Thriving
In a
Changing
Market
FORTUNA SILVER MINES INC. 2008 ANNUAL REPORT
MEXICO
San Jose Project
Ag-Au, Developing Project
PERU
Caylloma Mine
Ag-Zn-Pb, Operating Mine
pg.2
pg.04
pg.05
pg.13
pg.18
Our Vision.
Our Mission.
Operating
Highlights
President’s
Letter
Chairman’s
Letter
pg.20
Fortuna’s
Projects
pg.30
Silver’s
Run
pg.33
Financial
Statements
All figures expressed in Canadian dollars
unless otherwise stated.
One of Latin America’s
Fastest-Growing Silver Producers
Fortuna Silver Mines is a growth-oriented silver and
base metals producer currently operating in Peru and
Mexico. Our acquisition and exploration horizon cov-
ers all of Latin America, a region we believe holds
significant untapped mineral potential.
Our Caylloma silver-lead-zinc mine in Peru achieved
a 77% increase in silver production over 2007
with comparable growth projected this year. At
our San Jose silver-gold project in Mexico, pre-
feasibility work progresses towards the develop-
ment of a mine and processing plant.
pg.3
OUR PRIMARY GOAL AT FORTUNA is
to generate growth by becoming a mid-
tier silver producer in Latin America.
Management’s extensive experience
building and operating mines in
the region, provides a key advan-
tage to help reach this goal. >>
Our Vision
is to become a leading, publicly-traded silver mining
company centered on developing mineral resources
in Latin America. We will operate with a commitment to
profitability, sustainable growth, high standards and the
well-being of our workers, neighboring communities and the
environment.
Our Mission is to maximize shareholder value through the rational
acquisition, exploration, development and mining of silver-bearing
deposits in Latin America with a commitment to sustainable growth of
mineable reserves and annual metal production.
pg.4
01
03
06
02
05
04
01 SIMON RIDGWAY, Chairman of the Board
02 JORGE A. GANOZA DURANT, President, CEO and Director
03 THOMAS I. VEHRS, Vice President, Exploration
04 JORGE R. GANOZA AICARDI, Vice President, Operations
05 MANUEL RUIZ-CONEJO CARLOS, Vice President, Business Development
06 LUIS DARIO GANOZA DURANT, Chief Financial Officer
OPERATING HIGHLIGHTS
1st Qtr
2nd Qtr
3rd Qtr
4th Qtr
2008
2008
Total
2007
Total
Ore Milled (tonnes)
70,408
80,121
89,827
91,025
331,380
250,913
Silver (oz)
Lead (tonnes)
Zinc (tonnes)
Unit cash production cost
140,239
186,276
243,280
291,381
861,176
486,465
1,189
2,079
1,633
2,629
2,139
2,877
2,524
2,976
7,485
10,561
3,771
6,299
(US$/tonne)
$ 49.97 $ 46.92 $ 44.43 $ 44.60 $ 46.00
$ 48.00
Unit net smelter return
(US$/tonne)
$ 97.70 $ 97.79 $ 80.40 $ 60.00 $ 83.00
$ 117.80
FINANCIAL HIGHLIGHTS
Sales
EBITDA*
Income (loss) before income taxes & non-controlling interest
Net loss
Net loss per share, basic & diluted
Total assets
pg.5
12 mos ended
Dec 31, 2008
(000s)
$ 26,339
1,585
727
(964)
(0.01)
15 mos ended
Dec 31, 2007
(000s)
$ 31,667
12,891
1,380
(2,789)
(0.04)
$ 141,072
$ 124,446
* EBITDA was calculated by adding back to Operating Income
< Write-off of deferred exploration costs, stock-based compensation, depreciation, depletion and accretion. >
ANNUAL SILVER PRODUCTION
2006: *
58,844 oz
2007:
2008:
EST 2009:
486,465 oz
861,176 oz
5
1
2
3
4
5
6
7
8
9
0
,
0
0
0
0
0
0
0
0
0
0
0
0
,
0
0
,
0
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,
0
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,
0
0
,
0
0
,
0
0
,
0
0
,
0
0
,
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
1,600,000 oz
1
,
2
1
,
2
1
,
3
1
,
4
1
,
5
1
,
6
1
,
0
0
0
0
0
0
0
0
0
,
0
0
,
0
0
,
0
0
,
0
0
,
0
0
,
0
0
,
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
* Production figure accounts for 4th quarter, first production quarter under Fortuna
Highlights
pg.6
Highlights 08
Record production of
silver, lead and zinc
Initiated acquisition of Continuum
Resources to secure 100% ownership
of San Jose project (completed
subsequent to year-end)
Discovery of new high-grade silver veins
in Caylloma
Ended 08 fiscal year with CAD $36 million in cash
Net loss of $960,000, reduced from
$2.79 million loss in 2007
pg.7
Key Corporate Objectives 09
1.6 million ounces of silver; at least
50% of revenue
US $1.86/oz Ag cash cost net
of by-product credits
Fund working capital and investment at
Caylloma primarily through cash flow
Conclude feasibility study at
San Jose project
Expand Caylloma processing
plant throughput to 1,200 tpd
(achieved subsequent to year end)
pg.8
Caylloma Milestones 08
US $26.3 million in revenues
plus US $4.5 million gain on
commodity contracts
Produced 861,176 oz silver in
2008, up 77% over 2007
Zinc production up 68%;
lead production up 98%
Closed 2008 at an average
throughput of 1,023 tpd, up
44% from end 2007
Sufficient ore developed to
sustain operations well into 2010
New crushing circuit
commissioned
Objectives pg.9
Caylloma Objectives 09
Produce 1.6 million ounces of silver
Install and commission copper circuit
(completed Q2 09)
Increase average plant throughput to 1,200 tpd
(achieved beginning of Q2)
Discovery of new high-grade silver veins
Achieve OHSAS 18,001 certification
(occupational health and safety)
pg.10
San Jose Milestones 08
Completed 33,000m in-fill drill
program
Completed metallurgical testing
indicating >90% recovery for gold
and silver
Signed land agreements over main
mineralized area and key infrastructure
sites
Negotiations advanced towards a
collaborative community agreement
Milestones
San Jose Objectives 09
File “Manifiesto de Impacto
Ambiental” with Mexican
environmental authorities
(presented beginning of Q2)
Complete revised NI 43-101
compliant resource estimate
Conclude engineering studies for
mine water supply project
Sign long-term collaborative
agreements with community
Complete feasibility study
prior to year end; initiate
construction in 2010
pg.11
Thriving
in a Changing Market
The theme of this year’s report reflects the way
Fortuna is not only surviving a difficult industry
phase, it is thriving. Silver production is up sub-
stantially, the Caylloma mine in Peru is expanding
on schedule and the San Jose silver-gold project is ad-
vancing with feasibility studies. In short, we are moving
quickly towards our ultimate goal of establishing a profit-
able, mid-tier silver producer in Latin America.
TO OUR SHAREHOLDERS:
pg.13
Metals Output Sharply Higher. At both Caylloma and San Jose, our strategy of
building long-term value through organic growth delivered outstanding results in
2008. Caylloma’s silver production increased 77% over 2007, while lead and zinc
output rose 98% and 68% respectively. Meanwhile, San Jose moved into permit-
ting, engineering and feasibility.
Higher Grade Ore at Caylloma. The increase in Caylloma’s silver production result-
ed from improvements to head grades, recoveries, and processing capacity. Throughout
the year, we focused on making the operation more efficient and cost-effective. The
biggest boost to production was achieved by blending the mill feed with high-grade ore
from the Bateas and Soledad veins discovered in 2007.
More Improvement Ahead. Caylloma’s production of all metals in 2009 is expected to
grow even more. Silver output should reach 1.6 million ounces, representing an increase
of 86% over 2008, while lead and zinc production are forecast to grow 28% and 15%
respectively. Processing plant throughput capacity is projected to reach 1,200 tpd, up from
1,023 tpd at the end of 2008.
Becoming a Primary Silver Producer. In 2007, silver accounted for only 18% of revenues.
In 2008, this figure rose to 35%. When Fortuna first acquired Caylloma, production was re-
stricted to several narrow high grade silver-only veins. The Animas vein, which currently pro-
duces much of Fortuna’s silver, lead and zinc, had been evaluated for its silver potential but
was never put into production. The mine property had exploration potential and our technical
team saw good possibilities for the discovery of new high-grade silver veins. Concurrent with
the upgrade of the plant to allow it to process a mix of base metals and silver, Fortuna suc-
cessfully explored and developed new silver veins. These discoveries gradually increased the
proportion of silver in the mine’s output. Caylloma’s production figures from 2006 through
pg.14
2008 attest to the success of this strategy. For 2009 we anticipate silver will generate at least
50% of sales. Ultimately, with San Jose in full production, we believe silver will constitute at
least 65-70% of Fortuna’s revenue mix.
Moving Closer to Construction at San Jose. Subsequent to the end of the fiscal year,
we purchased the remaining shares of Continuum Resources and gained full ownership of
the San Jose project. We expect to complete permitting and design in 2009 prior to the
beginning of mine construction in 2010. The “Manifiesto de Impacto Ambiental” has been
submitted to Mexico´s environmental authorities at the beginning of Q2 2009. Along with
the on-going engineering studies, we intend to complete the new resource estimate and
continue negotiating a collaborative agreement with the local community. We have also
signed crucial land agreements for the 70 hectares which cover the main zones of miner-
alization and future infrastructure site locations.
Towards 5 Million Ounces Annual Silver Production. Our combined Caylloma-San Jose
production target when both assets are in full production is 5 million silver equivalent
ounces, a figure that would launch us into mid-tier silver producer status. Looking beyond
2011, we have many opportunities for continued growth. Both Caylloma and San Jose
contain mineralized zones with exciting expansion potential and both are situated on
large land packages with much unexplored ground.
Lower Prices Impact Revenues. The metals markets provided less positive news through
the year and significantly impacted our financial performance. Due entirely to lower metal
prices, Fortuna’s revenues declined from $31.67 million in 2007 to $26.34 million in 2008,
representing a drop of 17%. During the same period, the silver price fell 30%, lead was
down 58% and zinc was 50% lower. We alleviated some of the market’s impact through
higher silver, lead and zinc grades, increased throughput, hedging and cost reductions.
A Smaller Loss in 08. The drop in revenues contributed to an operating loss for 2008
of $5.93 million after deducting $1.43 million of stock-based compensation charges.
This amount was offset partially by a $4.52 million gain in commodity hedging contracts.
pg.15
The result was a net loss for 2008 of $0.96 million compared with a loss of $2.97 million
in 2007.
Hedging Policies for 08 and 09. We are committed to realizing our growth targets de-
spite the challenging economic climate. Our decisions to hedge, in all circumstances, are
based on projected capital requirements. For example, our most recent hedge (66% of
Caylloma’s lead and zinc production through July 2009) aimed to secure the minimum
capital that would guarantee completion of our plant expansion and copper circuit proj-
ect. Silver sales remain unhedged.
Adapting to Market Conditions We have also implemented a number of cost-cutting
measures and modified our plans and budgets for the current year into 2010. At
Caylloma, we shifted our focus to production efficiencies and higher production rates.
In fact, our efforts in 2008 were devoted almost entirely to process optimization.
With over 600,000 tonnes of ore developed for production, we have enough mill
feed to supply the mine well into 2010. In order to avoid dilution of shareholder´s
interests, we plan to continue funding Caylloma´s improvements and expansion
from the mine´s cash flow- as we have done successfully since the mine opened
in 2006.
Strong Treasury. Combining our cash balance with the expected net cash from Cayl-
loma, we are fully funded to meet all our capital budgets for 2009.
Success: A Team Effort. Our success in Peru and Mexico is due partially to good proj-
ects, intelligent exploration and—as is often the case in mining—a bit of luck with the
drill bit. The more important factor, however, has been the people behind it all. We have
assembled a team of professionals committed to profitability, sustainable growth, high
standards and the well-being of the communities and environments in which we operate.
I am most grateful to our Board of Directors, management, employees and contractors for
pg.16
their contributions and I look forward to celebrating their achievements in the months and
years ahead.
Jorge A. Ganoza Durant,
President, CEO and Director
Success
a Team Effort
TO OUR SHAREHOLDERS:
Growth and Adaptability. Growth and adaptability best describe our current path
at Fortuna. We are thriving through a challenging period, and I believe our flexibility
and creative management approach have been the keys to our success.
Growth has been most evident at our Caylloma mine, where impressive production gains
in 2008 will likely be repeated in 2009. Once our San Jose project comes on stream,
growth will be marked more significantly by a probable tripling of our silver equivalent
output. We are well on our way to becoming a primary, mid-tier silver company.
pg.18
Adaptability has driven our decisions since the first hints of the economic downturn. Mea-
sures such as base metal hedging, cost-cutting at all levels, production efficiencies and a
timely re-orienting of our priorities to mine development have kept Fortuna vital and viable.
Growing Organically While Remaining Opportunistic. Since acquiring both Caylloma
and San Jose, our growth has been entirely through the drill bit. We are not purchasing
resources—we are discovering and developing them at low costs. We will adhere to this
strategy for the time being. Our team is opportunistic, however, and attractive assets may be
purchased in the future. We are continually looking for new opportunities throughout Latin
America. We believe the region offers vast potential for silver exploration and mining, and
the current economic climate offers opportunities to acquire excellent projects at attractive
prices.
Thriving Through Cycles. If there is one overriding characteristic of all metals markets, it is
rapid change in the form of recurrent, somewhat predictable cycles. Look at the silver and gold
charts of the past 30 years, and you can plot regular, significant swings from boom to bust. That’s
why the winners in this industry are the ones that: 1) consistently discover new sources of low-cost
and/or high-grade supply, and 2) foster a culture of adaptability and creativity. I believe our list of
accomplishments and upcoming developments proves we are doing both of these things
very well at Fortuna.
Silver: Fundamental Value. We are focused on silver because we believe in the
metal’s long-term fundamentals. Silver is both utilitarian and precious. Its properties of
conductivity, malleability, corrosion resistance, light sensitivity, scarcity, beauty and even
bacteria prevention mean that the many ways silver can be used will continue to grow.
That’s why the steady decline in film-based photography has been offset by silver’s increas-
ing demand for industry, technology and investment.
pg.19
Latin America: No Better Place for Silver. We remain focused on Latin America for two
reasons: 1) we have built a formidable team with particular expertise in all facets of Latin
American mining, exploration and commerce; and 2) the region produces nearly half the
world’s silver. More important to Fortuna, Peru and Mexico rank first and second respec-
tively amongst silver producing countries.
Turning Challenges into Opportunities. The past year has certainly presented challenges, but
it has also presented opportunities. I am extremely pleased and grateful for the way everyone
at Fortuna has fostered an environment of enthusiasm, flexibility and teamwork to move ahead
and meet our goals. The next few years will present new challenges and opportunities. I know
we are prepared to not only survive in this rapidly changing market, we are ready to thrive.
Simon Ridgway,
Chairman
Caylloma
Mine
pg.20
Commodities:
Silver, Zinc, Lead & Gold
Location:
Arequipa, Peru
(15° 13’ S, 71° 49’ W)
Ownership:
100%
Deposit Type:
Intermediate-sulfidation epithermal deposit
Status:
Mine and processing plant operating at 1,050 tpd
with expansion to 1,200 (achieved beginning of
Q2 2009)
PERUCaylloma MineAg-Zn-Pb, Operating Mine
pg.21
Fortuna’s 100%-owned Caylloma Mine is a rapidly-growing producer
of silver, lead, zinc and gold located in southern Peru.
CAYLLOMA MINE
Rapid Growth in Silver, Lead and Zinc. Fortuna’s 100%-owned Caylloma Mine is a
rapidly-growing producer of silver, lead, zinc and gold located in southern Peru. The mine
and related concessions cover more than 12,000 hectares (29,650 acres) in the Caylloma
mining district of the Arequipa region. A former producer, Caylloma was purchased by For-
tuna in 2005 and returned to production in October of 2006.
pg.22
Mine Improvements and Higher-Grade Veins. Caylloma produced 861,176 ounces of
silver in 2008, a 77% increase over the mine’s first full year of production in 2007. Higher-
grade veins and ongoing improvements are expected to boost 2009 production to 1.6 million
ounces, representing another 86% annual increase. Lead and zinc production in 2009 are
forecast to increase by 28% and 15% respectively over 2008 (see Production Forecast table
on page 23). Beginning in the second quarter of this year, a new flotation circuit will add
copper to the production mix. At the beginning of 2009, the plant was operating at an
average throughput of 1,050 tpd and by the beginning of Q2, the throughput had increased
to 1,200 tpd.
Efficiency Efforts Bring Costs Down. Ongoing mill improvements brought metallurgical re-
coveries to 79.9% for silver, 91.1% for lead and 87.4% for zinc. Cash costs at Caylloma were
lowered from US $48.10 per tonne to an average of $46.40 per tonne in 2008. For 2009, our
projected cash cost is US $1.86 oz of silver, net of by-product credits.
