NIF.UN Noranda Income Fund Annual Report MAR

Transcription

1 NIF.UN Noranda Income Fund Annual Report 2011

2 Noranda Income Fund is an income trust whose units trade on the Toronto Stock Exchange under the symbol NIF.UN. The Noranda Income Fund owns the processing facility and ancillary assets (the Processing Facility ) which are located in Salaberry-de-Valleyfield, Québec. It is the second largest zinc processing facility in North America and the largest zinc processing facility in eastern North America, where the majority of its zinc customers are located. It produces refined zinc metal and various by-products from zinc concentrate purchased from mining operations. The Processing Facility is operated and managed by Canadian Electrolytic Zinc Limited. Contents Highlights 2 Letters to Unitholders 3 Management s Discussion and Analysis 29 Management s Statement of Responsibility 30 Independent Auditors Report 31 Consolidated Statements of Financial Position 35 Notes to the Consolidated Financial Position * All dollar amounts are in Canadian dollars, unless otherwise stated. IBC Corporate Information

3 2011 Highlights Financial Highlights Net Revenues were 12% higher at $303.8 million Adjusted EBIDTA was $97.6 million compared to $81.4 million A long-term refinancing was completed Monthly cash distributions of $ per unit were recommenced in September Debt was reduced by 49% to $98.7 million Operational Highlights The employees of the Processing Facility ratified a new, three-year collective agreement Reduced inventory levels contributed to the $55.3 million decrease in working capital Capital spending to sustain the Processing Facility in good running order totalled $27.3 million Net Revenues $M $303.8m 2010 $271.4 m Adjusted EBITDA* $M $97.6m 2010 $81.4 m $350 $300 $250 $200 $150 $100 $50 $ % $ % $80.0 $60.0 $40.0 $20.0 $- $ * Adjusted Earnings before Distributions to Unitholders, Finance Costs, Income Taxes, Depreciation and Amortization Debt $M $98.7m 2010 $194.7 m Monthly Cash Distributions Re-started September 2011 $ per Priority Unit per month 2010 Nil paid $250 $0.05 $200 $150 49% $0.04 $0.03 $100 $50 $ $0.02 $0.01 $- Jan-10 Mar-10 May-10 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 13MAR Nov-11 ANNUAL REPORT 2011 NORANDA INCOME FUND 1

4 Letters to Unitholders Dear Unitholders, Dear Unitholders, Achievements Achievements I am very pleased to report on the achievements of the Noranda The financial results of 2011 were supported by a strong Income Fund in Our long-term debt was refinanced until operational performance, healthy premiums and strong 2016, and we approved a monthly cash distribution commencing by-product revenues. in September We signed a new, three-year collective agreement with the The Board, under the guidance of the Independent employees at the Processing Facility. This is the ninth Committee, commenced a process to develop a long-term consecutive collective agreement signed without a strike. Good strategy for the Fund beyond the expiry of the Supply and labour relations are fundamental to the Fund s ongoing success. Processing Agreement in A review was undertaken by a During the year, zinc metal and copper in cake inventories highly regarded international consulting Firm to help the Board were lowered which resulted in a reduction in our working capital. assess the ability of the Fund to obtain zinc concentrate in the Zinc refining is capital intensive and we have to invest in the market post In December 2011, the Independent Committee received a preliminary report from the international Processing Facility to keep it in good running order. In 2011, consulting group. capital expenditures totalled $27.3 million, of which $3.2 million The preliminary report indicated that subject to certain major was spent on the cell house rehabilitation project and assumptions, the Processing Facility could operate profitably if $9.2 million on anode replacement. the Fund is able to secure zinc concentrate in the market post The report identified sources of zinc concentrate that Looking Forward would be available post The Board will be utilizing the We are encouraged by the improving economic indicators in our Consultant s findings to determine the best course of action. major market, the United States. Automotive sales continue to The Supply and Processing Agreement expires in May look healthy. However, residential and non-residential Xstrata Canada is required to advise the Partnership of its construction continues to be weak. decision with respect to an extension, if any, beyond 2017 by In spite of slow construction activity, zinc demand is November The Board has taken a prudent approach with expected to steadily build during the first half of 2012 as respect to potential closure costs at the Processing Facility and customers experience better order levels and rebuild their has decided to begin accumulating reserves that would be inventories as the general economic outlook improves. required to pay for such costs, should the Fund be unable to secure concentrate post Our Appreciation and Thanks Notwithstanding the foregoing, and assuming no major sudden changes in the zinc and related by-products markets, I Mario Chapados, the former President and Chief Executive am pleased to report that the Board has determined that the Officer of the Fund s Manager retired in January Under his current level of distributions can be sustained for the present leadership, Mario s focus on continuous improvement generated time while the reserves, mentioned above, are being substantial improvements at the Processing Facility, particularly accumulated. in the areas of productivity, health and safety. We would like to thank him for his strong commitment and dedication to the Fund. The Year Ahead In conclusion, I would like to thank our employees who have During 2012, the Board plans to make a decision on whether or remained focussed on delivering results. I would like to thank all not to recommend conversion to a corporation and will make of our Trustees, for the guidance and support they have provided. further progress on the long-term strategy. A conversion must be And on behalf of the entire management team at Canadian completed by December 31, 2012 to obtain certain tax benefits Electrolytic Zinc Limited, I would like to thank you, our for the Unitholders. Unitholders, for your continued support. In conclusion, I would like to thank our management and employees on delivering strong operating results. I would also like to thank my fellow Trustees for their hard work which has enabled the Fund to achieve some significant milestones. Finally, 22FEB our thanks to you, our Unitholders, for your patience and support. Manuel Álvarez Dávila Chief Executive Officer Canadian Electrolytic Zinc Limited Noranda Income Fund s Manager 22FEB John J. Swidler Chairman of the Board 2 ANNUAL REPORT 2011 NORANDA INCOME FUND

5 Management s Discussion and Analysis This Management s Discussion and Analysis 2011 HIGHLIGHTS ( MD&A ) of the financial position and results of Earnings before finance costs and income taxes were operations of Noranda Income Fund (TSX: NIF.UN) $59.9 million compared to $47.7 million in is the responsibility of management and has been Cash provided by operating activities before non-cash working capital items was $71.5 million compared to $69.6 million a prepared as at February 14, The board of year ago. trustees of Noranda Operating Trust carries out its Zinc premiums were 34% or $7.6 million higher than in responsibility by reviewing this disclosure By-product revenues were 46% or $15.9 million higher than principally through its audit committee and it in approves this disclosure prior to its publication. Debt (before deferred financing fees) was reduced by $96.0 million to $98.7 million. This MD&A provides a review of the consolidated financial The Fund completed a long-term financing. position, results of operations and performance of Noranda The Fund issued a cash distribution of $ per unit to Income Fund (the Fund ), Noranda Operating Trust Priority Unitholders in each of September, October, November (the Operating Trust ) and the Noranda Income Limited and December. Partnership (the Partnership ), and the subsidiaries of the The employees of the Processing Facility ratified a new, foregoing for the years ended December 31, 2011 and three-year collective agreement. December 31, It should be read in conjunction with the Fund s audited consolidated financial statements and notes to OVERVIEW those statements. The Fund is an unincorporated open-ended trust, established The Fund has prepared its consolidated financial statements for under the laws of Ontario, whose priority units (the Priority the year ended December 31, 2011 in accordance with Units ) trade on the Toronto Stock Exchange ( TSX ) under the International Financial Reporting Standards ( IFRS ). For all symbol NIF.UN. The Fund was created to acquire periods up to and including the year ended December 31, 2010, Noranda Inc. s CEZinc electrolytic zinc plant and processing the Fund prepared its consolidated financial statements in facility (together with the associated roasters, acid plants, accordance with the previously-applicable Canadian generally remediation facilities, settling ponds, wastewater treatment accepted accounting principles ( Canadian GAAP ). Upon plants and related assets and equipment) (the Processing transition to IFRS, the Fund s December 31, 2010 consolidated Facility ), located in Salaberry-de-Valleyfield, Québec, in financial statements have been restated to IFRS. All amounts are Canadian Electrolytic Zinc Limited (the Administrator and expressed in Canadian dollars, the Fund s reporting currency, alternatively, the Manager ), a wholly-owned subsidiary of except where indicated. Xstrata Canada Corporation ( Xstrata Canada ) (through its Xstrata Zinc Canada division), operates and manages the Additional information regarding the Fund, including the Fund s Operating Trust and the Partnership and administers the Fund. Annual Information Form, is available on SEDAR at Concurrently with the creation of the Fund and the acquisition of the Processing Facility by the Partnership from Noranda Inc. in 2002, the Administrator entered into various agreements with This MD&A contains forward-looking information and forward- the Fund and/or the Operating Trust relating to the management, looking statements within the meaning of applicable securities administration and operation of the Fund, the Operating Trust, laws. See Forward Looking Information below. the Partnership and the Processing Facility. In August 2006, Xstrata Canada acquired Falconbridge Limited, the successor corporation to Noranda Inc., and subsequently became Xstrata Canada Corporation. Xstrata Canada is a wholly-owned subsidiary of Xstrata plc. The Processing Facility, which the Fund indirectly owns through the Partnership, produces refined zinc metal and various by-products from zinc concentrate purchased from mining operations and sells refined zinc products to customers in the open market. The Fund earns a processing fee for transforming ANNUAL REPORT 2011 NORANDA INCOME FUND 3

