terms. The fair value of the convertible notes approximate theircarrying value due to the interest rate implicit in the convertible notesapproximating interest rates available at this time for similar convertiblenotes payable. The carrying amounts of all other financial instruments on thebalance sheet approximate fair value due to their short-term maturities.

 

**15. COMMITMENTS**

 

**(a)****                                 ****Palladiumand Platinum Advance Purchase Facility**

 

On January 19, 2007 theCompany entered into a palladium and platinum advance purchase facility withAuramet Trading, LLC (“Auramet”), a precious metals merchant, providingfor the sale of an average of 10,000 ounces of palladium and500 ounces of platinum per month. The Company may not request Auramet topurchase metals after June 15, 2008 and all sales and payments prior tothat date are required to be settled by December 31, 2008. Under the termsof the agreement the Company may receive advance payments not exceeding, at anytime, an aggregate maximum of US$25,000. The

 

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Company pays a commitmentfee of 0.50% per annum, payable monthly, on the unused portion ofthe facility.

 

The purchase price may befixed or provisional. For fixed pricing the Company may price at either: (i) Auramet’scurrent market bid price at the time of the transaction, or (ii) marketlimit orders, as defined under the terms of the agreement. In the case ofprovisional pricing, it is determined based on the afternoon fixing of theLondon Bullion Marketing Association immediately preceding the purchase. Ineach case such pricing will reflect the forward value corresponding to thescheduled delivery date. Advance payments to the Company may not exceedspecified values of fixed and provisionally priced palladium and platinum.Provisional prices must be fixed prior to the scheduled delivery date for suchprecious metals. Each advance payment will be subject to a discount equal toLIBOR plus 1.90% per annum for the period between the date the advance paymentis made and the scheduled delivery date. Upon the delivery of the preciousmetals to Auramet, Auramet will pay to the Company the difference between theadvance payment and the purchase price.

 

To secure the obligations ofthe Company under the Agreement, the Company has granted to Auramet a securityinterest in, among other things, the concentrates (including the precious andbase metals contained therein) mined at the Lac des Iles mine, together withthe proceeds arising from the sale of the concentrate, and, by way of security,an assignment of its smelting and refining agreement.

 

The first advance paymentwas used to repay the US$5,000 working capital loan from the Corporation’smajor shareholder, while subsequent advance payments will be used to financeworking capital requirements. The balance outstanding under the advancepurchase facility at December 31, 2007 is $nil.

 

**(b)****                                 ****SheridanPlatinum Group of Companies (“SPG”) Commitment**

 

The Company is required topay a royalty to SPG equal to 5% of the Net Cash Proceeds, as defined in theagreement from mining operations until the expiration of the Lac desIles leases.

 

**(c)****                                 ****OperatingLeases and Other Purchase Obligations**

 

As at December 31,2007, the Company had outstanding operating lease commitments and otherpurchase obligations of $3,257 and $10,808, respectively (2006 – $4,695and $1,351) all of which had maturities of less than five years.

 

**(d)****                                 ****Flow-throughshares**

 

To satisfy its commitmentspursuant to the issuance of flow-through shares, the Company is required tospend $6,050 of qualifying Canadian exploration expenses, as defined in theIncome Tax Act (Canada), by December 31, 2008 (2006 – $3,375, byDecember 31, 2007).

 

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**16. REVENUE FROM METAL SALES**