Head Grades Improving. Mining is presently concentrated on the Animas polymetallic vein
and the high grade bonanza-type Soledad and Bateas silver veins. The Soledad and Bateas veins
were discovered in 2007 and brought to production in the fourth quarter of 2008. In 2007, the
silver head grade averaged 73.3 grams per tonne. By the fourth quarter of 2008, the grade had
improved to 114.8 grams per tonne and to over 140 grams per tonne in early 2009.
Focus on Plant Expansion. Due to the challenging economic conditions of 2008 and 2009,
management has re-vamped its near-term strategy at Caylloma to focus on mine development
and plant expansion rather than on generative exploration. More than 600,000 tonnes of ore
have been developed, a reserve sufficient to sustain the mine for 18 to 20 months with-
out further underground access development. Plant expansion—and the resulting higher
output—will generate increased cash flow. Since 2007, Caylloma has totally self-funded
its capital expenditures.
Caylloma (NI 43-101 October 3, 2006)
pg.23
Category
Tonnes (M)
Ag (g/t)
Au (g/t)
Ag (M oz)
Proven & Probable
Measured & Indicated
Inferred
0.34
1.2
1.4
454
143
305
0.8
0.7
0.4
5.0
5.4
13.8
2009 Production Forecast for Caylloma Mine:
Metal
Silver
Zinc
Lead
Copper
Unit
Production
oz
lb
lb
lb
1,600,000
26,900,000
21,200,000
1,200,000
San Jose
Project
pg.24
Commodities:
Silver & Gold
Location:
Oaxaca, Mexico in the Taviche Mining District
(16° 41’ N, 96° 42’ W)
Ownership:
100%
Deposit Type:
High-grade, low-sulfidation epithermal deposit
Status:
Resource definition, permitting and engineering
MEXICOSan Jose ProjectAg-Au, Developing Project
pg.25
The 43,000-hectare San Jose silver-gold project is progressing
rapidly towards a planned 2011 start-up.
SAN JOSE PROJECT
Towards a 2011 Opening. Located only an hour’s drive from the city of Oaxaca, the 43,000-
hectare San Jose silver-gold project is progressing rapidly towards a planned 2011 start-up. San
Jose is a high-grade epithermal project with Measured and Indicated resources totaling 1.47 mil-
lion tonnes grading 262.6 g/t silver and Inferred resources totaling 3.90 million tonnes grading
260.6 g/t silver. Fortuna is preparing an updated NI 43-101 resource estimate based on more
than 60,000 meters of drilling completed from 2001 through early 2009.
Full Ownership Acquired in 2009. San Jose was operated previously as a joint venture
pg.26
between Fortuna (76%) and Continuum Resources (24%). Subsequent to year end, Fortuna
obtained 100% interest in the project by acquiring all the issued and outstanding shares of
Continuum in March 2009.
Construction Slated to Begin in 2010. A US $6.0 million pre-development budget for
San Jose in 2009 includes engineering and metallurgical studies, permitting and com-
munity relations. Mine and plant construction are planned for 2010.
Recoveries of over 90%. As part of the project’s feasibility-level studies, Fortuna
has contracted for advanced engineering and design for the mine, tailings dam, water
supply and power. The planned plant will produce silver-gold concentrate and oper-
ate with a throughput of 1,000 to 1,200 tpd. Open circuit flotation tests returned
recoveries of over 90% for both silver and gold without the use of cyanide.
Environmental Permitting and Community Relations. Fortuna submitted its
“Manifiesto de Impacto Ambiental” to the Mexican environmental authorities in
March of 2009. Concurrently, the company’s Community Relations Department
is engaging local communities and authorities through project briefings and site
visits. The company is also working with communities in the development of
economically sustainable activities.
Upgrading Resources Through In-fill Drilling. 32,922.6 meters of in-fill
drilling were completed in 2008 and in early 2009. The program was designed
to convert a significant portion of the resources in the upper 250 meters of the
deposit to the Indicated and Measured classification. Results of the drilling were
released publicly in 2008 and early 2009.
Highlights from the 2004 – 2008 drilling programs include:
Selected Results of the Trinidad Zone Drilling
100 g/t Ag Eq. Cut-off
Interval (m)
7.54
4.90
23.91
24.25
2.50
25.10
6.85
18.20
20.55
4.90
29.05
3.20
12.80
15.10
7.15
7.00
11.15
5.10
6.55
1.00
30.55
12.70
3.05
Au (g/t)
5.94
5.90
2.00
10.09
11.86
10.85
6.28
4.89
8.89
8.98
6.75
9.41
1.54
5.71
8.06
8.29
3.10
4.99
11.06
28.40
1.34
5.99
5.32
To (m)
375.43
47.65
352.41
448.45
176.10
154.80
435.65
478.10
448.80
191.30
423.55
216.10
247.60
311.60
277.25
269.00
267.55
280.30
145.25
187.60
273.00
327.40
295.30
From (m)
367.89
42.75
328.50
424.20
173.60
129.70
428.80
459.90
428.25
186.40
394.50
212.90
234.80
296.50
270.10
262.00
256.40
275.20
138.70
186.60
242.45
314.70
292.25
Ag (g/t)
997
843
245
892
1151
588
391
503
752
1182
933
603
151
1022
546
693
419
863
534
5350
113
973
930
pg.27
Ag Eq. (g/t)
1300
1144
347
1407
1756
1141
711
752
1206
1640
1278
1083
229
1313
957
1115
576
1117
1098
6798
181
1279
1201
Hole_Id
SJO-020
SJO-039
SJO-051
and
SJO-055
SJO-060
SJO-108
and
and
SJO-123
SJO-127
SJO-128
and
and
SJO-143
SJO-147
SJO-169
and
SJO-175
SJO-183
SJO-193
and
SJO-231
SAN JOSE PROJECT
Underground Ramp to Allow Mechanized Mining. Development work in 2008
included completion of the main underground ramp to the upper portion of the
Trinidad Zone mineralized deposit. Covering a length of 1,100 meters, the 4.5m x
4.5m ramp reaches a depth of 120 meters below surface and supports mechanized
mining methods. Further development of the ramp will allow for testing of trial min-
ing methods and geologic control of mineralization.
San Jose Mineral Resource
pg.28
Resource Classification
Indicated Mineral Resources:
- Trinidad Vein
- Bonanza Vein
- Paloma Vein
Ore Ktonnes Eq Ag (g/t) Silver (g/t) Gold (g/t) Silver (koz) Gold (koz)
824
599
48
322.8
453.3
263.8
232.2
310.5
185.2
1.78
2.8
1.54
6,151.6
5,979.8
285.8
47.2
53.9
2.4
Total Indicated Resource
1,471
374.0
262.6
2.19
12,417.2
103.5
Inferred Mineral Resources:
- Trinidad Vein
- Bonanza Vein
- Bonanza Splay Vein
- Paloma Vein
- Stockwork Zone
1,687
1,609
15
373
214
376.7
443.6
922.5
275.5
281.6
268.0
272.6
694.2
194.3
196.6
2.13
3.35
4.48
1.59
1.67
14,536.1
14,102.0
334.8
2,330.1
1,352.7
115.5
173.3
2.2
19.1
11.5
Total Inferred Resource
3,898
391.5
260.6
2.57
32,655.7
321.5
Cut-off Grade of 150 g/t Ag Eq.
Current Indicated and Measured resources contain an estimated 17.7 million silver-equivalent
ounces, while Inferred resources are estimated to contain 49.1 million silver-equivalent ounces.
The Company is currently working on producing a 43-101 compliant resource estimate which
includes the drilling done in 2007 and 2008.
OUR SOCIAL AND
ENVIRONMENTAL COMMITMENT
Building a Positive Legacy. At Fortuna, we never forget that mining affects
communities, individuals and the environment. What those impacts are, and
the legacies they leave, are up to us. We are guests in the places we work. We
are neighbors. We are stewards of the environment. We know we must operate
ethically, responsibly and with respect.
Respect. Most of our work involves relationships. We build them with gov-
ernments, local authorities, communities, people and the environment. Our key
principle behind all those relationships is respect—for laws and regulations, for cul-
tures, for ethno-diversity, for personal growth and for the ecosystems that sustain us.
pg.29
Responsibility. No mine lasts forever, and we recognize our responsibility for the
footprint we leave behind. We strive to minimize our effect on the environment and
maximize the permanent, positive legacy we leave for the surrounding communities.
Ethics. Our most valuable currency is trust. That’s why we foster a corporate envi-
ronment of honesty, openness and adherence to the laws and regulations that govern us
wherever we work.
SILVER
Industrial or Precious Metal? Dual Identity and Volatility.
The world economic downturn produced lower fabrication demand (-3.1%) for silver and higher
investment demand in 2008—with the latter more than offsetting the former and helping the price
of silver remain firm. Total silver supply increased by 2.2%, with the largest increase coming from
additional mine output.
Three clear trends have emerged out of these market dynamics—two on the demand side and one
on the supply side—and these indicators are informing our growth strategy.
pg.30
Silver averaged US $14.98 per ounce in 2008 (including a high of $21.44 and a low of $8.40),
representing an 11.3% increase over the 2007 average of $13.45. By April of 2009, however,
the price had dropped to under $12.50. The silver market has been, and continues to be,
volatile due to its role as both an industrial and precious metal. Uncertainty and fear in world
economies has created demand for silver as a safe haven, while that same uncertainty has
generated a drop in demand for industrial use—which represents more than half of silver’s
consumption.
Outside of industrial demand, the rest of the world’s silver is consumed through photography,
jewelry, silverware, coins and investment hoarding. It’s the latter two factors that have given
silver its recent identity crisis. Safe haven buying has pushed demand for silver coins and
bullion to unprecedented levels. During 2008, the US Mint sold 19.5 million ounces of
silver coins, representing an increase of more than 98% over 2007. Holdings of the world’s
main silver exchange-traded fund, Barclay’s iShares Silver Trust, reached an all-time high
of 270 million ounces by April 2009.
Still, industrial demand is the primary catalyst for silver pricing. That’s why the price,
despite silver’s resurgence as a precious metal, is trading at a high discount to gold—
currently at 70 to 1 as opposed to historical levels of about 55 to 1.
Due to the global recession,
industrial demand for silver
is expected to drop substan-
tially in 2009, while invest-
ment demand should remain strong. Long term, however,
the outlook for the industrial use of silver is favorable.
Silver is used in just about every laptop computer, cell
phone and flat-screen television in the world, and new
uses are discovered at an increasing pace. On the in-
vestment side, new vehicles such as the U.S. bullion
purchase program and silver-specific Exchange Traded
Funds are attracting more and more investors.
Continuing high prices for silver resulted in higher mine
output (+2.7%) and secondary/scrap supply (+4.7%)
in 2008. Since about 80% of silver mined worldwide
is a by-product of gold, lead, zinc and/or copper min-
ing, the world recession has slowed silver output from
declining base metal production. However, supply
from new or expanding silver and gold mines has—
and will likely continue to—more than offset any de-
cline from base metal output.
WORLD SILVER SUPPLY IN 2008
(MILLION OUNCES)
77%
Mine Production
680.9
20%
Silver Scrap
176.6
3%
Net Government Sales
30.9
pg.31
WORLD SILVER DEMAND IN 2008
(MILLION OUNCES)
1%
Producer De-hedging
5.6
18%
Jewelry
158.3
50%
Industrial
447.2
7%
Coins/Medals
64.9
12%
Photography
104.8
In summary, we believe these supply/demand dy-
namics will keep the silver market volatile but strong
for at least the next two years. We are basing our in-
6%
6%
Silverware
Implied Net
57.3
Investment
50.2
vestment and exploration strategies accordingly.
Source: The Silver Institute: World Silver Survey 2009
GLOSSARY OF
ABBREVIATIONS USED
IN THIS REPORT
Ag:
Au:
silver
gold
EBITDA: earnings before interest, taxes, depreciation
pg.32
and amortization
g/t:
grams per metric tonne.
(To convert grams/metric tonne
to troy ounces/short ton, divide
grams/tonne by 34.2857)
m:
koz:
oz:
Pb:
tpd:
meters
= 1,000 oz
troy ounce, approximately equivalent
to 31.1034 grams
lead
metric tonnes per day. One metric
tonne equals 2,204.62 pounds
Zn:
zinc
2008
Financial Statements
FORTUNA SILVER MINES INC.
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2008 AND 2007
(Expressed in thousands of Canadian Dollars, except for share amounts)
pg.33
pg.34
pg.54
pg.55
pg.56
Management’s
Discussion
and Analysis
Consolidated
Balance
Sheets
Consolidated
Statements of
Operations and
Comprehensive
Loss
Consolidated
Statements of
Shareholders’
Equity
pg.57
pg.58
pg.83
Consolidated
Statements of
Cash Flows
Notes to
Consolidated
Financial
Statements
Corporate
Information
34
34
35
35
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
GENERAL
This Management’s Discussion and Analysis (“MD&A”) should be read in conjunction with the au-
dited consolidated financial statements of the Company for the years ended December 31, 2008 and
2007, prepared in accordance with Canadian generally accepted accounting principles. This MD&A
is prepared as of March 29, 2009. All amounts are expressed in Canadian dollars unless otherwise
indicated.
BUSINESS OF
THE COMPANY
Fortuna Silver Mines Inc. is a mining company focused on producing silver and developing silver proj-
ects in Latin America. The Company’s principal assets are the Caylloma poly metallic mine in southern
Peru and the San Jose Silver-Gold Project in southern Mexico.
RECENT
DEVELOPMENTS
AND 2008
HIGHLIGHTS
Financial and Operating Results
In 2008 the Company generated a net loss of $0.96 million compared to a net loss of $2.79 million in
2007. For the fourth quarter of 2008 the Company generated a net loss of $2.53 million compared to a
net profit of $1.41 million in the corresponding period of 2007. Cash generated by operating activities
for 2008 was $8.85 million compared to $13.24 million in 2007.
In the twelve months concluding December 31, 2008 331,380 tonnes of ore were treated, and metal
production amounted to 861,176 ounces of silver, 10,561 MT of zinc, and 7,485 MT of lead. Cash
cost per tonne of treated ore for the year was US$46 and the corresponding unit net smelter return
(NSR) was US$83 (cash cost is a non-GAAP measure. See page 8 for reconciliation of cash cost to the
cost of sales in the consolidated statement of operations).
Acquisition of Continuum Resources Ltd. and San Jose project
On March 6, 2009 the Company closed the acquisition of all the issued and outstanding shares of
Continuum Resources Ltd. As consideration for the acquisition of Continuum, Fortuna has issued
6,786,706 common shares, for an exchange ratio of approximately 0.0564 of a share of Fortuna for
every one Continuum share held.
As a result of the acquisition of Continuum, Fortuna now owns 100% of the San Jose Project in Oax-
aca, Mexico. In March 2007, Fortuna published a National Instrument 43-101 compliant resource
estimate for San Jose (see Fortuna news release dated March 12, 2007). Using a cut-off grade of 150
g/t silver (Ag) equivalent, the inferred and indicated mineral resources for the Trinidad zone at San Jose
are estimated at:
• Indicated Mineral Resources: 1.47 million tonnes grading 262.6 g/t Ag + 2.19 g/t Au
containing 17.7 million Ag equivalent oz
• Inferred Mineral Resources: 3.9 million tonnes grading 260.6 g/t Ag + 2.57 g/t Au containing
49.1 million Ag equivalent oz
Fortuna recently completed an extensive drill program designed to convert inferred mineral resources to
the measured and indicated categories. The revised resource estimate is expected for June 2009.
34
34
35
35
The Company has also concluded metallurgical tests for the project with Metcon Research of Tucson,
Arizona and is advancing with feasibility level engineering studies for the development of the San Jose
deposit. Engineering contracts were awarded in February for mine design, process plant design, tail-
ings dam, water and power. Fortuna expects to present the Environmental Impact Study (EIS) to the
Mexican authorities by the end of March.
Management Changes
On February 6, 2008 the Company announced the appointment of Manuel Ruiz-Conejo to the new
position of Vice President of Business Development. Mr. Ruiz-Conejo is based in Lima. Effective Feb-
ruary 28, 2009 Mark Moseley-Williams stepped down as Vice President of Project Development.
SELECTED ANNUAL
INFORMATION
Sales
Income (loss) before income taxes
and non-controlling interest
Net loss
Net loss per share, basic and diluted
Total assets
Total long-term financial liabilities
(1)
Twelve month period
ended Dec. 2008
26,339
Twelve month period
ended Dec. 2007
31,667
Fifteen month period
ended Dec. 2006 (1)
3,372
727
(964)
(0.01)
141,072
876
1,380
(2,789)
(0.04)
124,446
433
(3,854)
(4,348)
(0.12)
59,194
97
$ 000
$ 000
$ 000
$
$ 000
$ 000
In August, 2006, Fortuna Silver Mines Inc. (“Fortuna” or the “Company”) changed its fiscal year-end from September 30th
to December 31st. As a result of this the period ended December 31, 2006 was a transitional 15 month period.