6 Management s Discussion and Analysis zinc concentrate into zinc metal and it earns additional revenue from premiums, by-product revenues and metal gains. The Processing Facility is favourably located along major transportation networks which connect it to its principal markets in the United States and Canada. Zinc is central to our daily lives. Its main use is to galvanize steel for the construction and automotive industries. Zinc is also used in the production of die-castings and brass. Zinc powders, oxide and dust are used in the manufacture of batteries, rubber tires, pigments and various creams. The board of trustees of the Operating Trust (the Board or the Trustees ), the majority of whom are independent from Xstrata Canada, oversees the Fund. The Fund is in turn the sole unitholder of the Operating Trust. Pursuant to an administration agreement dated April 18, 2002 between the Fund and the Administrator (the Administration Agreement ), Computershare Trust Company of Canada, the sole trustee of the Fund (the Sole Trustee ), has delegated all of its power and authority to the Administrator, and the Administrator provides administrative and support services to the Fund. Pursuant to a management services agreement dated April 18, 2002 between the Operating Trust and the Manager (the Management Services Agreement ), the Manager provides management services to the Operating Trust. Pursuant to an operating and management agreement dated May 3, 2002 between the Manager and the Partnership (the O&M Agreement ), the Manager operates and maintains on an ongoing basis, the Processing Facility owned by the Partnership and provides management services to the Partnership. In addition, Xstrata Canada and the Partnership are parties to a supply and processing agreement dated May 3, 2002 (the Supply and Processing Agreement ), pursuant to which Xstrata Canada is obligated, except in certain circumstances, to sell to the Partnership until 2017 all of its zinc concentrate requirements up to 550,000 tonnes of zinc concentrate per year at a concentrate price based on the price of zinc metal on the London Metal Exchange ( LME ) for the payable zinc metal contained in the concentrate, less a fixed, escalating processing fee (calculated in Canadian dollars). Pursuant to the Supply and Processing Agreement, Xstrata Canada acts as exclusive agent for the Partnership to arrange for purchases of any additional zinc concentrate in excess of the 550,000 tonne amount described above, and for sales of zinc metal and by-products and related hedging and derivative arrangements. Further details concerning these arrangements relating to the management, administration and operation of the Fund, its subsidiaries and the Processing Facility are described under Transactions with Related Parties below. Long-Term Strategy The Board is charged with evaluating the Fund s long-term strategy, and for evaluating and supervising the formulation and execution of the Fund s business and operating plans, which the Manager prepares. As announced in the Press Release dated November 11, 2011, the Board undertook, under the guidance of its Independent Committee, a review to determine the availability of funds for future distributions. Progress has been made and the Board has received a preliminary report from the international consulting group it had retained. The preliminary report indicates, without concluding and subject to certain major assumptions, that if the Fund is able to secure zinc concentrate in the market post-2017, and if the Supply and Processing Agreement between the Partnership and Xstrata Canada is not renewed, it could operate profitably. In the circumstances, it would be prudent for the Board, through its Independent Committee, to identify possible alternative sources of zinc concentrate post-2017 and the Partnership may be required to commit funds to assure the continued supply of concentrate. There can be no assurance that alternative sources of zinc concentrate will be available or, if available, would be available in sufficient quantities and on terms and conditions, including pricing, that will allow the processing facility to continue production and operations at profitable levels. The Supply and Processing Agreement with Xstrata Canada is automatically renewed for successive periods of five years unless Xstrata Canada provides the Partnership with written notice to the contrary at least 180 days prior to the expiry of the applicable term. The current term expires in May Xstrata Canada is required to advise the Partnership by November 2016 of its decision with respect to an extension, if any, beyond Due to the uncertainty of supply of concentrate post-2017, the Board has determined in its business judgment, as it did when it agreed to allow for the full amortization of the Fund s long-term debt concurrently to the end of fiscal 2016, that it would be wise and prudent, based on the preliminary information available at this time, to begin accumulating reserves that are expected to be required to pay for the closure costs of the facility at Salaberry-de-Valleyfield. The costs include severance payments, pension and retirement benefit plans and site rehabilitation costs. The amounts required to fund such reserves have been established by third-party independent professionals based on certain assumptions. Should these assumptions need to be modified due to changing circumstances, the amount of the necessary reserves may increase or decrease, with a corresponding effect on any cash available for distributions. Notwithstanding the foregoing, and assuming no major sudden changes in the zinc and related by-products markets, while the reserves mentioned above are being accumulated, the 4 ANNUAL REPORT 2011 NORANDA INCOME FUND

7 Under the terms of the Fund s trust indenture, as amended and restated (the Trust Indenture ), the Fund is required on December 31 st of each year to distribute to its unitholders an amount equal to the Fund s taxable income and net capital gains for the year, to the extent that such amount has not already been distributed in the year, so as, to the extent possible, minimize its liability for tax under the Tax Act in the year. Such distributions are to be made in cash, unless the Fund is restricted from distributing cash or sufficient cash it not available, in which case such distributions are required to be satisfied in whole or in part in-kind by the issuance of additional Priority Units having a value equal to the amount of cash which is unavailable for distribution (which units are then automatically consolidated such that the number of Priority Units held by a Canadian resident Unitholder after the distribution of additional units and the consolidation is the same number of units held immediately prior to the distribution of additional units). In December 2011, the Fund amended its Trust Indenture to mitigate the tax consequences for taxable Unitholders. Specifically, in light of the changes in tax laws discussed above, effective December 12, 2011, the Board amended the Fund s Trust Indenture, which used to require that the Fund distribute 100% of its taxable income to Unitholders and would, absent such amendment, have resulted in the Fund making a larger in-kind distribution in 2011 than was necessary. As amended, the Fund s Trust Indenture now requires that the Fund distribute a specified percentage (approximately 71.6% in 2011) of its income attributable to its NPE Earnings. This amendment was made to reflect the fact that the Fund is now subject to entity- level tax on its NPE Earnings. The amendment was adopted in accordance with the provisions of the Fund s Trust Indenture and a copy of the Trust Indenture is available on SEDAR at In accordance with the terms of the Trust Indenture, as so amended and restated, the Board approved in December 2011 an in-kind distribution (an In-Kind Distribution ) of $0.58 per Priority Unit payable on December 31, 2011 to holders of Priority Units of record on December 31, This was the second such In-Kind Distribution by the Fund, the first of which was made in December There were two changes in the 2011 In-Kind Distribution which improved the tax consequences for investors holding units in a taxable investment account, compared to the Fund s 2010 In-Kind Distribution: The Fund expected that substantially all of the 2011 In-Kind Distribution would be attributable to NPE Earnings. Accordingly, for Canadian tax purposes, the 2011 In-Kind Distribution is expected to receive the favourable treatment as a taxable dividend from a Canadian corporation while the 2010 In-Kind Distribution was treated as taxable income for Unitholders. Board has determined that the current level of distributions can be sustained for the present time. There is no assurance that monthly distributions will continue in the future; nor is there any assurance that, if they do continue, the level or frequency of such monthly distributions will not vary from the level of the most recent monthly cash distribution. See Liquidity and Capital Resources and Risks and Uncertainties below. Cash Distributions With the long-term refinancing completed in July 2011 and the resulting elimination of the prohibition on cash distributions to unitholders of the Fund (the Unitholders ) that existed under the Operating Trust s prior bridge facility and preceding revolving credit facility, the Board declared a cash distribution to Priority Unitholders of $ per unit for each of the months of September, October, November and December of And subsequently, on January 20, 2012 and February 14, 2012, the Fund announced that the Board had approved a distribution for the months of January and February 2012 of $ per Priority Unit. There is no assurance that monthly distributions will continue in the future; nor is there any assurance that, if they do continue, the level or frequency of such monthly distributions will not vary from the level of the most recent monthly cash distribution. The Fund s distribution policy and practices are impacted by various risks, uncertainties and other factors, which are discussed in greater detail in this section and in the sections entitled Liquidity and Capital Resources, Distribution Policy and Forward-Looking Information below. Taxation, Structure and Conversion of the Fund The Independent Committee of the Board, together with the Board, are currently considering the impact of taxation and other consequences should the Fund decide to convert to a corporation, while also considering the impact to the Fund and its Unitholders of remaining as a trust. Taxation 2011 and Beyond On January 1, 2011, the specified investment flow-through rules came into effect under the Income Tax Act (Canada) (the Tax Act ) for publicly-traded income trusts, such as the Fund and, as a consequence, the Fund is now taxable. In particular, the Fund will be subject to tax on its non-portfolio earnings (as defined in the Tax Act) (the NPE Earnings ) at the same rate as a Canadian corporation provided it distributes a sufficient portion of such earnings to Unitholders. Otherwise, the Fund would be subject to a tax on such earnings at the higher personal income tax rate applicable to individuals. As a result, the Fund can no longer make distributions to Unitholders without the imposition of entity level taxation. ANNUAL REPORT 2011 NORANDA INCOME FUND 5