 
| ** **                                          | ** ** | **Total**   | ** **  | **Palladium** | ** ** | **Platinum** | ** ** | **Gold**   | ** ** | **Nickel** | ** ** | **Copper** | ** ** | **Other Metals** | ** ** |
|-----------------------------------------------------|------------|-------------|-------------|---------------|------------|--------------|------------|------------|------------|------------|------------|------------|------------|------------------|------------|
| **2007  Year ended December 31**               |       |        |        |          |       |         |       |       |       |       |       |       |       |             |       |
| **Revenue –  before pricing adjustments** | ** ** | **$**       | **201,367** | ** **    | **95,146** | ** **   | **29,183** | ** ** | **12,315** | ** ** | **46,862** | ** ** | **15,589** | ** **       | **2,272**  | ** ** |
| Pricing  adjustments:                               |       |        |        |          |       |         |       |       |       |       |       |       |       |             |       |
| Commodities                                         | ** ** | **8,756**   | ** **  | **3,443**     | ** ** | **4,516**    | ** ** | **1,825**  | ** ** | **(1,621** | **)**      | **180**    | ** ** | **413**          | ** ** |
| Foreign  exchange                                   | ** ** | **(14,191** | **)**       | **(6,783**    | **)**      | **(2,723**   | **)**      | **(1,177** | **)**      | **(2,653** | **)**      | **(765**   | **)**      | **(90**          | **)**      |
| **Revenue –  after pricing adjustments**  | ** ** | **$**       | **195,932** | ** **    | **91,806** | ** **   | **30,976** | ** ** | **12,963** | ** ** | **42,588** | ** ** | **15,004** | ** **       | **2,595**  | ** ** |
| 2006 Year  ended December 31                   |       |        |        |          |       |         |       |       |       |       |       |       |       |             |       |
| Revenue –  before pricing adjustments     |       | $           | 145,819     |          | 70,645     |         | 23,438     |       | 8,970      |       | 27,930     |       | 13,984     |             | 852        |   |
| Pricing  adjustments:                               |       |        |        |          |       |         |       |       |       |       |       |       |       |             |       |
| Commodities                                         |       | 11,674      |        | 4,133         |       | 821          |       | 769        |       | 4,964      |       | 697        |       | 290              |       |
| Foreign  exchange                                   |       | 1,707       |        | 866           |       | 177          |       | 105        |       | 406        |       | 144        |       | 9                |       |
| Revenue –  after pricing adjustments      |       | $           | 159,200     |          | 75,644     |         | 24,436     |       | 9,844      |       | 33,300     |       | 14,825     |             | 1,151      |   |
| 2005 Year  ended December 31                   |       |        |        |          |       |         |       |       |       |       |       |       |       |             |       |
| Revenue –  before pricing adjustments     |       | $           | 85,233      |          | 38,364     |         | 16,635     |       | 5,950      |       | 15,845     |       | 7,464      |             | 975        |   |
| Pricing  adjustments:                               |       |        |        |          |       |         |       |       |       |       |       |       |       |             |       |
| Commodities                                         |       | 7,727       |        | 4,980         |       | 847          |       | 662        |       | 188        |       | 853        |       | 197              |       |
| Foreign  exchange                                   |       | (354        | )           | 54            |       | (338         | )          | (44        | )          | 8          |       | (33        | )          | (1               | )          |
| Revenue –  after pricing adjustments      |       | $           | 92,606      |          | 43,398     |         | 17,144     |       | 6,568      |       | 16,041     |       | 8,284      |             | 1,171      |   |

 

The Company delivers all of its concentrateto one customer (2006 – two customers) under the terms of an agreement.The customer has agreed to smelt and refine all of the Company’s concentrate toMarch 31, 2010, with an option by mutual agreement to extend for a furthertwo years to March 31, 2012.

 

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**17. INTEREST AND OTHER FINANCING COSTS**