The following table provides information for the most recent eight fiscal quarters to December 31, 2008:
QUARTERLY
INFORMATION
Quarters Ended
$ 000
$ 000
$ 000
Revenues
Mine operating
income (loss)
Net Income (loss)
Net Income (loss)
per share
- basic and diluted $
31-12-08 30-09-08 30-06-08 31-03-08 31-12-07 30-09-07 30-06-07 31-03-07
5,739
9,201
7,848
6,834
3,871
8,797
7,930
7,786
(2,860)
(2,532)
1,802
(308)
2,876
2,388
2,312
(511)
3,397
1,411
4,097
(3,391)
4,012
947
1,714
(1,756)
(0.03)
0.00
0.03
(0.01)
0.02
(0.05)
0.01
(0.03)
FINANCIAL
RESULTS
During 2008 the Company generated $26.34 million of sales compared to $31.67 million in 2007.
In US dollar terms which is the currency under which sales take place, there was a decrease of 16.5%
in sales for 2008 compared to the previous year. When broken down by type of concentrate; zinc con-
centrate sales increased in tonnage by 66% while unit value of concentrate decreased 64%. The latter
decrease is explained by a reduction in the metal price of 42% and an increase in smelter treatment
charges of US$210 per ton of concentrate. In the case of lead-silver concentrate, sales increased in
tonnage by 91% while unit value of concentrate decreased 31%. The latter decrease is the combined
result of a decrease in lead price and an increase in silver price of 19% and 12% respectively, and
higher smelter treatment charges of US$330 per ton of concentrate.
36
36
37
37
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
FINANCIAL
RESULTS
(continued)
The significant increase in concentrate sold is the result of the Company’s continuous investments
over the last two years in mine development, processing plant expansion, and infrastructure. As noted
below in the Operations section the Company expects this expansion trend to continue. Treatment
charges for 2009 have come down significantly, closer to 2007 levels.
During 2008 mine operating income was $4.13 million and an operating loss was recorded at $5.93
million. The operating loss reflects the significant decrease in base metal prices which was especially
pronounced in the last four months of 2008. The gain from the Company’s zinc and lead hedge pro-
gramme for the year was $4.52 million, as shown in the income statement under “Net gain on com-
modity contracts”, partially offsetting the decrease in revenues. Net loss for the period was $0.96 mil-
lion compared to a net loss of $2.79 million in 2007. Contributing to the improved net result are the
non operating gains, in particular gain on commodity contracts, foreign exchange gain, and a reduced
income tax provision generated at our operating subsidiary.
For the last quarter of 2008 the Company recorded a net loss of $2.53 million compared to a gain of
$1.41 million in the corresponding quarter of 2007. This is mainly explained by a decrease of 28%,
61%, and 55% in silver, lead, and zinc metal prices respectively.
Total cost of sales for 2008 was $22.21 million, of which $5.68 million was depletion, depreciation,
and accretion (2007: $18.45 million and $5.77 million respectively). This corresponds entirely to
production and sales from Caylloma mine.
Sales and administrative expenses for 2008 totalled $8.28 million compared to $6.13 million for
2007. The increase is largely due to higher total corporate expenses associated to the growth of the
Company which amounted to $3.59 million in 2008. The stock based compensation charge totalled
$1.43 million for the year ended December 31, 2008, compared to $6.97 million for the twelve year
ended December 31, 2007.
Interest and other income and expenses amounted to net income of $1.44 million for 2008 compared
to net income of $1.53 million for 2007. In 2008, this amount consisted principally of $1.54 million
of interest earned, and a $0.14 million charge for a direct contribution to local governments in the
Caylloma mine jurisdiction under a voluntary agreement between the Peruvian Government and the
majority of established mining companies in Peru.
Net gain on commodity contract for 2008 was $4.52 million compared to $1.56 million in 2007. The
result from 2008 was comprised of a $1.04 million gain on forward lead and zinc contracts entered
into with a bank to fix the final settlement price of metal delivered in concentrates, where the final
settlement price is yet to be set at a future quotational period according to contract terms, and a gain
of $3.48 million on lead and zinc derivative contracts entered into with a bank as part of a medium-
term price protection program.
Interest and finance expenses for 2008 were $0.10 million compared to $0.09 million in 2007. These
interest expenses relate to capital leases held by our operating subsidiary.
36
36
37
37
Year ended December 31, 2008
Foreign exchange gain recorded for the year was $0.84 million, compared to a loss of $1.67 million for
2007. The Company holds its foreign assets in US and local currencies. Under the temporal method
for translation of financial statements which the Company currently uses, gains and losses arising from
translation to the Canadian dollar are included in the statement of operations.
Write-off of deferred exploration costs was $0.35 million in 2008 compared to $0.01 million for 2007.
This is related mainly to a reduction of exploration ground of 2,700 hectares surrounding the San Jose
project in Mexico.
The $1.80 million Income tax provision recorded in 2008 (2007: $4.26 million) consisted of future
income tax expense only. Current income tax for 2008 was nil (2007: $0.54 million including the
worker profit sharing plan regulated by Peruvian law). Future income tax expense is mainly related to
temporary differences arising on amounts of mineral properties at Peruvian operations where explora-
tion and development are expensed for tax purposes.
RESULTS OF
OPERATIONS
Peru – Caylloma Ag-Pb-Zn Mine
Caylloma Mine
Quarters ended
31-Dec-08 30-Sep-08 30-Jun-08 31-Mar-08 31-Dec-07 30-Sep-07 30-Jun-07 31-Mar-07
52,687
579
63,806
701
70,408
800
68,615
754
80,121
910
65,806
715
91,025
1,023
89,827
1,009
3.69
2.97
3.75
82.43
93.41
87.25
3.14
2.58
3.64
80.07
92.19
88.11
2.75
2.29
3.75
78.12
88.94
87.58
2.64
1.94
3.42
76.42
87.26
86.45
2.43
1.87
3.09
77.74
87.51
85.09
2.45
1.80
3.01
75.75
88.50
86.51
2.29
1.67
2.92
73.28
89.22
86.22
2.23
1.39
2.65
71.39
88.59
84.16
291,381
2,524
2,976
243,280
2,139
2,877
186,276
1,633
2,629
140,239
1,189
2,079
139,433
1,124
1,805
132,450 119,110
952
1,605
1,049
1,712
95,473
646
1,178
44.60
44.43
46.92
49.97
52.41
49.15
46.65
42.62
60.00
80.40
97.79
97.70
118.41
133.70
123.65
90.26
Tonnes milled
Average tons milled per day
Grade per tonne
Silver (oz)
Lead (%)
Zinc (%)
Recoveries
Silver (%)*
Lead (%)
Zinc (%)
Production (metal contained)
Silver (oz)
Lead (tonnes)
Zinc (tonnes)
Unit cash production cost
(US$/tonne)
Unit Net Smelter Return
(US$/tonne)
* Silver recovery in lead concentrate
38
38
39
39
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
RESULTS OF
OPERATIONS
(continued)
In 2008 the Caylloma mine increased throughput by 32% compared to 2007 by processing 319,380
tonne of ore. Silver production increased 77% with respect to 2007 reaching 861,176 oz in 2008.
Lead and zinc metal production increased 98.5% and 67.7% respectively. The mill started the year at
a 750 tpd throughput rate and closed the year at an average monthly rate of 1,027 tpd. Metallurgical
parameters and overall plant performance improved steadily throughout 2008, especially silver recovery
in the lead concentrate which reached highs of 83% in November. Our recoveries for lead and zinc, as
well as concentrate grade in the lead concentrate, experienced steady increases throughout the year and
significant improvements compared to 2007 as shown in the table above.
Mine production throughout the year took place principally on the poly metallic Animas vein which
provided 96% of ore sourced to the mill in 2008. Caylloma´s silver head grades have been increasing
steadily every quarter as a result of the successful discovery and development of high grade silver veins
Bateas, Soledad, and Silvia. Production on the “bonanza” grade silver vein Soledad started in late
November and already provided close to 10% of production in December. Another contributing factor
to the steadily increase in head grades throughout the year has been the development that has taken
place along Animas vein which has extended the Central ore shoot in the northeast direction providing
good grade zones up to 15 to 20 meter wide. These will be added to reserves in the coming resource
update.
During 2008 total underground preparation and development amounted to 13,000 m, a similar figure
to the one recorded in 2007. This accumulated mine development and preparation has provided ap-
proximately 600,000 tonnes of ore developed and ready to enter production as at the end of 2008.
The important flexibility gained in the mine as a result of this will allow the Company to cut back mine
development in 2009 to 4,000 m in order to address capital investment reduction needs without af-
fecting short or medium term operations.
Cash production cost per tonne of treated ore evolved from US$50 for the first quarter of 2008 to
US$45 for the fourth quarter of the year, and the average for 2008 was US$46. This reduction in unit
production costs has been achieved through incremental tonnage and by a reduction in mine prepara-
tion costs, especially after the first quarter, as the mine met its targets in terms of ore tonnage prepared
ahead of current operation needs.
In late 2007 the Company launched an expansion project to ramp up capacity to 1,200 tpd and the
addition of a copper circuit which is scheduled to provide annual incremental income of US$1.4 million
at US$1.5/lb copper. The expansion project consists of an additional 6x8 ball mill and added zinc flota-
tion cells for total investment costs of US$460,000. The copper circuit is budgeted at US$650,000 as
well. Both projects are scheduled to be in production in May of 2009.
During the third quarter of 2007 the Company embarked on an investment plan designed to address
infrastructure requirements associated with the expansion at Caylloma, and which consisted mainly of
a tailings dam expansion, a main extraction level for the Animas vein, and connection to a new power
line for increased energy access. The energy project was concluded in February 2008 with a fraction of
previous estimated budgets, and securing energy capacity for the scheduled 1,200 tpd expansion. The
38
38
39
39
Year ended December 31, 2008
tailings dam expansion will provide an additional two years of mine life and requires a further budget of
US$600,000. Beyond this a longer lived tailings dam project is currently being taken to the feasibility
level. Scoping level estimates suggest a US$3 million investment for a 10 year life. The main extrac-
tion level project at Animas was put on hold in December 2008 after reviewing investment priorities.
The Company is working to produce a resource estimation technical report for Caylloma in June
2009.
Production forecast for Caylloma mine
Tonnes milled
Grade per tonne
Silver (oz)
Lead (%)
Zinc (%)
Copper (%)
Recoveries
Silver (%)*
Lead (%)
Zinc (%)
Copper (%)
Production (metal contained)
Silver (oz)
Lead (tonnes)
Zinc (tonnes)
Copper (tonnes)
Unit cash production cost (US$/tonne)
Cash cost per ounce (US$/ounce)
2009
394,350
4.81
2.65
3.58
0.33
82.00
92.00
86.50
60.00
1,677,349
9,621
12,207
574
41.21
1.86
* Combined silver recoveries in lead and copper concentrates
Cash cost per ounce is net of by-product credits and assumes the following prices: Zn US$1,100/t, Pb
US$950/t, Cu US$3,300/t, Au US$750/oz.
MEXICO –SAN JOSE
SILVER-GOLD
PROJECT
Trinidad Resource Estimation
On January 2009, the Company completed the 32,000 meter in-fill drilling program initiated in June of
2008. This program was designed to convert inferred resources to the indicated category in the upper
250m of the deposit, where mining is initially expected to take place. Complete assay results for the
drill program have been released and are available on the Company´s website at www.fortunasilver.com.
A new resource estimation is planned to be completed in June 2009.
40
40
41
41
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
MEXICO –SAN JOSE
SILVER-GOLD
PROJECT
(continued)
Metallurgical Studies
Metallurgical tests have now been completed by Metcon Research of Tucson Arizona, and based on
these results a definitive process flow sheet is being developed by the Company´s metallurgical con-
sultants.
Metallurgical results indicate that commercial grade silver and gold concentrates can be achieved with
recoveries over ninety per cent for both metals through a conventional flotation. The use of cyanide is
not required as part of this process.
Community Relations and Land Agreements
Over forty hectares of land that encompass the Trinidad mineralized zone and future infrastructure
sites have been secured with renewable thirty year land tenure agreements with parcel owners. The
Company is currently negotiating a long term collaborative agreement with the San Jose del Progreso
Ejido. The Community Relations department continues to engage local and surrounding communities
through project presentations, site visits, and sustainable development programs.
Industrial Water Supply
The Company has conducted a positive scoping study on the treatment of “grey water” from an existing
plant facility in a nearby town to source the industrial process requirements of the project. Manage-
ment is moving ahead with the detailed engineering and permitting of this water alternative.
Underground Development
The 1,000 meter long decline to the Trinidad mineralized zone reached the deepest level of the old
mine workings, 150 meters below surface, in July of 2008 and was subsequently stopped. Manage-
ment has achieved the objective of gaining access to the upper portion of the Trinidad zone resource.
The decline development to date will allow testing of trial mining methods, gain better geologic control
of mineralization and cut down a year´s worth of mine preparation time.
Project Engineering
The Company has awarded the following components of the project engineering; plant design and
engineering,to Promimet SA de CV, mine design to Proyectos y Estudios Mineros SAC, Geotechnical
studies and tailings design to SVS Ingenieros SAC, Energy project to Soto Ortega Ingenieros SA de CV,
water project to ICAYS SA de CV. The Company is in the process of selecting a North American engi-
neering firm to provide Qualified Person supervision for the project engineering and to author required
Technical Reports.
Permitting
The Company expects to submit the “Manifiesto de Impacto Ambiental” to the Mexican environmental
authorities in late March 2009.
40
40
41
41
Year ended December 31, 2008
Exploration
In February 2009 the Company made effective a reduction of 8,344 ha out of the approximately
49,000 ha surrounding the San Jose project for which it holds exploration and mining rights. This
decision was based on existing geological information and is part of an effort to prioritize capital ex-
penditures.
Cash cost per tonne (non-GAAP measures)
Cash cost per tonne is a key performance measure that management uses to monitor performance.
These performance measures have no defined meaning within Canadian Generally Accepted Account-
ing Principles (“Canadian GAAP”), and, therefore, amounts presented may not be comparable to simi-
lar data presented by other mining companies.
The following table presents a reconciliation of cash production costs per tonne of processed ore to the
cost of sales in the consolidated statement of operations:
Cost of sales
Change in inventory (ore and concentrate stock piles)
Depletion, depreciation, and accretion
Total cash production cost
Total processed ore (tonnes)
Cash production cost per tonne of processed ore (US$)
CAD$
$’000
22,209
(121)
(5,681)
16,407
US$
$’000
@ 0.9375
20,820
(113)
(5,326)
15,381
331,380
46.42
LIQUIDITY
AND CAPITAL
RESOURCES
The Company’s cash resources and liquid investments decreased during the year ended December 31,
2008 by $11.22 million to $36.02 million.
For 2008 operating activities generated a net cash amount of $8.85 million.
During 2008 the Company invested a total amount of $22.46 million in mineral properties, where
investments in Caylloma and San Jose accounted for $9.43 million and $13.03 million respectively.
Total amount invested in 2008 in plant and equipment was $3.74 million, where Caylloma and San
Jose accounted for $2.65 million and $0.94 million respectively. Additionally, the investments in
mining properties and projects in Mexico demanded total value added tax disbursements of $1.56
million. This value added tax is refundable and is included as part of current assets as at December
31, 2008.
During 2008, Caylloma was successful in self-funding its continued growth in processing and mine
capacity. Even under today´s metal price environment management expects ongoing and expansion
capital needs for 2009 to continue to be self-financed by internally generated cash from operations.
42
42
43
43
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
LIQUIDITY
AND CAPITAL
RESOURCES
(continued)
With regards to the San Jose project, management expects investments of US$6 million in 2009 in
order to advance the project to a feasibility level. These investments will be funded through cash
reserves.
As at December 31, 2008, the Company had working capital of $41.64 million compared to working
capital of $51.16 million at December 31, 2007.
Management believes the Company’s current financial position as well as results of its ongoing op-
eration in Caylloma is sufficient to support the Company’s operating and capital requirements on an
ongoing basis. Actual funding requirements may vary from those planned due to further acquisition
opportunities. Management believes it will be able to raise equity capital or access debt facilities as
required in both the short and long term, but recognizes the uncertainty attached thereto.
RELATED PARTY
TRANSACTIONS
The Company incurred charges from directors, officers, and companies having a common director or
officer as follows:
Mineral property costs – geological fees
Consulting fees
Salaries and wages
Management fees
Year ended
December 31,
2008($000)
$ -
66
110
-
Year ended
December 31,
2007($000)
$ 45
188
108
266
These charges were measured at the exchange amount, which is the amount agreed upon by the trans-
acting parties.
At December 31, 2008, due to related parties consists of $46,897 (December 31, 2007 - $14,000)
owing to a company with a common director. These amounts were incurred as a result of shared admin-
istrative costs. These amounts are unsecured, non-interest bearing and payable in the normal course
of business.
CRITICAL
ACCOUNTING
ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated finan-
cial statements and the reported amounts of revenue and expenses during the reporting periods. These
estimates and assumptions are based on established industry standards, historical experience, and are
reviewed on an ongoing basis to confirm their continued applicability.
Amortization and Mineral Property Costs
Mineral property costs are comprised of acquisition costs and capitalized exploration, construction and
development costs. Upon initiating production, the asset is amortized over its estimated useful life on
a units-of-production basis. The Company estimates reserves and resources and the economic life of
42
42
43
43
Year ended December 31, 2008
its mines and utilizes this information to calculate depletion and amortization expense. Depreciation
and depletion charges are adjusted prospectively based on periodic re-assessments of the Company´s
mineral reserves.