8 Management s Discussion and Analysis The amended Trust Indenture now requires that the Fund January 1, For more information, readers should refer to distribute a specified percentage (71.6% in 2011) of its the Fund s consolidated financial statements as at and for the income attributable to NPE Earnings to reflect the fact that year ended December 31, Copies are available on SEDAR the Fund is now subject to entity-level tax on its NPE Earnings at and this, in turn, has lowered the overall tax liability to Unitholders as a result of the lower In-Kind Distribution in Other Developments in In 2010, the Trust Indenture required that the Fund In December 2011, Canadian Electrolytic Zinc Limited, the distribute 100% of its taxable income to Unitholders. Fund s Administrator and Manager, informed the Fund that For further details concerning the Fund s distribution policy, Mr. Mario Chapados would retire as Chief Executive Officer please see Distribution Policy below. ( CEO ) and General Manager of the Manager, effective January 31, Mario has held this position since Structure and Conversion October With the long-term refinancing now in place, the Independent During his distinguished 32-year career with Noranda Inc., Committee and the Board are focused on reviewing the structure Falconbridge Limited and Xstrata Zinc, Mario held several of the Fund; that is, the possible conversion to a corporate positions of increasing responsibilities, before ultimately being structure and the implications thereof for the Fund and its appointed as the Manager s CEO and General Manager. Over the Unitholders. Regardless of the course that the Board past few years, Mario s commitment to continuous improvement recommends, it is expected that the conversion of the Fund to a has been significant, generating a substantial improvement at corporation, if pursued, would require the approval of the Fund s the Processing Facility, particularly with regards to productivity, Unitholders and Xstrata Canada. There is no assurance that the health and safety. Unitholders or Xstrata Canada will provide their approval, Effective February 1, 2012, Ms. Eva Carissimi assumed the if requested. position of Vice-President, Operations and General Manager of the Manager. Eva Carissimi holds a Bachelor of Science in RESULTS OF OPERATIONS Metallurgical Engineering from McGill University. She started her career at Xstrata Copper s Horne Smelter in 1989, where she Adoption of International Financial Reporting Standards was appointed Smelter Manager in She transferred to ( IFRS ) Xstrata Nickel s Sudbury Operations in 2005 where she held The Fund prepared its consolidated financial statements for the various managerial positions such as Operations Manager, Mine year ended December 31, 2011 in accordance with IFRS. For all Manager for Craig Mine and, more recently, Smelter Director. In periods up to and including the year ended December 31, 2010, 2011, Eva was selected as one of Canada s Most Powerful the Fund prepared its consolidated financial statements in Women: Top 100 Award Winners in the Trailblazers and accordance with the previously-applicable Canadian GAAP. The Trendsetters category from the Women s Executive Network. Fund adopted IFRS in accordance with IFRS 1, First-time Going forward, Mr. Manuel Álvarez Dávila will assume the role Adoption of International Financial Reporting Standards. The first of CEO for the Manager. Manuel Álvarez Dávila is currently a date at which IFRS was applied was January 1, 2010 Trustee on the Board and is Chief Operating Officer of Xstrata (the Transition Date ). Upon transition to IFRS, the Fund s Zinc Canada. December 31, 2010 consolidated financial statements have From September to December 2011, the Fund negotiated a been restated to IFRS. In accordance with IFRS, the Fund has: new labour contract with the United Steel Workers of America, provided comparative financial information; Local 6486, as the prior collective agreement was due to expire applied the same accounting policies throughout all periods on October 31, On December 22, 2011, the Fund presented; and announced that the unionized employees at its Processing applied certain optional exemptions and mandatory Facility voted in favour of a new collective agreement. Effective exceptions as applicable for first time IFRS adopters. November 1, 2011, the new three-year collective agreement Note 20 of the consolidated financial statements as at and provides for annual wage increases and improvements to the for the year ended December 31, 2011 describes in detail the applicable benefits and retirement programs. initial exemptions and transitional adjustments under IFRS as at 6 ANNUAL REPORT 2011 NORANDA INCOME FUND

9 Selected Financial Highlights by-product revenues and premiums, partially offset by the impact of a stronger Canadian dollar. ($ millions, except per-unit amounts) (IFRS) (IFRS) Production costs in 2011 were $181.2 million, compared to Sales $ $ $ $173.3 million recorded in The increase in costs in 2011 Revenues less raw material was mostly due to a non-recurring $6.4 million cost increase for purchase costs additional pension benefits and early retirement provisions for Earnings (loss) before the new three-year collective agreement, higher operating income taxes (3.3) supplies and higher contractor costs, partially offset by lower Increase in net assets energy costs. attributable to Unitholders Net earnings (loss) (3.3) Production Cost Breakdown Total assets Increase/ Bank and other loans ($ millions) (decrease) Cash distributions declared Labour $ 62.9 $ 56.3 $ 6.6 per Priority Unit Energy (1.2) In-Kind Distributions declared Operating supplies per Priority Unit Other Distributions declared Production cost before per Ordinary Unit $ $ $ change in inventory Canadian GAAP Change in inventory (1.4) $ $ $ 7.9 Sales in 2011 were $663.0 million, compared to $659.1 million in The 1% increase in sales was primarily the result of Selling and administration costs in 2011 were $20.1 million, higher by-product revenue and premiums, partially offset by a compared to $21.6 million in Selling and administration lower volume of zinc metal sales. By-product revenues from costs were lower in 2011 in part due to the absence of some sulphuric acid and copper in cake increased to $50.4 million in one-time 2010 charges which related to the change in the 2011 from $34.5 million in The increase was mainly due composition of the Independent Trustees on the Board and to a higher sulphuric acid netback and copper price, and higher preparation work for a special Unitholder meeting that was copper sales. These results were partially offset by lower zinc requisitioned by certain Unitholders, but ultimately successfully sales volumes. resolved without the need to hold such a meeting. This was In 2011, the Fund realized a zinc premium of US$0.059 per partially offset by $0.7 million charge in 2011 related to the new pound, up from US$0.044 per pound in The increase in collective agreement. realized 2011 zinc premiums compared to 2010 reflected the The foreign currency loss in 2011 was $0.9 million, compared impact of improved annual contract premiums and an increase in to a gain of $1.2 million in The foreign currency gains and the level of spot premiums in North America. losses are primarily a result of the impact of the Canadian/US Transportation and distribution costs in 2011 of $18.7 million exchange rate on the Fund s net US monetary liabilities. The were higher than the $16.1 million recorded in The Fund s main US denominated balances are comprised of cash increase was because the copper in cake transportation cost to and cash equivalents, accounts receivable, accounts payable Europe is higher than it was to the Kidd Metallurgical Facility in and a portion of its debt. Timmins, Ontario where the copper in cake was previously In 2011, the loss on the derivative financial instruments was treated. $3.5 million. In 2010, the gain on the derivative financial Raw material purchase costs in 2011 were $340.4 million instruments was $5.4 million. During these periods, the change compared to $371.6 million in The decrease was mainly in the market value of the Fund s financial instruments resulted due to lower volumes of zinc metal sales, a stronger Canadian in these amounts being recorded. dollar and the impact of the embedded derivative on the Fund s In 2011, depreciation was $34.1 million, compared to the concentrate payable which decreased raw material purchase $33.7 million recorded in costs in 2011 and increased raw material purchase costs In 2011, the rehabilitation expense was $4.1 million, in compared to $1.8 million in The $2.3 million increase Revenues less raw material purchase costs ( Net Revenues ) was mostly due to the larger decline in the risk-free interest rate in 2011 were $303.8 million, compared to $271.4 million in used to discount the liability in 2011, as compared to 2010, The $32.4 million increase was mainly due to higher ANNUAL REPORT 2011 NORANDA INCOME FUND 7