 
| ** **                                               | ** ** | **Note** | ** ** | **2007**   | ** ** | **2006**   | ** ** | **2005** | ** ** |
|----------------------------------------------------------|------------|----------|------------|------------|------------|------------|------------|----------|------------|
| Interest on  convertible notes payable                   |       | 9        |       | **$**      | **2,763**  | ** ** | $          | 2,519    |       | $ | — |   |
| Accretion  expense relating to convertible notes payable |       | 9        |       | **12,947** | ** ** | 10,090     |       | —   |       |
|                                                     |       |     |       | **15,710** |       | 12,609     | ** ** | —   |       |
| Interest on  long term debt                              |       | 10       |       | **1,013**  | ** ** | 1,505      |       | 1,651    |       |
| Interest on  capital leases                              |       | 8        |       | **460**    | ** ** | 404        |       | 22       |       |
| Interest on  Kaiser Francis credit facility              |       | 11       |       | **90**     | ** ** | 569        |       | 836      |       |
|                                                     |       |     |       | **17,273** | ** ** | 15,087     |       | 2,509    |       |
| Interest on  advance purchase facility                   |       | 15       |       | **446**    | ** ** | 148        |       | —   |       |
| Other  interest and financing costs                      |       |     |       | **837**    | ** ** | 123        |       | 41       |       |
| Deferred  financing costs                                |       |     |       | **751**    | ** ** | 1,090      |       | 43       |       |
|                                                     |       |     |       | **19,307** | ** ** | 16,448     |       | 2,593    |       |
| Interest  income                                         |       |     |       | **(674**   | **)**      | (801       | )          | (1,641   | )          |
|                                                     |       |     |       | **$**      | **18,633** | ** ** | $          | 15,647   |       | $ | 952 |   |

 

**18. CONTINGENCIES**

 

(a)                                  TheCompany is a defendant in an action by another mining company claiming actualdamages in the amount of $20,000, punitive and exemplary damages in the amountof $5,000, and a declaration that the Company held the Compania Minerales deCopan, S.A. de C.V. (“Copan”) property in trust for the plaintiff. Thisaction relates to a predecessor company of the Company and has been inactivefor sometime. No provision has been made in the accounts as at December 31,2007 or 2006 for any possible loss from this action as management of theCompany believes it has a valid defense and it has been indemnified by SPGregarding this action. In addition, certain stock options are claimed to beheld by employees of Copan. These options have not been included innote 13(a) as the Company has been indemnified by SPG regardingsuch matters.

 

(b)                                 TheCompany has filed a claim with its insurance company relating to lossesincurred in connection with the failure of the primary crusher in 2002. During 2004,the Company received $7,148 as an interim payment against this claim and hasincluded this amount in income from mining operations. The Company is pursuingthe balance of its insurance claim and will record any additional recovery inincome if and when received.

 

(c)                                  Fromtime to time, the Company is involved in other litigation, investigations, orproceedings related to claims arising out of its operations in the ordinarycourse of business. In the opinion of the Company’s management, these claims andlawsuits in the aggregate, even if adversely settled, will not have a materialeffect on the consolidated financial statements.

 

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**19. INCOME TAXES**

 

The provision for income and mining taxesdiffers from the amount that would have resulted by applying the combinedCanadian Federal and Ontario statutory income tax rates of approximately 36.1%(2006 – 36.1%, 2005 – 36.1%).

 
| ** **                                                  | ** ** | **2007**   | ** **  | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------------------------|------------|------------|-------------|----------|------------|----------|------------|
| Income tax  recovery using statutory income tax rates       |       | **$**      | **(10,692** | **)**    | $          | (12,822  | )          | $ | (21,524 | ) |
| Increase  (decrease) in taxes resulting from:               |       | ** ** | ** **  |     |       |     |       |
| Resource allowance                                          |       | **77**     | ** **  | 133      |       | 3,354    |       |
| Non-taxable portion of capital gains                        |       | **(1,196** | **)**       | (76      | )          | (162     | )          |
| Losses not tax benefited                                    |       | **10,126** | ** **  | 11,002   |       | 16,556   |       |
| Losses incurred in foreign entities, taxed  at a lower rate |       | **569**    | ** **  | 701      |       | —   |       |
| Federal large corporations taxes                            |       | **—** | ** **  | —   |       | 339      |       |
| Ontario mining taxes                                        |       | **177**    | ** **  | (195     | )          | (1,654   | )          |
| Other                                                       |       | **2**      | ** **  | (152     | )          | 209      |       |
| Income and mining tax recovery                              |       | **$**      | **(937**    | **)**    | $          | (1,409   | )          | $ | (2,882 | ) |

 