The estimate of mineral reserves is prepared by qualified persons in accordance with industry standards
defined under NI 43-101 of the Canadian Securities regulatory authorities. Mineral reserve estimates
can change over time as a result of numerous factors, including changes in metal prices, production
costs, or the re-evaluation of geological, engineering and economic data of a deposit. A significant
reduction in mineral reserves would have a negative impact on the calculation of the amortization of
this asset.
Asset Retirement Obligations
Fortuna’s determination for asset retirement obligations involves estimation of timing and amounts of
future costs relating to ongoing environmental and mine closure activities required under applicable
law or the Company’s own remediation plans. These estimates are subject to significant uncertainties
because many of these costs will not be incurred for a number of years, the nature of the reclamation
activities might change and the assumptions regarding the rate of inflation and credit risk-adjusted
interest rate used in the calculation may vary over time. Therefore, actual costs and their timing might
differ from current estimates.
Impairment of Long-lived Assets
Management reviews and evaluates its long-lived assets for impairment when events or changes in
circumstances indicate that the related carrying amounts may not be recoverable. Examples of such
events or circumstances are changes in metal prices, sudden physical deterioration of the asset, legal
circumstances or political risks in the countries Fortuna operates, or other external factors which could
have a significant impact on the operations of the Company. Impairment is considered to exist if total
estimated future cash flows or probability-weighted cash flows on an undiscounted basis are less than
the carrying amount of the assets, including mineral property, plant and equipment and non-producing
property. An impairment loss is measured and recorded based on discounted estimated future cash
flows or the application of an expected present value technique to estimate fair value in the absence
of a market price. Future cash flows include recoverable proven and probable reserves and a portion
of recoverable resources, silver, zinc, copper, lead and gold prices (considering current and historical
prices, price trends and related factors), production levels, capital and reclamation costs, all based on
detailed engineering life-of-mine plans. Assumptions underlying future cash flow estimates are subject
to risks and uncertainties. Any differences between significant assumptions and market conditions and/
or the Company’s performance could have a material effect on any impairment provision, and on the
Company’s financial position and results of operations.
Income Taxes
The estimation of the Company’s future tax liabilities and assets involves significant judgment around
a number of assumptions. Judgement must be used to determine the Company´s future earning poten-
tial, and the expected timing of the reversal of future tax assets and liabilities. Further uncertainties
are the result of interpretation of tax legislation in a number of jurisdictions which might differ from
44
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45
45
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
CRITICAL
ACCOUNTING
ESTIMATES
(continued)
the ultimate assessment of the tax authorities. These differences may affect the final amount or the
timing of the payment of taxes.
Stock-based Compensation
The determination of the value of stock-based compensation is estimated using the Black-Scholes
option pricing model. Option pricing models require the input of highly subjective assumptions, par-
ticularly as to the expected price volatility of the stock. Other assumptions include the expected life of
the options and the risk-free interest rate at the time of the grant. Changes in these assumptions can
materially affect the fair value estimated.
FINANCIAL
INSTRUMENTS
The carrying value of receivables, due from/to related parties and accounts payable and accrued liabili-
ties approximate their fair value because of the short-term maturity of those instruments.
The Company enters into derivative contracts to manage its exposure to fluctuations in base metal pric-
es. These contracts are marked-to-market at the end of each period, and the changes in estimated fair
value are recorded as an unrealized gain (loss) on commodity contracts in the statement of operations.
As at December 31, 2008 the Company estimated the fair value of the outstanding contracts at $1.73
million, and recorded a gain in the consolidated statements of operations for the 2008 period of $4.52
million. The estimated fair value was determined based on using applicable valuation techniques for
commodity options with reference to the published marked prices for underlying commodities quoted
at London Metal Exchange.
The net amount of settled positions on commodity contracts in 2008 was $4.53 million.
The long-term investments into marketable securities are classified as available-for-sale and are mea-
sured at fair value at the end of each period. Fair value of these investments is determined based on
published market prices of underlying securities. Change in fair values of available-for-sale marketable
securities is recognized in other comprehensive income. During 2008, the Company recorded other
comprehensive loss of $0.69 million relating to change in fair value of marketable securities. This
amount is net after tax.
The Company’s financial instruments are exposed to certain financial risks, including currency risk,
credit risk, liquidity risk, interest risk and price risk.
(a) Currency risk
The Company is exposed to the financial risk related to the fluctuation of foreign exchange rates. The
Company operates in Canada, Peru, Mexico and Barbados and a portion of its expenses are incurred
in US dollars, Nuevo Soles, and Mexican Pesos. A significant change in the currency exchange rates
between the Canadian dollar relative to the other currencies could have an effect on the Company’s
results of operations, financial position or cash flows. The Company has not hedged its exposure to
currency fluctuations.
44
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45
45
Year ended December 31, 2008
At December 31, 2008, the Company is exposed to currency risk through the following assets and
liabilities denominated in US dollars, Nuevo Soles and Mexican Pesos (all amounts are expressed in
thousands of US dollars, thousands of Nuevo Soles or thousands of Mexican Pesos):
Cash and cash equivalents
Derivatives
Accounts receivable
Long-term receivable
Accounts payable and accrued liabilities
Long-term liability
Obligations under capital lease
US Dollars
5,078
1,418
102
114
(2,096)
(876)
(1,399)
December 31, 2008
Nuevo Soles
629
-
10,400
-
(5,281)
-
-
Mexican Pesos
3,864
-
46,460
-
(10,259)
-
-
Based on the above net exposures as at December 31, 2008, and assuming that all other variables
remain constant, a 10% depreciation or appreciation of the Canadian dollar against the US dollar would
result in an increase/decrease of $286 in the Company’s net earnings. Likewise, a 10% depreciation
or appreciation of the Canadian dollar against the Nuevo Soles would result in an increase/decrease of
$224 in the Company’s net earnings and a 10% depreciation or appreciation of the Canadian dollar
against the Mexican Pesos would result in an increase/decrease of $359 in the Company’s net earn-
ings.
(b) Credit risk
Credit risk is the risk of an unexpected loss if a customer or third party to a financial instrument fails
to meet its contractual obligations. The Company’s cash equivalents are held through large Canadian
and international financial institutions. These investments mature at various dates over the current
operating period. All of the Company’s trade accounts receivables are held with a large international
metals trading company. The Company has a Mexican value added tax of $4,026 as at December 31,
2008, of which a significant portion is past due. Additionally, the Company has Peruvian value added
tax of $2,230. The Company expects to recover the full amounts from the Mexican and Peruvian Gov-
ernments.
(c) Liquidity risk
Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall
due. The Company manages liquidity risk by continuing to monitor forecasted and actual cash flows.
The Company has in place a planning and budgeting process to help determine the funds required to
support the Company’s normal operating requirements on an ongoing basis and its development plans.
The Company strives to maintain sufficient liquidity to meet its short term business requirements, tak-
ing into account its anticipated cash flows from operations, its holdings of cash and cash equivalents
and its committed liabilities.
Accounts payable and accrued liabilities, amounts due to related parties and the current portion of
obligations under capital lease are due within the current operating period.
46
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47
47
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
FINANCIAL
INSTRUMENTS
(continued)
(d) Interest rate risk
Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate
because of changes in market interest rates. The risk that the Company will realize a loss as a result
of a decline in the fair value of the amounts in investments with maturities of 90 days or less included
in cash and cash equivalents is limited because these investments, although available for sale, are
generally held to maturity.
(e) Price risk
The Company is exposed to metals price risk with respect to silver, gold, zinc, and lead sold through
its mineral concentrate products. The Company mitigates this risk by implementing price protection
programs for some of its zinc and lead production through the use of derivative instruments. As a mat-
ter of policy the Company does not hedge its silver production.
OTHER
DATA
Additional information related to the Company is available for viewing at www.sedar.com.
Share Position and Outstanding Warrants and Options
The Company’s outstanding share position at March 20, 2009 is 92,141,365 common shares. In
addition, a total of 18,774,355 share purchase warrants and incentive stock options are currently
outstanding as follows:
Type of Security
No. of Shares
Warrants
Stock Options:
8,588,000
862,117
1,613,238
11,063,355
200,000
20,000
50,000
50,000
100,000
250,000
177,000
29,000
30,000
250,000
270,000
250,000
60,000
200,000
35,000
Exercise
Price
$2.30
$0.345
$0.345
$0.85
$1.90
$1.96
$2.22
$3.22
$2.97
$0.85
$0.37
$0.80
$2.82
$1.35
$2.29
$1.75
$1.75
$0.85
Expiry Date
July 11, 2009
June 27, 2010
Nov. 17, 2010
April 29, 2009
April 29, 2009
April 29, 2009
April 29, 2009
April 29, 2009
May 28, 2009
May 28, 2009
Dec. 2, 2009
July 24, 2010
Oct. 9, 2010
Feb. 5, 2016
Mar. 30, 2016
May 8, 2016
May 22, 2016
July 5, 2016
46
46
47
47
Year ended December 31, 2008
245,000
860,000
225,000
110,000
730,000
50,000
15,000
50,000
50,000
50,000
1,075,000
25,000
250,000
150,000
1,205,000
650,000
7,711,000
$1.55
$1.66
$1.61
$0.85
$2.22
$2.75
$0.85
$0.85
$0.85
$0.85
$3.22
$0.85
$2.52
$1.25
$0.85
$0.85
July 5, 2016
July 10, 2016
Sept. 13, 2016
Jan. 11, 2017
Jan. 11, 2017
Feb. 6, 2017
April 22, 2017
May 31, 2017
June 27, 2017
July 2, 2017
July 2, 2017
Oct. 24, 2017
Feb. 5, 2018
Aug. 25, 2018
Oct. 5, 2018
Nov. 5, 2018
CHANGE IN
ACCOUNTING
POLICY
Effective January 1, 2008, the Company adopted the following new accounting standards issued by the
Canadian Institute of Chartered Accountants:
a) Section 1535 – Capital Disclosures – Disclosures. Section 1535 requires disclosures of an entity’s
objectives, policies and processes for managing capital, and quantitative data about what the entity
regards as capital.
b) Section 3031 – Inventories. Section 3031 requires inventory to be valued on a first-in, first-out or
weighted average basis, which is consistent with the Company’s current treatment. The adoption of
this standard does not have a material impact on the Company’s Consolidated Financial Statements.
c) Section 3862 “Financial Instruments – Disclosures” and Section 3863 “Financial Instruments –
Presentation”, replace Section 3861 “Financial Instruments – Disclosure and Presentation”. The new
disclosure standard increases the emphasis on the risks associated with both recognized and
unrecognized financial instruments and in addition requires companies to provide disclosures in their
financial statements that enable users to evaluate the significance of financial instruments for the
company’s financial position and performance and the nature and extent of risks arising from financial
instruments to which the company is exposed during the period and at the balance sheet date,
and how the company manages those risks. The new presentation standard carries forward the
former presentation requirements.
The Company holds cash balances and incurs payables that are denominated in Canadian Dollars,
Mexican Peso and Peruvian Soles. These balances are subject to fluctuations in the exchange rate between
the Canadian Dollar, Peruvian Soles and the U.S. Dollar, resulting in currency gains or losses for
the Company.
48
48
49
49
CHANGE IN
ACCOUNTING
POLICY
(continued)
RECENT RELEASED
CANADIAN
ACCOUNTING
STANDARDS
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
d) Section 1400 – General Standards of Financial Statement Presentation. Section 1400 was amended
to include requirements to assess and disclose an entity’s ability to continue as a going concern.
The adoption of Sections 1535, 3031, 3862, 3863 and 1400 had no impact on the opening equity
and losses of the Company.
The Company has assessed new and revised accounting pronouncements that have been issued that are
not yet effective and determined that the following may have an impact on the Company:
Goodwill and Intangible Assets (Section 3064)
In February 2008, the CICA issued section 3064, “Goodwill and Intangible Assets”, which replaces
Section 3062, “Goodwill and Intangible Assets,” and CICA Section 3450, “Research and Development
Costs,” and CICA Section 1000, “Financial Statement Concepts.” The standard intends to reduce the
differences with International Financial Reporting Standards (“IFRS”) in the accounting for intangible
assets and results in closer alignment with U.S. GAAP. Under current Canadian standards, more
items are recognized as assets than under IFRS or U.S. GAAP. The objectives of CICA Section 3064
are to reinforce the principle-based approach to the recognition of assets only in accordance with the
definition of an asset and the criteria for asset recognition; and clarify the application of the concept
of matching revenues and expenses such that the current practice of recognizing assets that do not
meet the definition and recognition criteria are eliminated. The standard will also provide guidance for
the recognition of internally developed intangible assets (including research and development activi-
ties), ensuring consistent treatment of all intangible assets, whether separately acquired or internally
developed. This standard will be effective for fiscal years beginning on or after October 1, 2008. The
Company is currently evaluating the impact of adopting this standard in 2009.
Business Combinations
In January 2009, the CICA issued Section 1582, Business Combinations, Section 1601, Consolida-
tions, and Section 1602, Non-controlling Interests. These new standards are harmonized with Interna-
tional Financial Reporting Standards (IFRS). Section 1582 specifies a number of changes, including:
an expanded definition of a business, a requirement to measure all business acquisitions at fair value,
a requirement to measure non-controlling interests at fair value, and a requirement to recognize acqui-
sition-related costs as expenses. Section 1601 establishes the standards for preparing consolidated
financial statements. Section 1602 specifies that non-controlling interests be treated as a separate
component of equity, not as a liability or other item outside of equity. The new standards will become
effective in 2011 but early adoption is permitted. The Company is evaluating the attributes of early
adoption of this standard and its potential effects if events or transactions occurred that this standard
applies to.
International Financial Reporting Standards
The Canadian Accounting Standards Board has confirmed January 1, 2011 as the date IFRS will
replace current Canadian Standards and interpretations as Canadian generally accepted accounting
principles (Canadian GAAP) for publicly accountable enterprises. Canadian GAAP will be converged
with IFRS over a transition period with an effective implementation date effective for interim and an-
48
48
49
49
FORWARD LOOKING
INFORMATION
Year ended December 31, 2008
nual periods commencing January 1, 2011. The Company will begin reporting its financial statements
in accordance with IFRS on January 1, 2011, with comparative figures for 2010.
The adoption date of January 1, 2011 will require the restatement, for comparative purposes, of
amounts reported by the Company for its year ended December 31, 2010, and of the opening balance
sheet as at January 1, 2010.
The Company has begun planning its transition to IFRS but the impact on its consolidated financial
position and results of operations has not yet been determined. The process will consist of three phases:
Scoping and Diagnostics, Analysis and Development, and Implementation and Review. The Company
has begun the first phase which includes a diagnostic assessment of its current accounting policies
systems and processes in order to identify differences between current Canadian GAAP and IFRS treat-
ment. The Company will continue to monitor changes in IFRS during implementation process and
intends to update the critical accounting policies and procedures to incorporate the changes required
by converting to IFRS and the impact of these changes on its financial reporting.
Certain statements contained in this MD&A and elsewhere constitute forward-looking statements. Such
forward-looking statements involve a number of known and unknown risks, uncertainties and other
factors which may cause the actual results, and performance of achievements of the Company to be
materially different from any future results, performance or achievements expressed or implied by such
forward-looking statements. Such factors include, among others, changes in project parameters to deal
with unanticipated economic factors, risks related to technological and operational nature of the Com-
pany’s business, the speculative nature of exploration and development, changes in local and national
government legislation.
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak
only as of the date the statements were made, and readers are advised to consider such forward-looking
statements in light of the risks set forth in the section Risks and Uncertainties.
In particular, forward-looking information and statements include:
• Production forecast for 2009.
• Cash cost per ton of treated ore and cash cost per ounce of payable silver for 2009.
• Throughput expansion and copper circuit projects are scheduled to be in production in May
of 2009.
• Scheduled annual incremental income of the copper circuit project.
• Conclusion of the Caylloma resource estimation.
• Conclusion of the San Jose resource estimation.
• Management expects ongoing and expansion capital needs for 2009 at Caylloma to continue to
be self-financed by internally generated cash from operations.
• Management expects investments of US$6 million in 2009 at San Jose in order to advance
the project to a feasibility level.
50
50
51
51
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
RISK AND
UNCERTAINTIES
Metal prices
One of the most significant risks affecting the profitability and viability of the Company’s mining opera-
tions is the fluctuation of metal prices. Volatility of metal prices is high by historic measures and strong
downturns on these prices can have significant adverse effects on the continuity of the Company’s op-
erations. In order to mitigate this risk in the medium term, the Company put in place price protection
strategies for approximately 50% of its zinc and lead metal production during twelve months from the
original contract dates up to January 2009. Subsequently the Company extended the price protection
for 65% of zinc and lead production between the months of February and July of 2009.
Credit risk
The Company is subject to credit risk through its trade receivables. The Company enters in one year
contracts to sell its concentrate products at Caylloma and transacts only with credit worthy costumers
to minimize credit risk. The Company has awarded its full production of 2009 to Swiss metal trader
Glencore International.
The Company holds derivative contracts with financial institutions and in this regard is exposed to
counterparty risk. The Company mitigates this risk by transacting only with credit worthy costumers
to minimize credit risk. The Company currently holds derivatives contracts with Standard Bank PLC.
and BBVA SA.