10 Management s Discussion and Analysis resulting in a larger increase in the liability being recorded in the taxable entity effective January 1, The Fund is required to statement of comprehensive income in record a tax expense using the undistributed rate for both its In 2011, net finance costs were $16.1 million compared to current and deferred taxes, set at the highest marginal personal $14.4 million in The increase was largely due to an tax rate of approximately 48%. Upon the distribution of taxable increase in the amortization of deferred financing fees in 2011 income, the income tax provision is adjusted on the distribution relating to the Operating Trust s prior Bridge Facility and its ABL to a tax rate of 28.4%. In 2011, the impact of this adjustment Facility and Notes, as defined and described below, partially was $7.8 million which was primarily recorded in the fourth offset by lower average debt outstanding during the period. quarter in connection with the September through The current income tax expense was $19.0 million in 2011, December 2011 monthly cash distributions and the 2011 compared to $0.1 million in 2010, due to the Fund becoming a In-Kind Distribution. Summary of Quarterly Results The following table provides a summary of quarterly results for the past two years ended December 31, 2011 and December 31, 2010, respectively: Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 Revenues $ $ $ $ $ $ $ $ Increase (decrease) in net assets attributable to Unitholders $ (14.2) $ 9.3 $ 6.0 $ 10.7 $ (12.5) $ 1.7 $ 11.3 $ 8.7 Production (tonnes) 67,504 63,923 67,906 63,953 69,113 66,605 65,144 64,466 * 1 tonne = 2, pounds Fourth-Quarter 2011 Results The Fund reported earnings before finance costs and income taxes of $2.4 million in the fourth quarter of 2011, compared to $11.1 million in the same quarter a year ago. The $8.7 million decrease was mainly due to lower zinc metal sales and a non-recurring $7.1 million cost increase for additional pension benefits and early retirement provisions for the new three-year collective agreement. This decrease was partially offset by higher zinc metal premiums. Revenues in the fourth quarter of 2011 were $137.8 million, down from the $168.7 million recorded in the same quarter of Much of this decrease was due to lower zinc and copper prices, partially offset by higher sulphuric acid netbacks. Q Q Zinc metal production (tonnes) 67,504 69,113 Zinc metal sales (tonnes) 63,655 65,716 Zinc metal premium (US$/pound) Byproduct revenues ($ millions) Copper in cake production (tonnes) Copper in cake sales (tonnes) Sulphuric acid production (tonnes) 104, ,701 Sulphuric acid sales (tonnes) 100,541 97,290 Average LME copper price (US$/pound) Sulphuric acid netback (US$/tonne) * 1 tonne = 2, pounds In the fourth quarter of 2011, zinc metal production was 67,504 tonnes, compared to 69,113 tonnes in the same quarter of Zinc recoveries in the fourth quarter of 2011 were 96.6%, compared to 97.0% in the fourth quarter of Stronger zinc metal orders were realized from the galvanizing and the die cast alloy sectors, which were supported by improved demand from the automotive and general manufacturing end user markets.fourth quarter 2011 sales were 63,655 tonnes versus 65,716 tonnes in the fourth quarter of Zinc metal premiums were US$0.058 per pound in the fourth quarter of 2011, compared to US$0.047 per pound in the same quarter of 2010, primarily due to higher premiums realized on contract sales. In the fourth quarter of 2011, the Fund generated $11.2 million in revenue from the sale of its copper in cake and sulphuric acid, compared to $12.5 million achieved in the fourth quarter of Revenues from the sale of sulphuric acid were $7.5 million in the fourth quarter of 2011, up from $5.0 million in the fourth quarter of 2010, as a result of higher netbacks and sales volumes. Sulphuric acid sales totalled 100,541 tonnes in the fourth quarter of 2011, compared to 97,290 tonnes in the fourth quarter of Copper in cake revenues were $3.7 million in the fourth quarter of 2011, compared to $7.2 million in the fourth quarter of 2010, as a result of lower copper prices and the impact of negative provisional pricing settlements in 2011 and positive provisional pricing adjustments in Copper in cake sales volumes in the fourth quarter of 2011 totalled 585 tonnes compared to 780 tonnes in the corresponding period of ANNUAL REPORT 2011 NORANDA INCOME FUND

11 Cash provided from operating activities, before net changes in non-cash working capital items in the fourth quarter of 2011, was $18.0 million compared to $17.0 million in the fourth quarter of During the fourth quarter of 2011, non-cash working capital decreased by $28.2 million. The decrease in working capital primarily resulted from a decrease in accounts receivable and an increase in accounts payable and accrued liabilities. The decrease in accounts receivable resulted, in part, from the decrease in the monthly average price of zinc from September to December. The increase in the accounts payable and accrued liabilities was mainly due to the increase in the volume of concentrate received in December compared to September, as well as the impact of declining zinc prices in the third quarter which resulted in lower accounts payable and accrued liabilities at the end of September due to the provisional price adjustments. Capital expenditures in the fourth quarter of 2011 were $9.1 million, compared to $7.9 million in the fourth quarter of Sustaining capital accounted for almost all of the expenditures in the last quarter of Cash distributions paid to Priority Unitholders during the fourth quarter of 2011 totalled $4.7 million compared to $1.6 million in the third quarter. KEY PERFORMANCE DRIVERS The principal factor affecting the Fund s performance is the processing of zinc concentrates into zinc metal. This activity results in the Fund earning a processing fee. In 2011, the processing fee accounted for 77% of the Fund s Net Revenues ( %). A second key factor affecting the performance of the Fund is the premiums that are realized on the sale of zinc products to customers. Zinc metal is sold to customers on the basis of an LME zinc price plus a premium that is negotiated between the buyer and seller. Premiums can vary according to various factors including product form, quantity, quality and payment terms. In 2011, product premiums accounted for 6% of the Fund s Net Revenues (2010 5%). The sale of by-product (copper in cake and sulphuric acid) and zinc metal recovery gains generated 15% and 2%, respectively, of the Fund s Net Revenues in 2010 ( % and 3%). The Canada/US exchange rate also impacts the Fund s performance through premiums, by-product revenues and zinc recovery gains which, collectively, represented 23% of the Net Revenues in 2011 ( %). As the processing fee is earned in Canadian dollars, 77% of the Fund s Net Revenues are not exposed to currency risk. Two other performance drivers that impact the Fund are managing costs and a disciplined use of capital. The Fund provides annual guidance for a number of its key performance drivers, including production, sales, processing fee, and capital expenditures. Guidance for 2012 key drivers can be found in Outlook below. The following table provides a summary of the performance of these key drivers for the years ended December 31, 2011 and December 31, 2010, respectively. The discussion of key performance drivers that follows is subject to various risks and uncertainties, some of which are discussed under Risks and Uncertainties and Forward-Looking Information below, which investors are encouraged to read carefully. Year Zinc concentrate processed (tonnes) 504, ,376 Zinc grade (%) Zinc recovery (%) Zinc metal production (tonnes) 263, ,328 Zinc metal sales (tonnes) 266, ,114 Processing fee (cents/pound) Zinc metal premium (US$/pound) Byproduct revenues ($ millions) Copper in cake production (tonnes) 2,604 2,537 Copper in cake sales (tonnes) 3,396 2,257 Sulphuric acid production (tonnes) 419, ,779 Sulphuric acid sales (tonnes) 414, ,220 Average LME copper price (US$/pound) Sulphuric acid netback (US$/tonne) Average LME zinc price (US$/pound) Average US/Cdn. exchange rate * 1 tonne = 2, pounds Zinc Metal Production Capacity The amount of zinc metal produced in a year is a function of four main factors: (1) the volume of zinc concentrate processed; (2) the grade of the zinc concentrate processed; (3) the zinc recoveries; and (4) changes to work-in-process inventory levels. In 2011, 504,851 tonnes of zinc concentrate were processed, compared to 482,376 tonnes in In 2011, the average concentrate grade was 54.1% and zinc recovery was 96.8% compared to 54.2% and 97.4%, respectively, in Work-in-process inventory levels increased in 2011, while in 2010, work-in-process inventory levels were drawn down. As a result, production in 2011 was 263,286 tonnes compared to 267,328 tonnes in 2010, as a lower zinc recovery and the increase in work-in-process inventory levels more than offset the higher quantity of zinc concentrate being processed. The Fund pays for 96% of the zinc in the concentrate it purchases; therefore, any recovery over 96% results in additional revenue for the Fund. In 2011, the bulk of the zinc concentrate came from five mines: Brunswick, Antamina, Perseverance, Kidd Creek and ANNUAL REPORT 2011 NORANDA INCOME FUND 9