The details of the Company’s incomeand mining tax recovery are as follows:

 
| ** **                              | ** ** | **2007**   | ** ** | **2006** | ** ** | **2005** | ** ** |
|-----------------------------------------|------------|------------|------------|----------|------------|----------|------------|
| Current  income tax expense (recovery): |       | ** ** | ** ** |     |       |     |       |
| Income taxes                            |       | **—** | ** ** | (360     | )          | (15      | )          |
| Mining taxes                            |       | **—** | ** ** | (310     | )          | 80       |       |
| Federal  large corporations tax         |       | **—** | ** ** | —   |       | 339      |       |
|                                    |       | **—** | ** ** | (670     | )          | 404      |       |
| Future  income tax expense (recovery):  |       | ** ** | ** ** |     |       |     |       |
| Income taxes                            |       | **(1,114** | **)**      | (854     | )          | (1,552   | )          |
| Mining taxes                            |       | **177**    | ** ** | 115      |       | (1,734   | )          |
|                                    |       | **$**      | **(937**   | **)**    | $          | (739     | )          | $ | (3,286 | ) |
|                                    |       | **$**      | **(937**   | **)**    | $          | (1,409   | )          | $ | (2,882 | ) |

 

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Future tax assets (liabilities)consist of the following temporary differences:

 
| ** **                                  | ** ** | **2007**    | ** ** | **2006**   | ** ** |
|---------------------------------------------|------------|-------------|------------|------------|------------|
| Long-term  future income tax asset:         |       | ** **  | ** ** |       |       |
| Mining interests, net                       |       | **38,476**  | ** ** | 38,185     |       |
| Deferred financing costs                    |       | **2,004**   | ** ** | 414        |       |
| Mine restoration obligation                 |       | **2,235**   | ** ** | 2,532      |       |
| Future mining tax liability                 |       | **106**     | ** ** | 101        |       |
| Other assets                                |       | **141**     | ** ** | 199        |       |
| Non-capital loss carry-forwards             |       | **10,556**  | ** ** | 13,363     |       |
| Ontario corporate minimum tax credits       |       | **327**     | ** ** | 327        |       |
| Capital loss carry-forwards                 |       | **533**     | ** ** | 847        |       |
| Valuation allowance                         |       | **(52,941** | **)**      | (55,089    | )          |
| Net future  income tax asset, long-term     |       | **1,437**   | ** ** | 879        |       |
| Future  income tax liability, long-term:    |       | ** **  | ** ** |       |       |
| Long-term debt                              |       | **(300**    | **)**      | (289       | )          |
| Convertible notes payable                   |       | **(447**    | **)**      | 40         |       |
| Kaiser-Francis credit facility              |       | **—**  | ** ** | (4         | )          |
| Obligations under capital leases            |       | **(122**    | **)**      | (72        | )          |
| Net future  income tax liability, long term |       | **(869**    | **)**      | (325       | )          |
| Net future  income tax asset, long-term     |       | **$**       | **568**    | ** ** | $          | 554 |   |
| Future  income tax liability, current:      |       | ** **  | ** ** |       |       |
| Inventories                                 |       | **—**  | ** ** | (147       | )          |
| Crushed and broken ore stockpiles           |       | **(564**    | **)**      | (399       | )          |
| Deferred financing costs                    |       | **(4**      | **)**      | (8         | )          |
| Future tax  liability, current              |       | **$**       | **(568**   | **)**      | $          | (554 | ) |
| Future  income tax assets (liabilities)     |       | **$**       | **—** | ** ** | $          | — |   |
|                                        |       | ** **  | ** ** | ** ** |       |   |   |
| Future  mining tax liability, current:      |       | ** **  | ** ** |       |       |
| Inventories                                 |       | **—**  | ** ** | (40        | )          |
| Crushed and broken ore stockpiles           |       | **(168**    | **)**      | (109       | )          |
| Future  mining tax liability, current       |       | **(168**    | **)**      | (149       | )          |
| Future  mining tax liability, long-term:    |       | ** **  | ** ** |       |       |
| Mining interests, net                       |       | **(1,742**  | **)**      | (1,499     | )          |
| Provision for mine closure costs            |       | **449**     | ** ** | 420        |       |
| Mine restoration obligation                 |       | **754**     | ** ** | 698        |       |
| Future  mining tax liability, long-term     |       | **$**       | **(539**   | **)**      | $          | (381 | ) |

 

At December 31, 2007, the Company hadcapital loss carry-forwards of approximately $3,700 (2006 - $5,100), whichare available to reduce capital gains of future years.