Environmental risk
The Company has recorded an asset retirement obligation of $1,30 million as of December 31, 2008.
The initial amount was based on an estimate prepared by an independent third party at the time of
acquisition as to the cost of reclamation associated with the Caylloma property. The Company has
reviewed its reclamation obligations at the property in light of changing regulations and is currently
working on a new estimate.
In view of the uncertainties concerning environmental reclamation, the ultimate cost of reclamation
activities could differ materially from the estimated amount recorded. The estimate of the Company’s
asset retirement obligation relating to the Caylloma mine is subject to change based on amendments to
laws and regulations and as new information regarding the Company’s operations becomes available.
Exchange rate risk
The Company´s reporting currency is the Canadian dollar, however the Company’s foreign assets as well
as most of its commercial transactions are held and take place in US and local currencies. As a conse-
quence, the financial results of the Company´s operations as reported in Canadian dollars are subject
to changes in value of the Canadian dollar relative to US and local currencies.
Exploration and development
The business of mineral exploration and extraction involves a high degree of risk. Few properties that
are in the exploration stage ultimately become producing mines. Major expenses may be required to
establish reserves by drilling and to construct mining and processing facilities at a site. It is impossible
50
50
51
51
Year ended December 31, 2008
to ensure that exploration and development programs carried out by the Company will result in profit-
able commercial mining operations.
Resources and reserves
There is a degree of uncertainty attributable to the calculation of resources and reserves and to expected
mineral grades. Mineral Resource and Mineral Reserves may require revision based on actual produc-
tion experience. Market fluctuations in the price of metals, as well as increased production costs and
reduced recovery rates, may render certain mineral reserves uneconomic and may ultimately result in a
restatement of resources and/or reserves. Short-term operating factors relating to the mineral resources
and reserves, such as the need for sequential development of ore bodies may adversely affect the Com-
pany’s profitability in any accounting period.
Political and country risk
The Company’s mineral properties are located in emerging nations and consequently may be subject
to a higher level of risk compared to developed countries. Operations, the status of mineral property
rights, title to the properties and the recoverability of amounts shown for mineral properties in emerging
nations can be affected by changing economic, regulatory, and political situations.
The State of Oaxaca has a history of social conflicts and political agitation which can lead to public
demonstrations and blockades that can from time to time affect the Company’s operations.
Considerations in Light of the Credit Crisis and General State of the Markets
The significant decline in the prices of silver, zinc and lead during the last four months of 2008 has
had a negative impact on the Company’s profitability. In Q4 2008, the strengthening of the U.S. dollar
relative to the Canadian dollar partially offset this negative impact. With the current global economic
uncertainty, the Company anticipates that commodity prices will remain depressed and the Canadian-
U.S. dollar exchange rate will remain volatile in the near term. Based on current metal prices, the
current value of the U.S. dollar, and planned production levels, and after the effects of negative price
adjustments as discussed, the Company expects to resume generating positive cash flows in the first
half of 2009, albeit at significantly lower levels than earlier in 2008.
In light of the current market environment, the Company’s near-term goal is to preserve its cash bal-
ances to the greatest extent possible, by minimizing operating costs and by curtailing capital expendi-
tures. In that regard, the Company is currently reviewing its operations in Peru with a view to optimizing
efficiencies and reducing costs wherever possible without compromising safety, health or environmental
standards. The Company will be monitoring market conditions and the planned capital budget for the
Mexican operations with a view to determining an optimal development schedule given the Company’s
current cash balances, its ability to generate sufficient cash flows, and its ability to obtain additional
funding in the current market environment. Additional funding may include external debt financing, or
the public or private sales of equity or debt securities of the Company.
52
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53
53
MANAGEMENT’S DISCUSSION AND ANALYSIS
Year ended December 31, 2008
RISK AND
UNCERTAINTIES
(continued)
The Company has assessed the carrying values of its mineral properties as a result of the market down-
turn. In the last few months, declining metal prices as a result of the global economic uncertainty, and
negative market sentiment have lead to the Company’s market capitalization dropping below its book
value as at December 31, 2008. Based on current and expected metal prices and cost structures,
management has determined that the values of the Company’s mineral properties have not been im-
paired at this time. However, should current market conditions and commodity prices worsen and/or
persist for a prolonged period of time, an impairment of mineral properties may be required.
INTERNAL
DISCLOSURE CONTROLS
AND PROCEDURES
During 2008 the Company engaged an external consulting firm to assist Fortuna’s management in
documenting and assessing the design effectiveness of Internal Control over Financial Reporting on its
main business and accounting processes. This is an ongoing effort.
The Company evaluated the effectiveness of the design and operation of the disclosure controls and
procedures as of December 31, 2008 under the supervision of the Chief Executive Officer (“CEO”)
and the Chief Financial Officer (“CFO”). Based on the results of this evaluation the CEO and the CFO
have concluded that such disclosure controls are sufficiently effective to provide reasonable assurance
that material information relating to the Company is made known to management and disclosed in ac-
cordance with the applicable securities laws.
Management is responsible for establishing a system of internal control over financial reporting to
provide reasonable assurance regarding the reliability and integrity of the Company´s financial informa-
tion and the preparation of its financial statements in accordance with Canadian generally accepted
accounting principles. Management of the Company has evaluated the effectiveness of internal control
over financial reporting as of December 31, 2008 and has concluded there are no material weaknesses.
Management continues to review and refine its internal controls and procedures.
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53
Deloitte & Touche LLP
2800 - 1055 Dunsmuir Street
4 Bentall Centre
P.O. Box 49279
Vancouver BC V7X 1P4
Canada
Tel: 604-669-4466
Fax: 604-685-0395
www.deloitte.ca
AUDITORS’ REPORT TO THE SHAREHOLDERS OF FORTUNA SILVER MINES INC.
We have audited the consolidated balance sheet of Fortuna Silver Mines Inc. as at December 31,
2008 and the consolidated statements of operations and comprehensive loss, shareholders’ equity
and cash flows for the year then ended. These financial statements are the responsibility of the Com-
pany’s management. Our responsibility is to express an opinion on these financial statements based
on our audit.
We conducted our audit in accordance with Canadian generally accepted auditing standards. Those
standards require that we plan and perform an audit to obtain reasonable assurance whether the
financial statements are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation.
In our opinion, these consolidated financial statements present fairly, in all material respects, the
financial position of the Company as at December 31, 2008 and the results of its operations and
its cash flows for the year then ended in accordance with Canadian generally accepted accounting
principles.
The consolidated financial statements as at December 31, 2007 and for the year then ended were
audited by other auditors who expressed an opinion without reservation on those statements in their
audit report dated March 20, 2008.
Chartered Accountants
March 31, 2009
54
54
55
55
FORTUNA SILVER MINES INC.
AS AT DECEMBER 31,
Expressed in thousands of Canadian Dollars
See accompanying Notes
CONSOLIDATED
BALANCE SHEETS
ASSETS
CURRENT
Cash and cash equivalents
Derivatives (Note 4)
Accounts receivable and prepaid expenses (Note 5)
GST and value added tax
Inventories (Note 6)
LONG-TERM RECEIVABLES
LONG-TERM INVESTMENT AND RECEIVABLE (Note 7)
PROPERTY, PLANT & EQUIPMENT (Note 8)
MINERAL PROPERTIES (Note 9)
CURRENT
Accounts payable and accrued liabilities
Due to related parties, net (Note 10)
Current portion of obligation under capital lease (Note 11)
Current portion of long-term liability (Note 11)
LIABILITIES
OBLIGATIONS UNDER CAPITAL LEASE (Note 11)
LONG-TERM LIABILITY (Note 11)
ASSET RETIREMENT OBLIGATION (Note 12)
FUTURE INCOME TAX LIABILITY (Note 13)
NON-CONTROLLING INTEREST (Note 9)
$
$
$
2008
36,017
1,734
2,281
6,269
2,112
48,413
139
3,781
16,245
72,494
141,072
5,790
47
834
98
6,769
876
813
1,304
11,507
11,013
32,282
SHAREHOLDERS’ EQUITY
SHARE CAPITAL (Note 14)
CONTRIBUTED SURPLUS
DEFICIT
ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME (Note 15)
108,221
13,171
(11,972)
(630)
108,790
141,072
$
Nature and continuance of operations (Note 1)
Commitments and contingencies (Note 18)
Subsequent events (Note 21)
APPROVED BY THE DIRECTORS:
2007
47,240
1,400
2,051
5,147
1,693
57,531
-
908
13,669
52,338
124,446
5,917
14
439
-
6,370
433
-
1,916
8,069
6,593
23,381
100,159
11,770
(11,008)
144
101,065
124,446
$
$
$
$
Jorge Ganoza Durant
Director
Simon Ridgway
Director
54
54
55
55
FORTUNA SILVER MINES INC.
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in thousands of Canadian Dollars, except for share and per share amounts
See accompanying Notes
CONSOLIDATED
STATEMENTS OF
OPERATIONS AND
COMPREHENSIVE
LOSS
Sales
Cost of sales (including depletion, depreciation and accretion
of $5,681 (2007 $5,766))
MINE OPERATING INCOME
Selling, general and administrative expenses (includes
depreciation of $52 (2007 $32))
Stock-based compensation (Note 14)
Write-off of deferred exploration costs
OPERATING (LOSS) INCOME
Interest and other income and expenses
Interest and finance expenses
Net gain on commodity contracts (Note 4)
Loss on disposal of property, plant and equipment
Foreign exchange gain (loss)
INCOME BEFORE INCOME TAXES AND
NON-CONTROLLING INTEREST
Income tax provision (Note 13)
Non-controlling interest
NET LOSS FOR THE YEAR
2008
2007
$
26,339
$
31,667
22,209
4,130
8,278
1,428
349
10,055
(5,925)
1,442
(103)
4,521
(47)
839
6,652
727
1,799
(108)
(964)
(774)
(1,738)
(0.01)
18,447
13,220
6,127
6,974
12
13,113
107
1,529
(90)
1,558
(59)
(1,665)
1,273
1,380
4,261
(92)
(2,789)
(305)
(3,094)
(0.04)
$
$
Other comprehensive loss, net of tax
Unrealized loss on available for sale long-term investments
COMPREHENSIVE LOSS FOR THE YEAR
Loss per share –
Basic and diluted
$
$
Weighted average number of shares outstanding –
Basic and diluted
84,400,969
71,602,275
56
56
57
57
FORTUNA SILVER MINES INC.
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in thousands of Canadian Dollars, except for share amounts
See accompanying Notes
CONSOLIDATED
STATEMENTS OF
SHAREHOLDERS’
EQUITY
Share Capital
Shares
Amount
Contributed
Surplus
Accumulated
Total
Other
Comprehensive Shareholders’
Equity
Income
(Deficit)
CONSOLIDATED
STATEMENTS OF
CASH FLOWS
Balance
– December 31, 2006
Cumulative impact of
accounting changes,
net of tax (Note 15)
Exercise of options
Exercise of warrants
Private placement for cash
Private placement
commission non-cash
transaction
Transfer of contributed
surplus on exercise of
options
Stock based compensation
Issue costs (non-cash amount
$802)
Loss for the year
Other comprehensive loss,
net of tax
Balance December 31, 2007
Exercise of options
Exercise of warrants
Transfer of contributed surplus
on exercise of options
Stock based compensation
Loss for the year
Other comprehensive loss, net of
tax
Balance December 31, 2008
46,587,728
$ 43,341
$ 6,085 $
(8,219)
$
-
$ 41,207
-
1,753,600
14,214,035
18,000,000
-
1,957
21,057
34,200
422,300
802
-
-
-
-
1,289
-
(2,487)
-
-
-
-
-
-
(1,289)
6,974
-
-
-
-
-
-
-
-
-
-
(2,789)
449
-
-
-
-
-
-
-
-
449
1,957
21,057
34,200
802
-
6,974
(2,487)
(2,789)
-
80,977,663
-
$ 100,159
-
$ 11,770
-
$ (11,008)
(305)
144
(305)
$ 101,065
$
31,400
4,322,596
-
-
-
38
7,997
27
-
-
-
-
(27)
1,428
-
-
-
-
-
(964)
-
-
-
-
-
38
7,997
-
1,428
(964)
-
85,331,659
-
$ 108,221
-
-
$ 13,171 $ (11,972)
(774)
(630)
(774)
$ 108,790
$
56
56
57
57
CONSOLIDATED
STATEMENTS OF
CASH FLOWS
FORTUNA SILVER MINES INC.
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
Expressed in thousands of Canadian Dollars
See accompanying Notes
OPERATING ACTIVITIES
Net loss for the year
Items not involving cash
Depletion and depreciation
Accretion expense
Future income tax
Stock based compensation
Unrealized loss (gain) on commodity contracts
Non-controlling interest
Write-off of deferred exploration costs
Loss on disposal of equipment
Other
Unrealized foreign exchange loss (gain)
Changes in non-cash working capital items
Accounts receivable and prepaid expenses
Inventories
Accounts payable
Payments from (to) related parties (Note 10)
Net cash from (used in) operating activities
FINANCING ACTIVITIES
Net proceeds on issuance of common shares
Capital lease obligations
Repayment of debt (Note 11)
Net cash from financing activities
INVESTING ACTIVITIES
Mineral property expenditures
Value added taxes on purchase of property, plant and equipment
Property, plant & equipment expenditures
Long term receivable
Proceeds from disposal of equipment
Net cash used in investing activities
INCREASE (DECREASE) IN CASH
Cash and cash equivalents – beginning of period
2008
2007
$
(964)
$
(2,789)
5,667
108
1,799
1,428
9
(108)
349
47
24
807
270
(436)
(182)
33
8,851
8,035
(372)
-
7,663
(22,455)
(1,560)
(3,744)
(17)
39
(27,737)
(11,223)
47,240
5,640
158
3,717
6,974
(1,466)
(92)
12
59
-
(515)
(527)
(798)
2,877
(13)
13,237
55,528
(132)
(5,730)
49,666
(10,515)
(1,033)
(5,795)
-
39
(17,304)
45,599
1,641
CASH AND CASH EQUIVALENTS – END OF PERIOD
$
36,017
$
47,240
Supplementary disclosure of cash flow information:
Cash received for interest
Cash paid for income taxes
Non-cash transactions (Note 17)
$
$
(1,500)
507
$
$
(1,504)
608
58
58
59
59
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
01. NATURE AND
CONTINUANCE OF
OPERATIONS
Fortuna Silver Mines Inc. (the “Company”) is engaged in silver mining and related activities, including
exploration, extraction, and processing. The Company operates the Caylloma zinc/lead/silver mine in
southern Peru and is currently developing the San Jose silver/gold project in Mexico.
These consolidated financial statements have been prepared using Canadian generally accepted
accounting standards (“Canadian GAAP”) applicable to going concern, which contemplates the
realization of assets and satisfaction of liabilities in the normal course of business. For the years
ended December 31, 2008 and 2007, the Company had net losses of $964 and $2,789, respectively,
and as at December 31, 2008, had an accumulated deficit of $11,972. The Company’s continuing
operations as a going concern and the recoverability of amounts shown for its exploration stage mineral
properties are dependent upon the availability of the necessary financing to complete the exploration
and development of such mineral property interests, and upon future profitable production or proceeds
from the disposition of its mineral property interests.
02. SIGNIFICANT
ACCOUNTING
POLICIES
a) Basis of presentation
The consolidated financial statements have been prepared in accordance with Canadian generally
accepted accounting principles (“Canadian GAAP”). The consolidated financial statements include
the accounts of the Company’s wholly owned subsidiaries, Minera Bateas SAC (Bateas) and Fortuna
Silver (Barbados) Inc. and of the Company’s 76% interest in Compania Minera Cuzcatlan SA, a variable
interest entity for which a non-controlling interest has been recorded to reflect the 24% interest of the
Company’s partner. All significant intercompany balances and transactions have been eliminated on
consolidation.
b) Significant Changes in Accounting Policy
On January 1, 2008, the Company adopted four new Handbook Sections of the Canadian Institute of
Chartered Accountants (“CICA”): Section 1535, “Capital Disclosures”, Section 3031, “Inventories”,
Section 3862, “Financial Instruments-Disclosure” and Section 3863, “Financial Instruments –
Presentation”. The adoption of these guidelines did not have a material effect on the Company’s
results, financial position or cash flows.
Section 1535 “Capital Disclosures”, establishes standards for disclosing information about an entity’s
capital and how it is managed. These standards require a company to disclose its objectives, policies
and processes for managing capital along with summary quantitative data about what it manages
as capital. In addition, disclosures are to include whether a company has complied with externally
imposed capital requirements and when a company has not complied with capital requirements, the
consequences of such non-compliance.
Section 3031, “Inventories”, replaces the existing inventories standard. The new standard requires
inventory to be valued on a first-in, first-out or weighted average basis, which is consistent with the
Company’s current treatment. The adoption of this standard does not have a material impact on the
Company’s Consolidated Financial Statements.