12 Management s Discussion and Analysis Duck Pond. Four of the five mines are owned or partly-owned by $4.00 per pound, compared to $3.42 per pound in entities within the Xstrata Zinc group. Copper in cake sales volumes in 2011 totalled 3,396 tonnes, The annual zinc metal production capacity of the Processing compared to 2,257 tonnes in the prior year. Facility, under normal operating conditions, is 270,000 tonnes of During 2009 and 2010, copper in cake inventories increased zinc. The Fund continues to believe that the Supply and as Xstrata Canada sought an alternative treatment facility to the Processing Agreement will provide sufficient concentrate to run Kidd copper metallurgical site that closed in May Two the Processing Facility at its productive capacity until its smelters in Europe were identified and tested, and by the end of anticipated expiry in the third quarter of 2011, copper cake inventories had returned In 2010, the Processing Facility began a three-to-four year to their normal level, of approximately one to two months rehabilitation project to replace the liners protecting the concrete of inventory. walls in the cell house. The project is expected to be completed by mid The project requires two cells to be off-line at any Sulphuric Acid time, thereby reducing availability by approximately 2%. As a Revenues from the sale of sulphuric acid rose to $29.5 million in result, effective annual zinc metal production capacity has been 2011 from $17.5 million in Sulphuric acid netbacks in reduced from 270,000 tonnes to 265,000 tonnes of zinc metal. 2011, which were supported by higher spot and contract pricing, The target for productive capacity is subject to various risks rose to US$72 per tonne from US$41 per tonne in Sales and uncertainties, some of which are set out under Risks and volumes were also higher in 2011 at 414,010 tonnes compared Uncertainties and Forward-Looking Information below. to 411,220 tonnes a year ago. Sulphuric acid market fundamentals remained favourable Sales throughout Industrial demand growth slowed somewhat Zinc metal is used in a wide range of industries. Its major use is as a result of the economic uncertainty in the US, however it still in the production of galvanized steel. Sales in 2011 were maintained a slightly positive trend. Stable pricing for sulphur in 266,814 tonnes compared to 269,114 tonnes in Steady the US Gulf region continued to support sulphuric acid pricing. customer orders allowed the Fund to reduce metal inventories by 3,500 tonnes during Exchange Rate The stronger Canadian dollar has had a negative impact on the Processing Fee Fund s financial results. In 2011, a one-cent Canadian In 2011, the processing fee was $0.389 per pound ($858 per strengthening in the average Canadian/US exchange rate would tonne), compared to $0.385 per pound ($849 per tonne) in have negatively impacted the Fund s annual cash available for The processing fee is adjusted annually: (i) upward by 1% distribution by approximately $0.7 million. In 2011, the and (ii) upward or downward by 10% of the year-over-year Canadian dollar strengthened to an annual average of $0.99 per percentage change in the average cost of electricity per US dollar from an annual average $1.030 per US dollar in megawatt hour for the Processing Facility. Based on the annual See also Financial Instruments and Other Instruments below. 1% increase and the average increase in electricity costs, the processing fee for 2012 is expected to be $0.392 per pound. Costs Production costs include labour, energy, supplies and other costs Premiums directly associated with the production process, plus or minus Zinc metal premiums averaged US$0.059 per pound in 2011 changes in inventory levels. Production costs in 2011 were compared to US$0.044 per pound in The increase in $181.2 million, compared to $173.3 million in The realized premiums compared to last year reflected the impact of increase in costs in 2011 is mostly due to an increase in the cost improved annual contract and spot premiums in North America. of labour due to the pension benefits and early retirement provisions provided under the new collective agreement, higher By-products operating supplies and higher contractor costs, partially offset by The Fund produces copper in cake and sulphuric acid as lower energy costs. by-product from refining zinc concentrates. In 2011, the Fund generated $50.4 million in revenue from the sale of its copper in Capital Expenditures cake and sulphuric acid, compared to $34.5 million in Capital spending was $27.3 million in 2011, compared to $24.2 million in Most of the annual 2011 capital Copper in Cake spending of $27.3 million was spent on sustaining the Fund s Copper in cake revenues in 2011 were $20.4 million compared operations, including $3.2 million on the cell house rehabilitation to $16.0 million in In 2011, copper prices averaged 10 ANNUAL REPORT 2011 NORANDA INCOME FUND

13 project and $9.2 million on replacement anodes for the cell house. Adjusted Earnings before Distributions to Unitholders, Finance Costs, Income Taxes, Depreciation and Amortization ( Adjusted EBITDA ) Adjusted EBITDA is used by the Fund as an indication of cash generated from operations. Adjusted EBITDA is not a recognized measure under IFRS and therefore the Fund s method of calculating Adjusted EBITDA is unlikely to be comparable to methods used by other entities. The Fund s Adjusted EBITDA is calculated by earnings before finance costs and income taxes and adjusting for all of the non-cash items such as depreciation, rehabilitation expense, net change in employee benefits, changes in fair value of embedded derivatives and non-cash gains/(losses) on derivative financial instruments. The Fund s Adjusted EBITDA is currently supported by the stability provided by way of the Supply and Processing Agreement. It may be subject to more variability once this agreement expires in A reconciliation of Adjusted EBITDA in 2011 and 2010 is provided below: Adjusted EBITDA ($ thousands) Earnings before finance costs and income taxes $ 59,860 $ 47,748 Depreciation of property, plant and equipment 34,126 33,709 Net change in rehabiliation liability 4,111 1,560 Loss on derivative financial instruments 3,757 (2,165) Change in fair value of embedded derivatives (11,254) 2,501 Write-down of inventory 1,144 Loss on sale of assets 746 1,385 Net change in employee benefits 6,245 (4,472) $ 97,591 $ 81,410 OPERATING CASH FLOWS Distribution Policy When not restricted and when possible, and as may be considered appropriate by the Board, the Fund s policy is to make distributions at sustainable levels to Unitholders equal to distributable cash flows from operations (as discussed below). The Fund determines the cash available for distribution, if any, on a monthly basis for the Unitholders of record of the Fund on the last business day of each calendar month and these distributions are to be paid on or about 25 days thereafter. The Fund is required by its Trust Indenture to distribute on December 31 st of each year amounts equal to its taxable income and net capital gains for the year, so as, to the extent possible, minimize its liability for tax under the Tax Act for the year. Such distributions are to be made in cash, unless the Fund is restricted from distributing cash or sufficient cash is not available, in which case such distributions are required to be satisfied in whole or in part by the in-kind issuance of additional Priority Units having a value equal to the amount of cash which is unavailable for distribution. Immediately following such an In-Kind Distribution, the Priority Units are automatically consolidated such the number of outstanding Priority Units immediately prior to the In-Kind Distribution is the same as the number of Priority Units outstanding immediately after the distribution and the consolidation. As a result, a Canadian resident Unitholder will hold after the distribution and automatic consolidation the same number of Priority Units held by such Unitholder immediately prior to the In-Kind Distribution. The consequences for non-resident Unitholders may, however, be different, as previously disclosed by the Fund. In December 2011, the Fund amended its Trust Indenture to mitigate the tax consequences for taxable Unitholders. Specifically, in light of the changes in tax laws discussed above, effective December 12, 2011, the Board amended the Fund s Trust Indenture, which used to require that the Fund distribute 100% of its taxable income to Unitholders and would, absent such amendment, have resulted in the Fund making a larger in-kind distribution in 2011 than was necessary. As amended, the Fund s Trust Indenture now requires that the Fund distribute a specified percentage (approximately 71.6% in 2011) of its income attributable to its NPE Earnings. This amendment was made to reflect the fact that the Fund is now subject to entity- level tax on its NPE Earnings. The amendment was adopted in Cash provided by operating activities in 2011, before net changes in non-cash working capital items, was $71.5 million compared to $69.6 million in During 2011, non-cash working capital decreased by $55.3 million due to a decrease in accounts receivable and inventories and an increase in the income taxes payable. In 2010, non-cash working capital increased by $26.0 million due to an increase in accounts receivable and a decrease in accounts payable and accrued liabilities, partially offset by a decrease in inventory. Since 2011 is the first year that the Fund has been taxed at the entity level, it will be required to pay its 2011 income taxes in the first quarter of 2012, as well as begin making quarterly instalment payments for This is expected to result in a lower operating cash flow as the income tax payable balance is reduced. DISTRIBUTION POLICY ANNUAL REPORT 2011 NORANDA INCOME FUND 11