 

At December 31, 2007, the Company andits subsidiary had non capital losses of approximately $30,900 (2006 -$37,500), of which $12,200 expires in 2015, $8,800 expires in 2026 and $9,900expires in 2027. The tax benefit of these losses has not been recognized in thefinancial statements.

 

At December 31, 2007, the Company andits subsidiary had undepreciated capital cost allowance of approximately$254,000 (2006 - $278,000) available to offset future taxable income.

 

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**20. STATEMENT OF CASH FLOWS**

 

**(a)**                                  The net changes innon-cash working capital balances related to operations are as follows:

 
| ** **                                | ** ** | **2007**   | ** **  | **2006** | ** ** | **2005** | ** ** |
|-------------------------------------------|------------|------------|-------------|----------|------------|----------|------------|
| Cash  provided by (used in):              |       | ** ** | ** **  |     |       |     |       |
| Concentrate  awaiting settlement          |       | **$**      | **(16,201** | **)**    | $          | (44,194  | )          | $ | 29,406 |   |
| Inventories  and stockpiles               |       | **(4,485** | **)**       | (3,727   | )          | 3,484    |       |
| Other assets                              |       | **20**     | ** **  | (258     | )          | (729     | )          |
| Accounts  payable and accrued liabilities |       | **(769**   | **)**       | 5,009    |       | (3,839   | )          |
| Taxes  recoverable                        |       | **83**     | ** **  | (531     | )          | (135     | )          |
|                                      |       | **$**      | **(21,352** | **)**    | $          | (43,701  | )          | $ | 28,187 |   |

 

**(b)**                                  Cash outflows duringthe year for interest and income taxes were as follows:

 
| ** **                                         | ** ** | **2007** | ** ** | **2006** | ** ** | **2005** | ** ** |
|----------------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Interest  paid on long-term debt                   |       | **$**    | **1,249**  |     | $          | 2,319    |       | $ | 2,477 |   |
| Interest  paid on obligations under capital leases |       | **$**    | **393**    |     | $          | 592      |       | $ | 339 |   |
| Income and  mining taxes paid                      |       | **$**    | **263**    |     | $          | 291      |       | $ | 699 |   |

 

**(c)**                                  The Series Iand II convertible notes bear interest at a rate of 6.5% per annum payablebi-monthly. The interest payments may be paid to each Purchaser, at thePurchaser’s option, in any combination of cash and/or common shares. During2007, in a non cash transaction, the Purchaser’s elected to receive commonshares in settlement of their interest expense in the amount of $2,644(2006 – $1,974; 2005 – $nil).

 

**(d)**                                  Principal repaymentsfor the Series I and II convertible notes may be paid to eachPurchaser, at the Purchaser’s option, in any combination of cash and/or commonshares. During 2007, in a non cash transaction, the Purchaser’s elected toreceive common shares in settlement of their principal repayments in the amountof $24,149 (2006 – $nil).

 

**(e)**                                  During 2007, mininginterests were acquired at an aggregate cost of $15,346 (2006 – $19,384;2005 – $41,998) of which $nil (2006 – $nil; 2005 – $6,583) wereacquired by means of capital leases.

 

**21. SUBSEQUENT EVENTS**

 

On January 9, 2008, the Company issuedan additional 2,800,000 units under a 30-day overallotment option grantedto the underwriters at an exercise price of US$4.00 per unit, for total grossproceeds of US$11.2 million. Kaiser-Francis also exercised itspre-existing right under the securities purchase agreement to subscribe for 25%of the overallotment units.

 

**22. COMPARATIVE FIGURES**

 

Certain of the prior years’ figures have beenreclassified to conform to the presentation adopted in 2007.

 

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