Section 3862 “Financial Instruments – Disclosures” and Section 3863 “Financial Instruments –
Presentation”, replace Section 3861 “Financial Instruments – Disclosure and Presentation”. The
new disclosure standard increases the emphasis on the risks associated with both recognized and
unrecognized financial instruments and in addition requires companies to provide disclosures in their
financial statements that enable users to evaluate the significance of financial instruments for the
company’s financial position and performance and the nature and extent of risks arising from financial
58
58
59
59
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
instruments to which the company is exposed during the period and at the balance sheet date, and
how the company manages those risks. The new presentation standard carries forward the former
presentation requirements.
c) Use of estimates
The preparation of financial statements in conformity with generally accepted accounting principles
requires management to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the dates of the consolidated financial
statements and the reported amounts of revenue and expenses during the reporting periods. Significant
items subject to such estimates and assumptions include the fair values of financial instruments
and derivatives, determination of mineral reserves, the carrying amount of mineral property, plant
and equipment, assay grades of metal concentrates sold, valuation of inventories and future income
taxes, recoverability of receivables, provisions for asset retirement obligation and reclamation, fair value
estimation of acquisitions and stock-based awards. Actual results could differ from those estimates.
d) Revenue Recognition
Revenue arising from the sale of metal concentrates is recognized when title and the significant risks
and rewards of ownership of the concentrates have been transferred to the buyer. The passing of title
to the customer is based on the terms of the sales contract and final commodity prices are set on a
specified quotational period, either one or three months after delivery at the option of the customer.
The Company’s metal concentrates are provisionally priced at the time of sale based on the prevailing
market price. Variations recorded between the price recorded at the time of provisional settlement and
the actual final price is caused by changes in metal prices.
e) Cash and cash equivalents
Cash and cash equivalents include highly liquid investments with original maturities of ninety days or
less.
f) Long-term investments
Long-term investments are those investments which the Company will be retaining for a period longer
than one year. These investments are classified as available-for-sale and are recorded at fair value.
g) Property, Plant and Equipment
Property, plant and equipment are recorded at cost and are depreciated over the estimated economic
life of the asset on a straight line basis as follows:
Buildings, mine site
Buildings, other
Machinery and equipment
Furniture and other equipment
Transport units
Life of mine
20 – 30 years
3 – 8 years
4 – 10 years
4 – 5 years
The expected remaining life of the mine as at December 31, 2008 is 7.3 years. Land is not depreciated.
Equipment under capital lease is initially recorded at the present value of minimum lease payments at
the inception of the lease.
60
60
61
61
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
02. SIGNIFICANT
ACCOUNTING
POLICIES
(continued)
h) Amortization and Mineral Properties Cost
The Company defers the cost of acquiring, maintaining its interest, exploring and developing mineral
properties when future inflow of economic benefits from the properties is probable and until such time
as the properties are placed into production, abandoned, sold or considered to be impaired in value.
Costs of producing properties, including capitalized interest are amortized on a unit-of-production
basis over proven and probable reserves and costs of abandoned properties are written-off. Proceeds
received from the sale of interests in mineral properties are credited to the carrying value of the mineral
properties, with any excess included in operations. Write-downs due to impairment in value are charged
to operations. Exploration costs that do not relate to any specific property are expensed as incurred.
i) Operational Mining Properties and Mine Development
For operating mines all exploration within the mineral deposit is capitalized and amortized on a unit-of-
production basis over proven and probable reserves as part of the production cost.
Costs associated with commissioning activities on constructed plants are deferred from the date of
mechanical completion of the facilities until the date the Company is ready to commence commercial
production. Any revenues earned during this period are recorded as a reduction in deferred
commissioning costs. These costs are amortized using the units-of-production method over the life of
the mine, commencing on the date of commercial service.
Significant payments related to the acquisition of land and mineral rights are capitalized as incurred.
Prior to acquiring such land or mineral rights the Company makes a preliminary evaluation to determine
that the property has significant potential to develop an economic ore body. The time between initial
acquisition and full evaluation of a property’s potential is dependent on many factors including: location
relative to existing infrastructure, the property’s stage of development, geological controls and metal
prices. If a mineable ore body is discovered, such costs are amortized when production begins. If no
mineable ore body is discovered, such costs are expensed in the period in which it is determined the
property has no future economic value. In countries where we have paid Value Added Tax (“VAT”) and
where there is uncertainty of its recoverability, the VAT payments will be deferred with mineral property
costs relating to the property or expensed if the exploration costs have been expensed according to our
policy. If we ultimately recover amounts that have been deferred, the amount received will be applied
to reduce mineral property costs or taken as a credit against current expenses depending on the prior
treatment.
j) Asset Impairment
Management reviews and evaluates its long-lived assets for impairment when events or changes
in circumstances indicate that the related carrying amounts may not be recoverable. Impairment
is considered to exist if total estimated future cash flows or probability-weighted cash flows on an
undiscounted basis are less than the carrying amount of the assets, including mineral property,
plant and equipment and producing and non-producing properties. An impairment loss is measured
and recorded based on discounted estimated future cash flows or the application of an expected
present value technique to estimate fair value in the absence of a market price. Future cash flows
are based on recoverable proven and probable reserves and a portion of recoverable resources, silver,
zinc, copper, lead and gold prices (considering current and historical prices, price trends and related
factors), production levels, capital and reclamation costs, all based on detailed engineering life-of-mine
plans. Assumptions underlying future cash flow estimates are subject to risks and uncertainties. Any
60
60
61
61
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
differences between significant assumptions and market conditions and/or the Company’s performance
could have a material effect on any impairment provision, and on the Company’s financial position
and results of operations. In estimating future cash flows, assets are grouped at the lowest levels for
which there are identifiable cash flows that are largely independent of cash flows from other groups.
Generally, in estimating future cash flows, all assets are grouped at a particular mine for which there
is identifiable cash flow.
k) Asset Retirement Obligation
The fair value of an obligation associated with the retirement of a tangible long-lived asset is recorded
in the period in which it is incurred and a reasonable estimate of the fair value can be made, with a
corresponding increase to the carrying amount of the related asset. The liability is accreted over time for
changes in the fair value of the liability through charges, which is included in depletion, depreciation
and accretion expense. The costs capitalized to the related assets are amortized in a manner consistent
with the depletion and depreciation of the related assets.
l) Inventories
Effective January 1, 2008, the Company adopted CICA Handbook Section 3031, “Inventories”, which
replaces Section 3030, “Inventories”. The new section establishes standards for the measurement
and disclosure of inventories, including the determination of cost and its subsequent recognition as
an expense, including any write-down to net realizable value. It also provides guidance on the cost
formulas that are used to assign costs to inventories. The adoption of this standard did not have a
material impact on the consolidated financial statements.
Ore stockpile and finished goods inventories are valued at the lower of production cost and net
realizable value. Materials and supplies are valued at the lower of average cost and net realizable
value. Production costs include all mine site costs.
m) Income Taxes
The Company uses the asset and liability method of accounting for income taxes in accordance to the
CICA Handbook Section 3465 “Income Taxes”. Under the asset and liability method, future tax assets
and liabilities are recognized for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their respective tax bases.
Future tax assets and liabilities are measured using substantively enacted tax rates expected to apply
to taxable income in the years in which those temporary differences are expected to be recovered or
settled. The effect on future tax assets and liabilities of a change in tax rates is recognized in income
in the year that includes the date of substantive enactment. Future tax assets are recognized to the
extent that they are considered more likely than not to be realized.
n) Stock-based Compensation
The Company has a share option plan which is described in Note 14. The Company records all stock-
based compensation relating to options granted using the fair value method such that stock-based
payments are measured at fair value and expensed over their vesting period with a corresponding
increase to contributed surplus. Upon exercise of share purchase options, the consideration paid by
the option holder, together with the amount previously recognized in contributed surplus, is recorded
as an increase to share capital.
62
62
63
63
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
02. SIGNIFICANT
ACCOUNTING
POLICIES
(continued)
o) Basic and Diluted Loss Per Share
Basic loss per share (“LPS”) is calculated by dividing the net loss applicable to common shareholders
by the weighted average number of common shares outstanding for the year. Potentially dilutive
outstanding options and warrants are excluded from the calculation of LPS, as they would be anti-
dilutive.
p) Foreign Currency Translation
The Company’s subsidiaries are accounted for as integrated foreign operations. Monetary items
denominated in a foreign currency are translated into Canadian dollars at exchange rates prevailing at
the balance sheet date and non-monetary items are translated at exchange rates prevailing when the
assets were acquired or obligations incurred. Foreign currency denominated revenue and expense items
are translated at the exchange rates prevailing at the transaction date. Foreign currency transaction
gains and losses are included in the determination of net income or loss.
q) Financial Instruments
The Company applies as prescribed Section 3855, “Financial Instruments – Recognition and
Measurement”. CICA Standard 3855 establishes standards for recognizing and measuring financial
assets, financial liabilities, and non-financial derivatives. Under CICA 3855, all financial assets must
be classified as either held-for-trading, available-for-sale, held-to-maturity investments or loans and
receivables. All financial liabilities must be classified as held-for-trading or other financial liabilities.
All financial instruments, including derivatives, are included on the Consolidated Balance Sheets and
are measured at fair value, except for held-to-maturity investments, loans and receivables which are
long-term, and other financial liabilities which are long-term, and these are all measured at amortized
cost. The carrying value of receivables, and accounts payable and accrued liabilities approximate their
fair value because of the short-term maturity of those instruments. Subsequent measurements and
recognition of changes in fair value depend on the instrument’s initial classification. Held-for-trading
financial instruments are measured at fair value, and all gains and losses are included in net income
(loss) in the period in which they arise. Available- for-sale financial instruments are measured at fair
value, determined by published market prices in an active market, except for investments in equity
instruments that do not have quoted market prices in an active market which are measured at cost.
Changes in fair value are recorded in other comprehensive income (loss) until the assets are removed
from the balance sheet. Investments classified as available-for-sale are written down to fair value through
income whenever it is necessary to reflect other than-temporary impairment. Realized gains and losses
on the disposal of available-for-sale securities are recognized in investment and other income. Also,
transaction costs related to all financial assets and liabilities are recorded in the acquisition or issue
cost, unless the financial instrument is classified as held-for-trading, in which case the transaction
costs are recognized immediately in net income (loss).
CICA Section 3855 also requires financial and non-financial derivative instruments to be measured at
fair value and recorded as either assets or liabilities. Certain derivatives embedded in non-derivative
contracts must also be measured at fair value. Any changes in the fair value of recognized derivatives
are included in net income (loss) for the period in which they arise, unless specific hedge accounting
criteria are met, as defined in CICA Section 3865. The same accounting treatment applied to these
non-financial derivative contracts prior to the adoption of CICA Section 3855. Fair values for the
Company’s recognized commodity-based derivatives are based on the forward prices of the associated
market index.
62
62
63
63
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
The Company has designated each of its significant categories of financial instruments as of January
1, 2007 as follows:
Financial Instrument
Cash and cash equivalents
Accounts receivable
Derivatives
Long term receivables
Long term investments
Accounts payable and accrued liabilities
Long term liability
Classification
Held for trading
Loans and receivable
Held for trading
Loans and receivable
Available for sale
Other liabilities
Other liabilities
Measurement
Fair value
Fair value
Fair value
Amortized cost
Fair value
Fair value
Amortized cost
r) Derivatives and Trading Activities
The Company employs metals and currency contracts, including forward contracts to manage exposure
to fluctuations in metal prices and foreign currency exchange rates. For metals production, these
contracts are intended to reduce the risk of falling prices on the Company’s future sales. Foreign
currency derivative financial instruments, such as forward contracts are used to manage the effects
of exchange rate changes on foreign currency cost exposures. Changes in the fair value of derivative
instruments are reported in income or accumulated other comprehensive income (“AOCI”), depending
on the use of the derivative and whether it qualifies for hedge accounting treatment under the provisions
of CICA 3865, “Hedges”. Unrealized gains and losses on derivative instruments qualifying as cash flow
hedges are recorded in AOCI to the extent the hedges are effective, until the underlying transactions
are recognized in the Consolidated Statement of Operations.
The ineffective portions of cash flow hedges are recognized in income immediately. All derivative
instruments are recorded on the balance sheet at fair value. Unrealized gains and losses on derivative
instruments that do not qualify or are not designated as hedges are marked to market at the end of each
accounting period with the results included in gain or loss on commodity and foreign currency contracts
in the Consolidated Statement of Operations.
Derivatives may be embedded in other financial instruments (host instruments). Embedded derivatives
are treated as separate derivatives when their economic characteristics and risks are not closely related
to those of the host instrument, the terms of the embedded derivative are the same as those of a
standalone derivative, and the combined contract is not classified as held for trading. These embedded
derivatives are measured at fair value on the balance sheet with subsequent changes in fair value
recognized in income. The Company selected January 1, 2003 as its transition date for embedded
derivatives. The Company has not identified any embedded derivatives that are required to be accounted
for separately from the host contract.
s) Risk Management
Interest rate risk
The Company holds cash and cash equivalents which earn interest at variable rates as determined by
financial institutions.
64
64
65
65
02. SIGNIFICANT
ACCOUNTING
POLICIES
(continued)
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
Credit risk
The Company only places its cash with major financial institutions.
Foreign currency risk
The Company is exposed to currency risk in that its subsidiary operations are transacted in Peruvian
Nuevo Soles, Mexican Pesos and the U.S. dollar. The Canadian dollar value of the assets and liabilities of
the subsidiary denominated in these three currencies will fluctuate due to changes in foreign exchange.
The Company does not use any hedging instruments to reduce its foreign currency exposure.
t) Capital Disclosures
Effective January 1, 2008, the Company adopted CICA Handbook Section 1535 – Capital Disclosures.
Section 1535 establishes standards for disclosing information about an entity’s capital and how it is
managed. These standards require an entity to disclose the following:
its objectives, policies and processes for managing capital;
i.
ii.
summary quantitative data about what the Company views as capital;
iii. whether during the period, it complied with any externally imposed capital requirements to
which it is subject;
iv. when the entity has not complied with such requirement, the consequences of such
non-compliance.
The Company has included the disclosures recommended by the new Handbook section in Note 20 to
these consolidated financial statements.
u) Financial Instruments – Presentation and Disclosure
Effective January 1, 2008, the Company adopted CICA Handbook Sections 3862 “Financial Instruments
- Disclosures” and Section 3863 “Financial Instruments - Presentation”. These standards replace CICA
3861, Financial Instruments – Disclosure and Presentation. They increase the disclosures currently
required, which will enable users to evaluate the significance of financial instruments for an entity’s
financial position and performance, including disclosures about fair value. In addition, disclosure
is required of qualitative and quantitative information about exposure to risks arising from financial
instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk.
The quantitative disclosures must provide information about the extent to which the entity is exposed
to risk, based on information provided internally to the entity’s key management personnel.
The Company has included the disclosures recommended by the new Handbook section in Note 21 to
these consolidated financial statements.
v) Comprehensive Income
Effective January 1, 2007, the Company adopted CICA Handbook Section 1530 Comprehensive
Income. Comprehensive income is the change in net assets that results from transactions, events
and circumstances from sources other than the Company’s shareholders and includes items that
would not normally be included in net earnings such as unrealized gains or losses on available-for-sale
investments. Other comprehensive income includes the holding gains and losses from available for-sale
securities which are not included in net income (loss) until realized.
64
64
65
65
03. RECENT
RELEASED CANADIAN
ACCOUNTING
STANDARDS
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
The Company has assessed new and revised accounting pronouncements that have been issued that
are not yet effective and determined that the following may have an impact on the Company:
Goodwill and Intangible Assets (Section 3064)
In February 2008, the CICA issued section 3064, “Goodwill and Intangible Assets”, which
replaces Section 3062, “Goodwill and Intangible Assets,” and CICA Section 3450, “Research
and Development Costs,” and CICA Section 1000, “Financial Statement Concepts.” The standard
intends to reduce the differences with International Financial Reporting Standards (“IFRS”) in the
accounting for intangible assets and results in closer alignment with U.S. GAAP. Under current
Canadian standards, more items are recognized as assets than under IFRS or U.S. GAAP. The
objectives of CICA Section 3064 are to reinforce the principle-based approach to the recognition
of assets only in accordance with the definition of an asset and the criteria for asset recognition;
and clarify the application of the concept of matching revenues and expenses such that the
current practice of recognizing assets that do not meet the definition and recognition criteria are
eliminated. The standard will also provide guidance for the recognition of internally developed
intangible assets (including research and development activities), ensuring consistent treatment
of all intangible assets, whether separately acquired or internally developed. This standard will
be effective for fiscal years beginning on or after October 1, 2008. The Company is currently
evaluating the impact of adopting this standard in 2009.
International Financial Reporting Standards (“IFRS”)
In 2006, the Canadian Accounting Standards Board (“AcSB”) published a new strategic plan
that will significantly affect financial reporting requirements for Canadian companies. The AcSB
strategic plan outlines the convergence of Canadian GAAP with IFRS over an expected five year
transitional period. In February 2008 the AcSB announced that 2011 is the changeover date for
publicly-listed companies to use IFRS, replacing Canadian GAAP. This date is for interim and
annual financial statements relating to fiscal years beginning on or after 1 January 2011. The
Company will begin reporting its financial statements in accordance with IFRS on January 1,
2011, with comparative figures for 2010.