14 Management s Discussion and Analysis accordance with the provisions of the Fund s Trust Indenture and Base Distribution and a cash distribution is approved by the a copy of the Trust Indenture is available on SEDAR at Board. If at any time there is an accumulated Deficiency Amount owing on the Ordinary Units, any distribution on the Ordinary The Fund did not pay any cash distributions to Priority Units must be declared on the last business day of the month on Unitholders or Ordinary Unitholders in 2010 because the Fund which the Partnership has distributable cash flow in that month was renegotiating its debt, and consistent with the terms of the in excess of any amount required to be paid by the Partnership to extension of the then-outstanding revolving facility and the the holders of the Ordinary Units so as to ensure the declaration subsequent Bridge Facility (discussed below), it was not of the Base Distribution by the Fund to the holders of Priority permitted to make any cash distributions to the Unitholders Units for that month together with a declaration of an amount during such period. equal to the Base Distribution by the Partnership to the holders With the long-term financing completed in July 2011 and the of Ordinary Units for that month, until the Deficiency Amount is resulting elimination of the prohibition on cash distributions to paid in full. Unitholders that existed under the prior Bridge Facility, the Board In the event of an exchange of Ordinary Units on a one-for-one declared a cash distribution to Priority Unitholders of $ basis for Priority Units on or after May 2, 2017, or earlier upon per unit for each of the months of September, October, the occurrence of an early exchange event, any accumulated November and December of 2011, and in January and February Deficiency Amount related to the Ordinary Units prior to the of exchange is not accrued by the Fund until such time as excess In addition, in both 2010 and 2011, the Fund declared a cash is available for distribution above the Base Distribution, and year-end In-Kind Distribution to the holders of the Priority Units, a cash distribution is approved by the Board. Upon the exchange, in accordance with the terms of its Trust Indenture. See the holder of Ordinary Units has the right to receive any Overview Cash Distributions and Overview Taxation, distribution declared but not paid on the Ordinary Units as at that Conversion and Structure of the Fund above for further details. time and a promissory note in the amount of the outstanding In light of the changes to tax laws described above, taxable accumulated Deficiency Amount. Subsequent to an exchange, income that is distributed to Unitholders is expected to be taxed there is no further accumulation of the Deficiency Amount. The at the corporate tax rate (28.4% in 2011; estimated to be accumulated distribution Deficiency Amount was $4.6 million as 26.9% in 2012 and beyond) and the amount, if any, distributed at December 31, 2011 and $5.1 million as at February 14, to Unitholders is expected to be treated as a dividend from a For further details, reference should be made to the taxable Canadian corporation. Partnership s limited partnership agreement dated May 1, 2002, Cash distributions on Ordinary Units of the Partnership held a copy of which is available on SEDAR at indirectly by Xstrata Canada are subordinated to distributions on The Fund s distribution policy and practices are impacted by Priority Units of the Fund until May 2017, except upon the various risks, uncertainties and other factors, which are occurrence of certain events. Each Ordinary Unit is entitled to discussed in greater detail in this section and in the sections receive a cash distribution on a monthly basis in an amount entitled Liquidity and Capital Resources and Forward-Looking equal to the monthly cash distribution paid on each Priority Unit, Information below. if any, provided each Priority Unit is first paid an amount that is equal to the monthly cash distribution of not less than $ Distributable Cash per Priority Unit (the Base Distribution ) before any amount is The Fund s objective is to maximize unitholder value and, when paid to the holder of the Ordinary Units. If, notwithstanding the possible, make a sustainable level of distributions to Unitholders. subordination of the Ordinary Units, the cash available for Distributable cash is used by the Fund as an indication of distribution is not sufficient to make the Base Distribution on the cash generated from operations that is available for distribution Priority Units in a month, the amount of the deficiency does not to Unitholders. Distributable cash is not a recognized measure accumulate and is not paid to holders of the Priority Units. under IFRS and therefore the Fund s method of calculating However, if the cash available for distribution in a month is not distributable cash is unlikely to be comparable to methods used sufficient to make a distribution on the Ordinary Units that is by other entities. Distributable cash is calculated by taking cash equal to the distribution on the Priority Units, the amount of the provided by (used in) operating activities before distributions to deficiency does accumulate and is to be paid to the holder of the Unitholders and changes in non-cash working capital, and by Ordinary Units if and when there is excess cash available for subtracting purchases of equipment, debt financing cost and distribution, above the Base Distribution amount, in a permanent debt repayments, cash provided by the Manager s subsequent month (the Deficiency Amount ). Any accumulated operating activities and amounts retained for reserves. Amounts Deficiency Amount related to the Ordinary Units is not accrued by retained for reserves reflect amounts to fund future capital the Fund until excess cash is available for distribution above the requirements, rehabilitation liabilities and other amounts as 12 ANNUAL REPORT 2011 NORANDA INCOME FUND

15 considered necessary by the Board. Distributable cash per Priority Unit and Ordinary Unit is calculated as distributable cash divided by the number of Priority and Ordinary Units outstanding, respectively at the end of the year. As a result of the completion of the refinancing, the limitation on cash distributions that was in effect with the Bridge Facility (discussed below) was removed as at July 1, The Fund is now subject to the Operating Trust maintaining a minimum excess availability of cash per the ABL Facility and other customary restrictions pursuant to the terms of both its ABL Facility and the Notes (as discussed below under Liquidity and Capital Resources ). A reconciliation of cash provided by operations to distributable cash for the period July 1, 2011 to December 31, 2011 is provided below: ($ thousands) July 1, 2011 to December 31, 2011 Cash provided by operating activities $ 68,387 Capital adjustments: Purchase of property, plant and equipment (14,303) Debt financing costs (5,088) Total capital adjustments (19,391) Other adjustments: Distributions declared to Priority Unitholders 6,249 Scheduled debt repayment (7,500) Increase/(decrease) in non-cash working capital (31,510) Elimination of the Manager s cash provided by operating activities (99) Total other adjustments $ (32,860) Distributable Cash before reserve $ 16,136 Decrease/(increase) in reserve (9,887) Distributable Cash $ 6,249 Weighted average number of Priority Units outstanding (basic and diluted) 37,497,975 Distributable cash per Priority Unit $ Distributions declared per Priority Unit $ Weighted average number of Ordinary Units outstanding (basic and diluted) 12,500,000 Distributions declared per Ordinary Unit $ In 2011, distributable cash and distributions declared to Priority Unitholders was $6.2 million and reserves established during the period were $9.9 million. Tax Pools The Fund has certain tax pools available to shelter taxable income. The largest of these tax pools are capital cost allowance ( CCA ) deductions. These pools are available to the Unitholders in proportion to their respective interest in the Partnership. As at the end of December 31, 2011, the CCA tax pools available were as follows: ($ thousands) Class Federal Québec Rate 1 $ 8,880 $ 8,902 4% 1 7,558 7,586 6% % % % % % % % , ,568 25% Total $ 136,134 $ 146,055 LIQUIDITY AND CAPITAL RESOURCES As at December 31, 2011, the Fund s debt was $94.2 million (net of deferred financing fees), down from $190.3 million at the end of December The Fund s cash and cash equivalents as at December 31, 2011 totalled $1.5 million. Long-Term Refinancing Notes On July 28, 2011, the Operating Trust closed its private placement of senior secured notes (the Notes ), for an aggregate principal amount of $90 million, bearing interest at 6.875%. Commencing on December 28, 2011, the Notes began to amortize by an amount of $7.5 million and will continue to amortize on a semi-annual basis on June 28 and December 28 of each year prior to December 28, The $15 million remaining principal balance will be repayable at maturity on December 28, Under the Notes governing trust indenture, the Fund is permitted to distribute excess cash flows to its Unitholders subject to compliance with certain financial covenants and other customary restrictions. The excess cash flow is calculated based on quarterly periods beginning July 1, At any time prior to December 28, 2013, the Operating Trust may redeem all or part of the Notes at a redemption price equal to 100% of the principal amount of the Notes redeemed, plus a make-whole premium, and accrued and unpaid interest. The Notes are redeemable at the option of the Operating Trust in whole or in part, at any time on or after: December 28, 2013 at % of the principal amount; December 28, 2014 at % of the principal amount; December 28, 2015 and thereafter at 100% of the principal amount; plus, in each case, accrued and unpaid interest to the redemption date. ANNUAL REPORT 2011 NORANDA INCOME FUND 13

16 Management s Discussion and Analysis The Notes trust indenture lists events that constitute an event of default, should they occur. They include the non-payment by the Operating Trust of principal, interest or other obligations of the Operating Trust in respect of the Notes and a breach of any covenant pursuant to the ABL Facility credit agreement (discussed below), subject to customary cure periods where applicable. If any event of default occurs under the Notes trust indenture, the holders of the Notes may require the Operating Trust to repay any outstanding obligations pursuant to the Notes trust indenture, which would, among other things negatively impact the Operating Trust s ability to make cash distributions. ABL Facility Concurrently with the closing of the Notes offering, the Operating Trust entered into a 5-year secured asset-based revolving credit facility (the ABL Facility ) providing availability of up to $150 million. Under the credit agreement entered into in connection with the ABL Facility, the Fund is permitted to distribute excess cash flows to its Unitholders subject to maintaining a minimum excess availability and other customary restrictions. The ABL Facility is an asset-based credit facility and the loans thereunder will be made available to the Operating Trust based on a borrowing base test with the maximum amount available thereunder to be the lesser of (a) $150 million and (b) the aggregate of (i) 85% of eligible accounts receivable (90% in the case of insured accounts receivable or that are owed by qualified investment grade account debtors) plus (ii) the lesser of (A) 70% of the lower of cost or fair market value of eligible inventory, and (B) 85% of the appraised net orderly liquidation value of eligible inventory, with availability from inventory subject to a cap of 100% of availability under clause (i), minus customary priority payables and reserves. The borrowing base is tested on a monthly basis so long as excess availability is equal to or greater than $15 million and on a weekly basis if excess availability over the most recent 45-day period is less than $15 million. As at December 31, 2011, the borrowing base on the ABL Facility based on the Fund s working capital position was $83.1 million and $16.2 million was drawn down, leaving an excess availability of $66.9 million. The maturity of the ABL Facility is July 28, The credit agreement entered into in connection with the ABL Facility contains covenants that restrict the Operating Trust (and the Fund, the Manager, the Partnership and its general partner, NILP General Partner Ltd., as guarantors) in several respects, including their ability to make distributions or repurchase the Notes. The ABL Facility also contains customary representations, warranties and covenants and conditions to funding. The Fund s inability to meet these representations, warranties, covenants and conditions may require it to seek additional funding sources and may, among other things, adversely impact upon the Fund s ability to make cash distributions. The ABL Facility credit agreement does not contain financial covenants, provided the Fund s average excess availability over the most recent 45-day period is equal to or greater than $15 million. In the event that the Fund s average excess availability is less than $15 million for any 45-day period, the Fund will be required to maintain (i) adjusted tangible net worth of the Fund and its subsidiaries at a level prescribed in the credit agreement and (ii) annual capital expenditures at a level not to exceed 120% of budgeted annual capital expenditures. The ABL Facility credit agreement lists events that constitute an event of default, should they occur. They include the non-payment by the Fund of principal, interest or other obligations of the Fund in respect of the ABL Facility credit agreement, a default under the Notes trust indenture that permits, or has resulted in, the acceleration of the obligations owing to the holders of Notes, and a breach of any covenant pursuant to the ABL Facility credit agreement, subject to customary cure periods where applicable. If any event of default occurs under the ABL Facility credit agreement, the ABL Facility lenders will be under no further obligation to make advances to the Fund and may require the Fund to repay any outstanding obligations pursuant to the ABL Facility credit agreement, which would, among other things negatively impact the Fund s ability to make cash distributions. The Notes and the ABL Facility are fully and unconditionally guaranteed, on a senior secured basis (subject to the terms of an intercreditor agreement with the lenders under the ABL Facility), by the Fund, the Manager, the Partnership and NILP General Partner Ltd., the Partnership s general partner. The proceeds of the ABL Facility were used for working capital and other general corporate purposes, and, together with the net proceeds of the Notes offering, were used in part to repay all amounts outstanding in respect of the Operating Trust s prior Bridge Facility (described below). 14 ANNUAL REPORT 2011 NORANDA INCOME FUND