The adoption date of January 1, 2011 will require the restatement, for comparative purposes, of
amounts reported by the Company for its year ended December 31, 2010, and of the opening
balance sheet as at January 1, 2010.
The Company has begun planning its transition to IFRS but the impact on its consolidated
financial position and results of operations has not yet been determined. The process will consist
of three phases: Scoping and Diagnostics, Analysis and Development, and Implementation and
Review. The Company has begun the first phase which includes a diagnostic assessment of
its current accounting policies systems and processes in order to identify differences between
current Canadian GAAP and IFRS treatment. The Company will continue to monitor changes in
IFRS during implementation process and intends to update the critical accounting policies and
procedures to incorporate the changes required by converting to IFRS and the impact of these
changes on its financial reporting.
66
66
67
67
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
03. RECENT
RELEASED CANADIAN
ACCOUNTING
STANDARDS
(continued)
04. DERIVATIVES
Business Combinations
In January 2009, the CICA issued Section 1582, Business Combinations, Section 1601, Consolidations,
and Section 1602, Non-controlling Interests. These new standards are harmonized with International
Financial Reporting Standards (IFRS). Section 1582 specifies a number of changes, including: an
expanded definition of a business, a requirement to measure all business acquisitions at fair value, a
requirement to measure non-controlling interests at fair value, and a requirement to recognize acquisition-
related costs as expenses. Section 1601 establishes the standards for preparing consolidated financial
statements. Section 1602 specifies that non-controlling interests be treated as a separate component
of equity, not as a liability or other item outside of equity. The new standards will become effective in
2011 but early adoption is permitted. The Company is evaluating the attributes of early adoption of this
standard and its potential effects if events or transactions occurred that this standard applies to.
During October 2007, the Company entered into a series of put and call option commodity arrangements
to secure a minimum price level on part of its zinc and lead metal production throughout the period
November 2007 to December 2008. A long put and a long call refers to put and call options that
have been bought by the Company, and a short call refers to call options that have been sold by the
Company. Settlement of these options occurs monthly during the period from December 2007 until
January 2009. No initial premium associated with these trades has been paid. The counterparty is
Standard Bank PLC.
The following Zinc Asian Option contracts were entered into:
• 14 Long put options at strike price:
• 14 Short call options at strike price:
• 14 Long call options at strike price:
USD 2,575/t, for the total of 2,800 tons
USD 2,750/t, for the total of 2,800 tons
USD 3,450/t, for the total of 2,800 tons
The following Lead Asian Option contracts were entered into:
• 14 Long put options at strike price:
• 14 Short call options at strike price:
• 14 Long call options at strike price:
USD 3,000/t, for the total of 1,750 tons
USD 3,300/t, for the total of 1,750 tons
USD 4,300/t, for the total of 1,750 tons
As at December 31, 2008 the Company had 1 open position on each of these arrangements.
During January 2008 the Company entered into additional derivative contracts spread out evenly over
the period from February 2008 to January 2009.
The following Lead Asian Option contracts were entered into:
• 12 Long put options at strike price:
• 12 Short call options at strike price:
• 12 Long call options at strike price:
USD 2,200/t, for the total of 1,025 tons
USD 2,750/t, for the total of 1,025 tons
USD 3,750/t, for the total of 1,025 tons
As at December 31, 2008 the Company had 1 open position on each of these arrangements.
The following Zinc Forward sale contracts were entered into on a SWAP basis as defined below:
• 12 Forward contracts:
USD 2,360/t, for the total of 1,700 tons
The SWAP basis contract is settled against the arithmetic average of zinc spot prices over the month
in which the contract matures.
66
66
67
67
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
As at December 31, 2008, the Company had 1 open position on each of these arrangements.
Additionally, the Company will occasionally enter into forward lead and zinc contracts with banks to fix
the final settlement price of metal delivered in concentrates, where the final settlement price is yet to
be set at a future quotational period according to contract terms.
The estimated fair value of the outstanding derivative contracts of $1,734 was determined with reference
to the published market prices for underlying commodities quoted at London Metal Exchange. The
change in estimated fair value with respect to the amount recorded at December 31, 2007 has been
recorded as a gain on commodity contract of $4,521 as at December 31, 2008.
05. ACCOUNTS
RECEIVABLE AND
PREPAID EXPENSES
Trade accounts receivable
Advances and other receivables
Prepaid expenses and deposits
December 31, 2008
$ -
2,080
201
2,281
$
December 31, 2007
$ 409
1,505
137
2,051
$
Advances and other receivables include prepaid income tax of $740 and the $125 short-term portion
of the long-term receivable.
06. INVENTORIES
Inventories consist of the following:
Stockpile ore
Concentrate inventory
Materials and supplies
December 31, 2008
$
$
110
394
1,608
2,112
December 31, 2007
466
$
159
1,068
1,693
$
07. LONG TERM
INVESTMENT AND
RECEIVABLE
At December 31, 2008 and 2007 the Company had an investment in 3,706,250 shares of Continuum
Resources Ltd. With the adoption of financial instruments standards, the Company measures these
investments at fair value. The fair value was determined based on published share prices of underlying
securities on the active market. On adoption of financial instruments standards, a cumulative
adjustment was recorded in other comprehensive income to reflect the change in accounting policy.
Fair value
Cost
Unrealized (loss) gain (cumulative)
December 31, 2008
$
$
111
741
(630)
December 31, 2007
908
$
741
167
$
The Company has additionally granted a loan of $3,670 to Continuum Resources Ltd. under the terms
of the agreement by which Fortuna will acquire all of the issued and outstanding shares of Continuum.
This amount has been used by Continuum to meet its share of the San Jose project capital contributions
as well as general corporate expenditures.
68
68
69
69
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
08. PROPERTY,
PLANT & EQUIPMENT
Property, plant and equipment are comprised of the following:
Land
Machinery & equipment
Buildings
Furniture & other equipment
Transport units
Equipment under capital lease
Work in progress
Land
Machinery & equipment
Buildings
Furniture & other equipment
Transport units
Equipment under capital lease
Work in progress
December 31, 2008
Accumulated
Depreciation
-
2,084
736
267
208
264
-
3,559
$
$
December 31, 2007
Accumulated
Depreciation
-
1,034
409
104
75
71
-
1,693
$
$
Net book value
283
7,535
3,434
1,192
434
1,711
1,656
16,245
Net book value
259
7,188
2,580
808
449
964
1,421
13,669
$
$
$
$
Cost
283
9,619
4,170
1,459
642
1,975
1,656
19,804
Cost
259
8,222
2,989
912
524
1,035
1,421
15,362
$
$
$
$
09. MINERAL
PROPERTIES
Mineral properties are located in Peru and Mexico and are comprised of the following:
Caylloma, Peru
San Jose, Mexico
Caylloma, Peru
San Jose, Mexico
Other
Cost
40,249
41,342
81,591
Cost
31,063
26,070
12
57,145
$
$
$
$
December 31, 2008
Depletion
8,748
-
8,748
$
$
December 31, 2007
Depletion
4,795
-
-
4,795
$
$
Write-off
-
349
349
Write-off
-
-
12
12
$
$
$
$
Net
31,501
40,993
72,494
Net
26,268
26,070
-
52,338
$
$
$
$
Additions to mineral properties are comprised of development and exploration costs capitalized and
consist of $9,906 at Caylloma and $15,272 at San Jose properties for the year ended December 31,
2008. In addition, there was a revision to the estimate for the asset retirement obligation for Caylloma
which resulted in a decrease of $720 to the cost of the mineral property. Included in the additions
for the San Jose property is the acquisition of the Monte Alban II concession. This was acquired for a
68
68
69
69
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
total of US$1,900 and consists of a payment of US$1,100 made in May 2008 and a future payment
of US$800 to be made in May 2012. The present value of the US$800 is $720 (US$589) (Note 12).
This will be accreted monthly with the accretion amount being capitalized to the mineral property (Note
12). Also included in additions to San Jose mineral properties are depreciation of equipment involved
in construction work of $222 (2007: $57), and costs to develop the mine of $1,328 (2007: $929).
San Jose Project, Mexico
Cuzcatlan has been accounted for as a variable interest entity, as defined in CICA Accounting Guideline
15 “Consolidation of Variable Interest Entities” and has been consolidated from the date of acquisition.
A non-controlling interest of $11,013 has been recorded as at December 31, 2008 (December 31,
2007 - $6,593).
The San Jose Project is owned and operated by Compañia Minera Cuzcatlan (“Cuzcatlan”), a company
owned 76% by the Company and 24% by Continuum Resources Ltd. (“Continuum”). The Company
is the operator of the work programs and the Company and Continuum must contribute to the costs
thereof in proportion to its ownership percentage in Cuzcatlan.
10. RELATED PARTY
TRANSACTIONS
The Company incurred charges from directors, officers, and companies having a common director or
officer as follows:
Mineral property costs – geological fees
Consulting fees
Salaries and wages
Year ended
December 31,
2008
-
66
110
$
Year ended
December 31,
2007
45
188
108
$
These charges were measured at the exchange amount, which is the amount agreed upon by the
transacting parties.
At December 31, 2008, due to related parties consists of $47 (December 31, 2007 - $14) owing to
an officer and to companies with a common director. These amounts were incurred as a result of shared
administrative costs. These amounts are unsecured, non-interest bearing and payable in the normal
course of business.
70
70
71
71
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
11. LEASES AND
LONG-TERM
LIABILITIES
Obligations under capital lease
The following is a schedule of the Company’s capital lease obligations. These are related to the
acquisition of mining equipment, vehicles and buildings.
Interest Rate
Maturity Date
8.50%
9.29%
8.20%
8.66%
8.34%
8.20%
9.12%
8.49%
8.49%
2009
2009
2009
2010
2010
2010
2011
2011
2010
Banco Interamercano de Finanzas
Scotiabank
Scotiabank
Scotiabank
Scotiabank
Scotiabank
Interbank
Scotiabank
Scotiabank
Lease payments
Less current amount
Long-term liability
Long-term liability at inception
Less: adjustment to amortized cost
Fair value of liability at inception measured at amortized cost
Add foreign exchange revaluation
Add accretion to period end
Less payments
Liability at December 31, 2008
Less: current portion of long-term liability
December 31,
2008
46
17
163
276
32
653
303
85
135
1,710
(834)
876
December 31,
2008
992
(269)
723
168
50
(30)
911
(98)
813
$
$
$
$
$
December 31,
2007
82
28
252
335
37
138
-
-
-
872
(439)
433
December 31,
2007
-
-
-
-
-
-
-
-
-
$
$
$
$
$
In November 2007, Bateas acquired the Minera Condor II and the Minera Condor III concessions
for US$250. US$50 was paid at the signing of the contract; payments of US$30 are required to be
paid every six months for a total of five payments; and US$50 is required to be paid November 2010.
These payments are non-interest bearing and all debt relating to the acquisition of the mineral resource
property has been recognized as at December 31, 2008.
In May 2008, Cuzcatlan acquired the Monte Alban II concession (Note 9) and this includes a payment
of $978 (US$800) due May 2012. This payment is non-interest bearing all debt relating to the
acquisition of the mineral resource property has been recognized as at December 31, 2008.
70
70
71
71
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
Principal minimum repayment terms will be:
$
2009
2010
2011
2012
110
98
-
978
Contingent liability
Interbank bank, a third party, has established a bank letter of guarantee on behalf of Minera Bateas
in favor of the Peruvian mining regulatory agency in compliance with local regulation associated with
the approval procedures of Minera Bateas’ mine closure plan, for the sum of $734 (US$600). This
letter is available against first and simple demand and expires on April 27, 2009. At this point it will
be renewed until the end of 2009 when a new guarantee will be set up according to an approved mine
closure plan for an amount corresponding to the work to be executed during 2010. This amount is yet
to be established but it is expected to be less than the current guarantee.
12. ASSET
RETIREMENT
OBLIGATION
The Company has recorded an asset retirement obligation of $1,304 as of December 31, 2008 consisting
of accretion of the previously recorded asset retirement obligation of $1,916 as of December 31, 2007
by $108 and a reduction in the estimated amount of the asset retirement obligation of $720. The
accretion expense was calculated over the year using a rate of 9%. The initial amount was based on an
estimate prepared by an independent third party at the time of acquisition as to the cost of reclamation
associated with the Caylloma property. The Company has reviewed its reclamation obligations at the
property in light of changing regulations and on the basis of further data in respect of the mine life and
has made a reduction in the estimated amount of the asset retirement obligation of $720.
In view of the uncertainties concerning environmental reclamation, the ultimate cost of reclamation
activities could differ materially from the estimated amount recorded. The estimate of the Company’s
asset retirement obligation relating to the Caylloma mine is subject to change based on amendments to
laws and regulations and as new information regarding the Company’s operations becomes available.
Future changes, if any, to the estimated liability as a result of amended requirements, laws, regulations,
operating assumptions, estimated timing and amount of obligations may be significant and would be
recognized prospectively as a change in accounting estimate. Any such change would result in an
increase or decrease to the liability and a corresponding increase or decrease to the mineral property,
plant and equipment balance.
72
72
73
73
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
13. INCOME TAX
a)
Income tax expense differs from the amount that would be computed by applying the Canadian
statutory income tax rate of 31.00% (2007 – 34.12%) to loss before income taxes and non-
controlling interest. The reasons for the differences are as follows:
Income before income taxes and non-controlling interest
Statutory income tax rate
$
2008
727
31.00%
Expected income tax
Items non-deductible (deductible) for income tax purposes
Difference between Canadian and foreign tax rates
Change in income tax rates
Change in future tax assets and liabilities due to changes in foreign exchange
Change in valuation allowance
Total income taxes
$
$
Represented by:
Current income tax
Future income tax
$
$
225
757
202
218
151
246
1,799
-
1,799
1,799
2007
1,380
34.12%
471
(74)
3,202
-
-
662
4,261
544
3,717
4,261
$
$
$
$
$
b) The tax effects of temporary differences that give rise to significant portions of the future tax
assets and future tax liabilities at December 31, 2008 and December 31, 2007 are presented below:
Future income tax assets:
Non-capital losses
Share issue costs
Unrealized foreign exchange losses and other
Mineral properties and property, plant and equipment
Total future income tax assets
Valuation allowance
Net future income tax assets
Future income tax liabilities:
Mineral properties – Peru
Mineral properties – Mexico
Unrealized foreign exchange gains and other
$
$
2008
2,695
431
333
1,542
5,001
(2,619)
2,382
(10,391)
(2,131)
(1,367)
(13,889)
2007
1,275
657
-
441
2,373
(2,373)
-
(5,910)
(2,136)
(23)
(8,069)
Net future income tax (liabilities)
$
(11,507)
$
(8,069)
72
72
73
73
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
The Company has non-capital loss carry-forwards that will expire if unused of $8,895 that may be
available for tax purposes. The loss carry-forwards expire as follows:
Non-capital losses, expiring as follows:
2009
2013
2014
2016
2017
2025
2026
2027
2028
No expiry
$
$
Canada
104
122
698
-
-
985
466
2,437
546
-
5,358
$
Peru
-
-
-
-
-
-
-
-
-
3,304
3,304
Mexico
-
-
-
17
216
-
-
-
-
-
233
A full valuation allowance has been recorded against the majority of the potential future income tax
assets associated with the Canadian loss carry-forwards as their utilization is not considered more likely
than not at this time.
14. SHARE CAPITAL
a) Authorized: Unlimited common shares without par value
Balance, December 31, 2006
Exercise of options
Exercise of warrants
Private placement for cash
Private placement commission non-cash transaction (Note 18)
Transfer of contributed surplus on exercise of options
Less issue costs (non-cash amount $802)
Number of shares
46,587,728
$
1,753,600
14,214,035
18,000,000
422,300
-
-
Amount
43,341
1,957
21,057
34,200
802
1,289
(2,487)
Balance, December 31, 2007
80,977,663
$
100,159
Exercise of options
Exercise of warrants
Transfer of contributed surplus on exercise of options
31,400
4,322,596
-
38
7,997
27
Balance – December 31, 2008
85,331,659
$
108,221
74
74
74
75
75
75
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
14. SHARE CAPITAL
(continued)
b) Stock Options
A summary of stock options granted and exercised under the Company’s stock option plan is as
follows:
Year ended December 31, 2008
Weighted
Average
Exercised Price
2.24
1.03
1.22
-
2.77
1.87
Number of
Options
6,686,400
2,655,000
(31,400)
-
(1,576,000)
7,734,000
$
$
Year ended December 31, 2007
Weighted
Average
Exercised Price
1.62
2.82
1.48
2.56
-
2.24
Number of
Options
3,765,000
4,355,000
(1,321,100)
(112,500)
-
6,686,400
$
$
Outstanding, beginning of period
Granted
Exercised
Expired
Forfeited
Outstanding, end of period
The following stock options were outstanding at December 31, 2008:
Number of shares
29,000
30,000
250,000
270,000
250,000
60,000
200,000
35,000
245,000
860,000
225,000
20,000
50,000
110,000
780,000
50,000
15,000
50,000
50,000
50,000
1,175,000
250,000
25,000
250,000
150,000
1,405,000
850,000
7,734,000
Exercise Price $
0.37
0.80
2.82
1.35
2.29
1.75
1.75
0.85
1.55
1.66
1.61
1.90
1.96
0.85
2.22
2.75
0.85
0.85
0.85
0.85
3.22
2.97
0.85
2.52
1.25
0.85
0.85
Expiry Date
December 2, 2009
July 24, 2010
October 9, 2010
February 5, 2016
March 30, 2016
May 8, 2016
May 22, 2016
July 5, 2016
July 5, 2016
July 10, 2016
September 13, 2016
November 20, 2016
November 23, 2016
January 11, 2017
January 11, 2017
February 6, 2017
April 22, 2017
May 31, 2017
June 27, 2017
July 2, 2017
July 2, 2017
September 23, 2017
October 24, 2017
February 5, 2018
August 25, 2018
October 5, 2018
November 5, 2018
74
74
74
75
75
75
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
During the year, a total of 430,000 stock options were amended, whereby the exercise price was reduced
to $0.85 from $1.55, $2.22, $2.75, $3.05, $3.09, $3.10 and $3.22. The Company calculated the
incremental increase in the fair value of these amended options to be $76,019 which was charged to
operations.
5,404,000 options have vested as at December 31, 2008. The average remaining life of the outstanding
options at December 31, 2008 is 8.6 years.
c) Warrants
A summary of share purchase warrants issued and exercised is as follows:
Number of
Warrants
Year ended December 31, 2008
Weighted
Average
Exercise Price
1.89
-
1.85
2.30
1.86
16,479,375
-
(4,322,596)
(1,093,424)
11,063,355
$
$
Number of
Warrants
Year ended December 31, 2007
Weighted
Average
Exercise Price
1.23
2.30
1.44
-
1.89
20,566,185
10,559,725
(14,646,535)
-
16,479,375
$
$
Outstanding, beginning of period
Issued
Exercised
Expired
Outstanding, end of period
The following share purchase warrants were outstanding at December 31, 2008:
Number of warrants
862,117
1,613,238
8,588,000 *
11,063,355
Exercise Price $
0.345
0.345
2.300
Expiry Date
June 27, 2010
November 17, 2010
July 11, 2009
* During the year, the expiry date for these warrants was extended from July 11, 2008 to July 11, 2009.
d) Stock-Based Compensation
The Company has established a formal stock option plan in accordance with the policies of the TSX
Venture Exchange under which it is authorized to grant options up to 10% of its outstanding shares to
officers, directors, employees and consultants. The exercise price of each option must not be less than
the closing market price of the Company’s shares on the trading day immediately prior to the date of
grant. The options are for a maximum term of ten years.
76
76
77
77
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
14. SHARE CAPITAL
(continued)
The Company uses the fair value based method of accounting for share options granted to consultants,
directors, officers and employees. The non-cash compensation charge of $1,428 recognized for the year
ended December 31, 2008 (December 31, 2007: $6,974) is associated with the granting of options
to a consultant, directors and employees. These compensation charges have been determined under
the fair value method using the Black-Scholes option pricing model with the following assumptions:
Risk-free interest rate
Expected stock price volatility
Expected term in years
Expected dividend yield
Year ended December 31, 2008
2.57% - 3.97%
62% - 78%
2, 3, 5 & 10
0%
Year ended December 31, 2007
4.04% - 4.67%
59% - 68%
5 & 10
0%
Option pricing models require the input of highly subjective assumptions including the estimate of the
share price volatility, risk-free interest rate and expected life of the options. Changes in the subjective
input assumptions can materially affect the fair value estimate, and therefore the existing models do
not necessarily provide a reliable single measure of the fair value of the Company’s stock options.
15. ACCUMULATED
OTHER COMPREHENSIVE
INCOME (LOSS)
Balance at December 31, 2006
Cumulative impact of accounting changes, net of tax
Adjusted balance January 1, 2007
Unrealized (loss) on available-for-sale long term investment, net of tax
Balance at December 31, 2007
Unrealized (loss) on available-for-sale long term investment
Balance at December 31, 2008
$
$
-
449
449
(305)
144
(774)
(630)
No future income tax asset has been recorded as a result of this accumulated other comprehensive loss
because it is not considered more likely than not that the potential benefits will be realized.
16. SEGMENTED
INFORMATION
The Company is currently engaged in mining and the development of mineral properties. Details on a
geographical basis are as follows:
Canada
Peru
Mexico
Other
Total
Year ended December 31, 2008
Revenue
Operating (loss) income
As at December 31, 2008
Property, plant & equipment
Total assets
Year ended December 31, 2007
Revenue
Operating (loss) income
As at December 31, 2007
Property, plant & equipment
Total assets
$
$
$
$
$
$
$
$
-
(4,548)
5
30,657
-
(8,836)
7
40,273
$
$
$
$
$
$
$
$
26,339
(1,003)
11,133
56,401
31,667
8,972
9,252
49,297
$
$
$
$
$
$
$
$
-
(349)
5,104
50,560
-
-
4,407
34,155
$
$
$
$
$
$
$
$
-
(25)
$
$
26,339
(5,925)
3
3,454
$
16,245
$ 141,072
-
(29)
3
721
$
$
31,667
107
$
13,669
$ 124,446
76
76
77
77
17. SUPPLEMENTARY
DISCLOSURE OF
NON-CASH
TRANSACTIONS
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
Investing and financing activities that do not have a direct impact on current cash flows are excluded
from the statements of cash flows.
Cash and cash equivalents consists of:
Cash
Term deposits
The following non-cash transactions occurred:
Purchase of resource property on a deferred payment plan
Sale of equipment for a long-term receivable
Fair value of options exercised
Shares issued for commission on private placement
Purchase of equipment on a deferred payment plan
Fair value of options exercised
December 31, 2008
2,518
$
33,499
36,017
$
December 31, 2007
8,809
$
38,431
47,240
$
Number of shares
-
-
-
Number of shares
422,300
-
-
Year ended
December 31, 2008
Amount
$
911
151
27
Year ended
December 31, 2007
Amount
$
802
847
1,289
18. COMMITMENTS
AND CONTINGENCIES
On May 6, 2008, after renegotiating the existing option agreement on the Monte Alban II concession
surrounding the San Jose project, Compañia Minera Cuzcatlan SA closed the purchase of a direct
100% interest on this property (Note 10). The purchase price consisted of US$1,100 paid upon
closing, and an additional US$800 payment due by May 2012 (Note 11).
The Company has a contract with one customer who purchases the full production of the year 2008
from the Company’s operating Caylloma mine. Under the contract, the Company is committed to supply
8,700 wet metric tons of lead concentrate and 17,000 wet metric tons of zinc concentrate. As at
December 31, 2008, the Company fulfilled this commitment.
The Company has a contract to guarantee power supply at its Caylloma mine. Under the contract
the seller is obligated to deliver a “maximum committed demand” (for the present term this stands
at 2,800 Kw) and Bateas is obligated to purchase subject to exemptions under provisions of “Force
Majeure”. The contract is automatically renewed every two years for a period of 10 years. Renewal can
be avoided without penalties by notifying 10 months in advance of renewal date. Tariffs are established
yearly by energy market regulator in accordance with applicable regulations in Peru.
The Company acts as guarantor to capital lease obligations held by two of its mining contractors. These
capital lease contracts are related to the acquisition of mining equipment deployed at the Caylloma
mine. As at December 31, 2008 these obligations amounted to US$1,330 and mature in 2010.
78
78
79
79
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
18. COMMITMENTS
AND CONTINGENCIES
(continued)
Environmental Matters
The Company’s mining and exploration activities are subject to various laws and regulations governing
the protection of the environment. These laws and regulations are continually changing and are generally
becoming more restrictive. The Company conducts its operations so as to protect the public health and
environment and believes its operations are in compliance with applicable laws and regulations in all
material respects. The Company has made, and expects to make in the future, expenditures to comply
with such laws and regulations, but cannot predict the full amount of such future expenditures.
Estimated future reclamation costs are based principally on legal and regulatory requirements. As
of December 31, 2008 and December 31, 2007, $1.3 million and $1.9 million, respectively, were
accrued for reclamation costs relating to mineral properties in accordance with Section 3110, “Asset
Retirement Obligations”. See Note 12.
Income Taxes
The Company operates in numerous countries around the world and accordingly it is subject to, and
pays annual income taxes under the various income tax regimes in the countries in which it operates.
Some of these tax regimes are defined by contractual agreements with the local government, and others
are defined by the general corporate income tax laws of the country. The Company has historically filed,
and continues to file, all required income tax returns and to pay the taxes reasonably determined to be
due. The tax rules and regulations in many countries are highly complex and subject to interpretation.
From time to time the Company is subject to a review of its historic income tax filings and in connection
with such reviews, disputes can arise with the taxing authorities over the interpretation or application
of certain rules to the Company’s business conducted within the country involved.
Title Risk
Although the Company has taken steps to verify title to properties in which it has an interest, these
procedures do not guarantee the Company’s title. Property title may be subject to, among other things,
unregistered prior agreements or transfers and may be affected by undetected defects.
19. MANAGEMENT
OF CAPITAL RISK
The Company’s objectives when managing capital are to provide shareholder returns through
maximization of the profitable growth of the business and to maintain a degree of financial flexibility
relevant to the underlying operating and metal price risks while safeguarding the Company’s ability to
continue as a going concern.
The Company is not subject to externally imposed capital requirements.
20. MANAGEMENT
OF FINANCIAL RISK
The Company’s financial instruments are exposed to certain financial risks, including currency risk,
credit risk, liquidity risk, interest risk and price risk.
(a) Currency risk
The Company is exposed to the financial risk related to the fluctuation of foreign exchange rates. The
Company operates in Canada, Peru, Mexico and Barbados and a portion of its expenses are incurred
in US dollars, Nuevo Soles, and Mexican Pesos. A significant change in the currency exchange rates
between the Canadian dollar relative to the other currencies could have a material effect on the
Company’s results of operations, financial position or cash flows. The Company has not hedged its
exposure to currency fluctuations.
78
78
79
79
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
At December 31, 2008, the Company is exposed to currency risk through the following assets and
liabilities denominated in US dollars, Nuevo Soles and Mexican Pesos (all amounts are expressed in
thousands of US dollars, thousands of Nuevo Soles or thousands of Mexican Pesos):
Cash and cash equivalents
Derivatives
Accounts receivable
Long-term receivable
Accounts payable and accrued liabilities
Long-term liability
Obligations under capital lease
US Dollars
5,078
1,418
102
114
(2,096)
(876)
(1,399)
December 31, 2008
Nuevo Soles
629
-
10,400
-
(5,281)
-
-
Mexican Pesos
3,864
-
46,460
-
(10,259)
-
-
Based on the above net exposures as at December 31, 2008, and assuming that all other variables
remain constant, a 10% depreciation or appreciation of the Canadian dollar against the US dollar would
result in an increase/decrease of $286 in the Company’s net earnings. Likewise, a 10% depreciation
or appreciation of the Canadian dollar against the Nuevo Soles would result in an increase/decrease
of $224 in the Company’s net earnings and a 10% depreciation or appreciation of the Canadian
dollar against the Mexican Pesos would result in an increase/decrease of $359 in the Company’s net
earnings.
(b) Credit risk
Credit risk is the risk of an unexpected loss if a customer or third party to a financial instrument fails
to meet its contractual obligations. The Company’s cash equivalents are held through large Canadian
and international financial institutions. These investments mature at various dates over the current
operating period. All of the Company’s trade accounts receivables are held with a large international
metals trading company. The Company has a Mexican value added tax of $4,026 as at December 31,
2008, of which a significant portion is past due. Additionally, the Company has Peruvian value added
tax of $2,230. The Company expects to recover the full amounts from the Mexican and Peruvian
Governments.
(c) Liquidity risk
Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall
due. The Company manages liquidity risk by continuing to monitor forecasted and actual cash flows.
The Company has in place a planning and budgeting process to help determine the funds required to
support the Company’s normal operating requirements on an ongoing basis and its development plans.
The Company strives to maintain sufficient liquidity to meet its short term business requirements,
taking into account its anticipated cash flows from operations, its holdings of cash and cash equivalents
and its committed liabilities.
Accounts payable and accrued liabilities, amounts due to related parties and the current portion of
obligations under capital lease are due within the current operating period.
80
80
81
81
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
20. MANAGEMENT
OF FINANCIAL RISK
(continued)
(d) Interest rate risk
Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will
fluctuate because of changes in market interest rates. The risk that the Company will realize a loss as
a result of a decline in the fair value of the amounts in investments with maturities of 90 days or less
included in cash and cash equivalents is limited because these investments, although available for
sale, are generally held to maturity.
(e) Price risk
The Company is exposed to metals price risk with respect to silver, gold, zinc, and lead sold through
its mineral concentrate products. The Company mitigates this risk by implementing price protection
programs for some of its zinc and lead production through the use of derivative instruments. As a
matter of policy the Company does not hedge its silver production.
21. SUBSEQUENT
EVENTS
For the period from January 1, 2009 to March 29, 2009
Acquisition of Continuum Resources Ltd.
On March 6, 2009 the Company closed the acquisition of all the issued and outstanding shares of
Continuum Resources Ltd. Continuum had 124,037,920 shares outstanding as of March 6 and the
Company has issued to the Continuum shareholders a total of 6,995,738 shares, which is an exchange
ratio of approximately 0.0564 of a share of the Company for every one Continuum share held. As
Fortuna held 3,706,250 common shares of the issued and outstanding share capital of Continuum as
at March 6, 2009, those shares were cancelled and Fortuna issued a total of 6,786,706 shares to the
Continuum shareholders other than Fortuna. As a result of the acquisition of Continuum, Fortuna now
owns 100% of the San Jose Project in Oaxaca, Mexico.
The accounting for the acquisition is not yet completed but preliminary estimates have been calculated.
The following calculations assume that the cost of acquisition will comprise the fair value of Fortuna
shares issued, based on the issuance of 6,786,706 Fortuna shares at $0.98 per share for consideration
of $6,651. A valuation date of March 6, 2009 was determined for the share value.
The acquisition is being accounted for as a purchase of assets.
The difference between the purchase consideration and the adjusted book values of Continuum’s
assets and liabilities has been preliminarily assigned to “Mineral properties”. The fair value of all
identifiable assets and liabilities acquired will be determined by a valuation effective March 6, 2009.
Therefore, it is likely that the fair values of assets and liabilities acquired will vary from the amounts
shown and the differences may be material. Additional adjustments reflecting any changes in future
tax assets or liabilities that would result from recording Continuum’s identifiable assets and liabilities
at fair value will be made when the process of estimating the fair value of identifiable assets and
liabilities is complete.
80
80
81
81
FORTUNA SILVER MINES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007
All amounts expressed in thousands of Canadian Dollars, except for share and per share amounts
Purchase price
6,786,706 common shares of Fortuna
Loan to Continuum
Cost of shares previously acquired
Total purchase price
Preliminary estimate of the allocation of purchase price
Cash, accounts receivable and accounts payable
Mineral properties
Property, plant & equipment
Future income tax liability
Net identifiable assets of Continuum
$
$
$
$
6,651
300
185
7,136
(259)
10,260
8
(2,873)
7,136
Derivatives
During January 2009 the Company entered into additional derivative contracts spread out evenly over
the period from February 2009 to July 2009.
The following Zinc Forward sale contract was entered into on a SWAP basis:
• USD 1,240/t, for the total of 3,800 tons
The following Lead Forward sale contract was entered into on a SWAP basis:
• USD 1,109/t, for the total of 3,150 tons
SWAP basis contracts are settled against the arithmetic average of zinc spot prices over the month in
which the contract matures.
Exercise of stock options
Subsequent to December 31, 2008, the Company received $20 from the exercise of 23,000 stock
options.
Reduction of exploration ground at San Jose
In February 2009 the Company made effective a reduction of 8,344 ha out of the approximately
49,000 ha surrounding the San Jose project for which it holds exploration and mining rights. This is
equivalent to a write-down of $1,072. This decision was based on existing geological information and
is part of an effort to prioritize capital expenditures.
Thriving
In a
Changing
Market
83
Head office:
355 Burrard Street, Suite 840
Vancouver, BC
Canada, V6C 2G8
Tel: 604.484.4085
Fax: 604.484.4029
Auditors:
Deloitte & Touche LLP
Chartered Accountants
2800 – 1055 Dunsmuir Street
4 Bentall Centre
P.O. Box 49279
Vancouver, BC
Canada V7X 1P4
Share Transfer Agent:
Computershare
510 Burrard Street, 2nd Floor
Vancouver, BC
Canada, V6C 3B9
Peru Office:
Piso 17. Av. Pardo y Aliaga # 640
San Isidro, Lima - Peru
Tel: 51.1.616.6060
Stock Exchange:
TSXV: FVI
Lima Exchange: FVI
Frankfurt: F4S
Qualified Person
Mr. Miroslav Kalinaj, PGeo, is the
company’s qualified person, as defined
by National Instrument 43-101, and is
responsible for verifying the accuracy of
the technical information in this Annual
Report.
355 Burrard Street, Suite 840
Vancouver, BC
Canada, V6C 2G8
Tel: 604.484.4085
Fax: 604.484.4029
www.fortunasilver.com
TSXV: FVI
Lima Exchange: FVI
Frankfurt: F4S