17 Bridge Facility 2. it will require that the Fund provide this financial security over On December 2, 2010, the Operating Trust obtained a bridge a three-year period (compared to a 15-year period under the facility (the Bridge Facility ) for an amount of $250,000 from a current regime). syndicate of lenders, comprised of a $130,000 term loan It is expected that there would be a three year transition tranche ( Term Loan Tranche ) and a $120,000 operating line of period after the date of Bill 14 coming into force, however, the credit ( Revolving Facility Tranche ). The Bridge Facility was final details on the transition will not be known until the bill is obtained in order to refinance the then-outstanding revolving enacted into law. The financial security is expected to be in the credit facility of the Fund and the Operating Trust that matured on form of cash, letter of credit, or another acceptable form. December 3, 2010, and to finance general corporate purposes Under the current Mining Act, the Fund expects to post including working capital and to repay the then-remaining financial security, in the form of letters of credit, starting with amounts outstanding on the Operating Trust s previously $0.1 million in This is expected to increase over the next outstanding senior secured notes that matured on several years until it reaches a cumulative total of $11.7 million December 20, 2010, and to enable the Fund to pursue a in long-term debt financing, all as described further below. Any financial security that is posted under the current Effective June 3, 2011, the Bridge Facility was extended to legislation or the proposed Bill 14 is expected to reduce the December 1, 2011 for a total of $220,000 comprised of excess availability on the ABL Facility, and may negatively impact $120,000 under the Term Loan Tranche and $100,000 under distributable cash, if any, available to Unitholders. the Revolving Facility Tranche. The credit agreement governing It is not certain when, or if, Bill 14 will achieve formal passage the Bridge Facility contained covenants that restricted the Fund and be given assent to become law. in several respects, including its ability to make cash distributions The Fund has provided certain forward-looking information or redeem or repurchase units. On July 28, 2011, the Bridge regarding the Notes, the ABL Facility and financial security under Facility was fully repaid using proceeds from the Notes and the the Mining Act, which are subject to various risks and ABL Facility described above. uncertainties. Some of the risks, uncertainties and assumptions The Term Loan Tranche was used to partly repay all of the underlying this information can be found in the section entitled previously-outstanding senior secured notes in the amount of Forward-Looking Information below. $153.5 million that matured on December 20, The Revolving Facility Tranche was used to refinance the OUTSTANDING UNITS Operating Trust s prior revolving facility that matured on December 3, 2010, to finance general corporate purposes Outstanding Unit Data As at February 14, 2012 including working capital and to repay the remaining Priority Units 37,497,975 $23.5 million of the previously-outstanding senior secured notes Ordinary Units and Special Fund Units 12,500,000 mentioned above. The terms of the Revolving Facility Tranche were substantially the same as the terms of the Operating Trust s As noted above, a wholly-owned subsidiary of Xstrata Canada previous revolving facility. holds 12,500,000 Ordinary Units of the Partnership, which represent all of the outstanding Ordinary Units of the Partnership, Financial Security and which are exchangeable for Priority Units on a one-for-one In May 2011, the Québec government introduced Bill 14 which, basis on or after May 2, 2017, or earlier upon the occurrence of if enacted, would amend the Mining Act. It has been passed in the Québec National Assembly and is now going through various certain events. The 12,500,000 outstanding special voting units stages as a public bill before potentially becoming law in of the Fund listed above (the Special Fund Units ) provide It is expected that Bill 14 would have an impact on the voting rights in respect of the Fund to the holder of Ordinary financial guarantee to be provided by the Fund as required under Units. Further details concerning the rights, privileges and the Mining Act with respect to its residue ponds which are on site restrictions attached to the Fund s outstanding Priority Units and at the Processing Facility. Special Fund Units and the outstanding Ordinary Units of the If passed in its current form, Bill 14 is expected to have the Partnership, are contained in the Fund s 2010 Annual following impact on the Fund: Information Form under the section entitled General Description 1. it will require that the Fund provide financial security covering of the Capital Structure. A copy is available on SEDAR at 100% of the anticipated costs of rehabilitating and restoring the residue ponds (under the current Mining Act, the Fund is required to provide 70% of the anticipated costs to rehabilitate and restore of the accumulation areas ( residue ponds )); and ANNUAL REPORT 2011 NORANDA INCOME FUND 15

18 Management s Discussion and Analysis CONTRACTUAL OBLIGATIONS The following table shows the Fund s contractual obligations schedule for the years 2012 to 2016: (millions of Canadian dollars) Payments due by period 2016 Contractual Obligations Total and beyond Bank and other loans $ 98.7 $ 15.0 $ 15.0 $ 15.0 $ 15.0 $ 38.7 Operating leases Purchase commitments Rehabilitation liability Total $ $ 29.0 $ 16.4 $ 16.7 $ 16.1 $ 73.1 TRANSACTIONS WITH RELATED PARTIES In addition to those arrangements described elsewhere in the MD&A, the Fund entered into the following transactions with related parties. Pursuant to the O&M Agreement dated May 3, 2002 between the Partnership and the Manager, a wholly-owned subsidiary of Xstrata Canada, the Manager is responsible for the ongoing operation and management of the Processing Facility and provides management services to the Partnership in exchange for a management fee and reimbursement of certain specified costs incurred by the Manager in the course of performing its duties. These services include, among other things, preparing annual operating and maintenance plans and capital improvement plans for approval by the directors of the general partner of the Partnership, reporting to the general partner of the Partnership on the operation of the Processing Facility and the business of the Partnership, providing accounting and record keeping services including coordination and management of accounting, cash management, treasury and other systems and preparing financial statements and other reports on operations. Pursuant to the Supply and Processing Agreement dated May 3, 2002 between Xstrata Canada and the Partnership, which expires on May 3, 2017, unless extended, Xstrata Canada is obligated, except in certain circumstances, to sell to the Partnership a maximum of up to 550,000 tonnes of zinc concentrate per year at a concentrate price based on the zinc metal price on the LME for the payable zinc metal contained in the concentrate, less a fixed, escalating processing fee ($0.389 per payable zinc metal in 2011). Additionally, the Supply and Processing Agreement provides that Xstrata Canada will act as exclusive agent for the Partnership to arrange for purchases of any additional zinc concentrate in excess of the 550,000 tonnes described above, and for sales of zinc metal and by-products, and related hedging and derivative arrangements. The expiry of the Supply and Processing Agreement will result in a concurrent termination of the O&M Agreement. If the Supply and Processing Agreement terminates and is not replaced with a similar agreement providing for a known supply source of zinc concentrate, the Partnership will need to seek out alternative zinc concentrate supply relationships. As discussed above, in November 2011, the Board advised that it had undertaken a review of the availability of funds for future distributions through its Independent Committee. The focus of the review by the Independent Committee was, among other things, to examine, using independent expertise, the future operations of the Fund upon the expiry of the Supply and Processing Agreement in In the event that the Independent Committee determines that the supply of zinc concentrate beyond 2017 is not sufficient to keep the Processing Facility running at full capacity, it may be necessary to establish significant cash reserves to cover closure costs of the Processing Facility. See also Overview Long-Term Strategy above. Under the terms of an Administration Agreement dated April 18, 2002 between the Fund and the Administrator, the Administrator provides administrative services to the Fund and management services to the Operating Trust. Pursuant to the Administration Agreement, Computershare Trust Company of Canada, the sole trustee of the Fund, has delegated all of its power and authority to the Administrator and the Administrator provides certain administrative and support services to the Fund, including to: (i) ensure compliance by the Fund with continuous disclosure obligations under applicable securities legislation; (ii) provide investor relations services; (iii) provide or cause to be provided to Unitholders all information to which Unitholders are entitled under the Fund s Trust Indenture including relevant information with respect to income taxes; (iv) call, hold and distribute materials, including notices of meetings and information circulars, in respect of all meeting of Unitholders; (v) compute, determine and make distributions to Unitholders; (vi) determine the amount of cash flow of the Fund, distributable cash flow, income, net realized capital gains, redemption income and redemption gains pursuant to the Fund s Trust Indenture; (vii) attend to all administrative and other matters arising in connection with any redemption of units; and (viii) ensure compliance with the Fund s limitations on non-resident 16 ANNUAL REPORT 2011 NORANDA INCOME FUND

19 ownership; and (ix) undertake all matters required by the Fund s Trust Indenture to be performed by the sole trustee. All costs connection with providing credit support in respect of the Operating Trust s existing ABL Facility. relating thereto are for the account of the Fund. During the twelve month period ended December 31, 2011, Pursuant to the Management Services Agreement dated Xstrata Canada sold to the Partnership $319.4 million of zinc April 18, 2002 between the Operating Trust and the Manager, concentrate (2010 $335.9 million) and provided $1.2 million the Manager provides management services to the Operating in sales agency services (2010 $1.2 million). The sales agency Trust. These services include assisting the Operating Trust in: services are provided on a cost recovery basis. (i) developing, implementing and monitoring a strategic plan; The administration, management and operating services (ii) developing an annual business plan which may include provided by the Manager are provided on a cost recovery basis operational and capital expenditures budgets when appropriate; and for a management fee of $0.3 million per annum, adjusted (iii) developing acquisition strategies, investigating potential upward annually by 2%. As a result of the Administration acquisitions and analyzing the feasibility of potential acquisitions; Agreement between the Fund and the Administrator, the (iv) carrying out acquisitions or dispositions and related Management Services Agreement between the Operating Trust financings required for such transactions; (v) assisting in and the Manager and the O&M Agreement between the connection with any financing of the Operating Trust or the Fund; Partnership and the Manager, the Manager has been paid the (vi) computing, determining and making distributions to following amounts for administration, management and unitholders of distributions properly payable by the Operating operating services in respect of the Fund and its subsidiaries and Trust; (vii) providing technical and evaluation services on assets for the years ended December 31, 2011 and equipment, processes and techniques relating to the operations December 31, 2010, respectively. of the business; (viii) supervising the operation of the Operating Trust s business; and (ix) preparing, planning and co-ordinating Services provided by Xstrata Canada ($ millions) management and Trustees meetings. In consideration for Salary and benefits 1 $ 64.9 $ 67.5 providing the services under the Management Services Support services 1.2 $ 1.2 Agreement, the Manager is entitled to reimbursement of its O&M Agreement management fee 0.3 $ 0.3 direct and indirect costs and expenses incurred in connection Total $ 66.4 $ 69.0 with its duties under the Management Services Agreement. 1 This represents all amounts paid in respect of salaries and benefits for all of the For further details concerning the above agreements, reference is made to the Management Information Circular of the Fund dated May 4, 2011, the Fund s 2010 Annual Information Form dated March 22, 2011 (under the headings Xstrata Canada Corporation Major Agreements and The Administrator and Manager ), and the notes to the Audited employees of the Manager in connection with the operation of the Processing Facility and the services provided to the Fund, the Operating Trust and the Partnership. In addition, the Fund undertakes other transactions with Xstrata Canada and affiliated companies, at terms that reflect market rates. The table below summarizes sales and purchases that were transacted with Xstrata Canada and affiliated companies for 2011 and 2010, respectively: Consolidated Financial Statements of the Fund for the year ended December 31, Copies are available on SEDAR at Sales and Purchases ($ millions) Sales Any agreements entered into by Xstrata Canada as agent on Sales of zinc metal $ 34.0 $ 72.1 behalf of the Partnership with any party related to Xstrata Sales of byproducts Canada, and which are material to the Partnership, must be on Purchases terms that are, collectively, no less favourable to the Partnership Purchases of raw materials and than those available at the time from a reputable, non-related operating supplies party. These agreements must be reviewed and approved by the Credit support from Xstrata Canada $ 0.0 $ 0.4 Audit Committee of the Operating Trust, all of the members of which are unrelated to Xstrata Canada. In addition, Xstrata Canada and the Manager have entered into various agreements and provided certain consents in ANNUAL REPORT 2011 NORANDA INCOME FUND 17

20 Management s Discussion and Analysis FINANCIAL INSTRUMENTS AND OTHER INSTRUMENTS December 31, 2011 was recognized as a derivative financial liability of $5.8 million and a long-term derivative financial Due to the structure of the Processing Facility s purchase and liability of $0.3 million on the Fund s consolidated statements of sale contracts, the Fund has the ability to manage some of its financial position. exposure to fluctuations in zinc market prices. Zinc metal The Fund has applied hedge accounting to its fixed forward products are generally sold approximately two months after the sales contracts, and as such, in addition to recording the fair concentrate from which they are made is delivered. As a result, value of the fixed forward contract, the fair value of the related by pricing the payable zinc metal contained in zinc concentrate fixed sales commitment has also been recognized as a firm at the LME zinc reference price in the second month following its commitment asset of $5.9 million and a long term-firm delivery, and by pricing the processing fee in Canadian dollars, commitment asset of $0.3 million. Any net difference in the the Supply and Processing Agreement seeks to limit the change in the fair value of both items between reporting dates exposure to zinc metal price fluctuations during the period in represents the ineffective portion of the hedge, and is recorded which the concentrate is transformed into zinc metal. This results as a commodity hedging gain or loss. in matching the timing of pricing of the purchase of zinc The Fund does not enter into any hedging contracts for the concentrate with the expected timing of sales of the refined zinc purposes of speculation. metal produced from that concentrate. The Fund, through The Fund has separated and recorded at fair value, Xstrata Canada, enters into hedges ( inventory management embedded derivatives resulting from the provisional pricing program ) to the extent that the natural hedge does not fully feature in the Supply and Processing Agreement. Under the minimize exposure to fluctuations in zinc prices. As at terms of this agreement, final prices for purchases of December 31, 2011, the Fund had bought forward concentrate ( quotational pricing ) are based on the LME price approximately 26 million pounds of zinc, related to the inventory prevailing on a specified future date after shipment ( quotational management program hedges. The fair value of these positions period ). The Fund accounts for changes in the fair value of as at December 31, 2011 was a loss of $1.4 million and is unsettled concentrate payable amounts resulting from recognized as a derivative financial liability on the Fund s quotational pricing with reference to forward LME rates for the consolidated statements of financial position. remaining quotational period through gains or losses recorded in In addition, some customers request a fixed sales price raw material purchases costs and corresponding adjustments in (instead of the LME average price in the month of shipment) in accounts payable and accrued liabilities. During the twelve order to lock in the price of their zinc purchases for a future month periods ended December 31, 2011, the Fund recorded a period of time, generally not exceeding one year. These decrease of raw material purchase costs of $11.3 million related arrangements, referred to as fixed forward sales contracts, are to the change in fair value of the embedded derivatives resulting generally made available to customers who request them and from the quotational pricing feature of its zinc concentrate who meet the Fund s credit criteria for such contracts. When payables (2010 an increase of $2.5 million). entering into a fixed forward sales contract, the Fund, through its The Fund has exposure to the US dollar for its cash, accounts sales agent, Xstrata Canada, offsets this price risk by hedging receivable, inventory, accounts payable and accrued liabilities with appropriate futures contracts with maturities and quantities and bank debt. The Fund attempts to manage the overall which will match those which the customer has contracted to economic exposure to the US dollar by matching US dollar assets purchase the metal. These futures contracts typically allow the to US dollar liabilities. This currency exposure is managed in part Fund to receive the LME average price plus a premium in the through US dollar overnight transactions. As at December 31, month of shipment, while customers pay the agreed-upon price 2011, the Fund had bought forward US dollars with a notional plus a premium. In the event that the futures contracts have to amount of US$66.2 million and sold forward dollars with a be terminated early, due to the customer cancelling a fixed price notional amount of $67.5 million. An unrealized gain of order, Xstrata Canada, on behalf of the Fund has the right to $0.2 million related to these open positions was recorded as at charge the customer with the cost of settling the LME contract. December 31, The fair value of these open futures contracts as at 18 ANNUAL REPORT 2011 NORANDA INCOME FUND