Breakwater Resources Ltd.
TSX : BWR

Breakwater Resources Ltd.

November 01, 2006 18:47 ET

Breakwater Reports Financial and Operating Results for the Interim Periods Ended September 30, 2006 and 2005

TORONTO, ONTARIO--(Marketwire - Nov. 1, 2006) -

Attention Business/Financial Editors:

Breakwater Resources Ltd. (TSX:BWR) This Management's Discussion and Analysis (the "MD&A") of Breakwater Resources Ltd. ("Breakwater" or the "Company") should be read in conjunction with the Company's unaudited consolidated financial statements for the three and nine months ended September 30, 2006, and related notes thereto which have been prepared in accordance with Canadian generally accepted accounting principles ("GAAP"). This should also be read in conjunction with the audited consolidated financial statements for the year ended December 31, 2005, related annual Management's Discussion and Analysis, and the Annual Information Form 40-F on file with the Canadian provincial securities regulatory authorities and the U.S. Securities and Exchange Commission. Unless otherwise indicated, this Management's Discussion and Analysis has been prepared as of November 1, 2006.

Breakwater is a mining, exploration and development company with operations in Canada, Honduras and Chile. The Company produces and sells zinc, copper, lead and gold concentrates to customers around the world. The Company's revenues are earned in US dollars, but are reported in Canadian dollars.



Third Quarter 2006 Highlights

- Net earnings increased to $40.7 million or $0.11 basic earnings per
common share.

- The Caribou property was sold for a gain of $13.8 million or $0.04
basic earnings per common share.

- Gross sales revenue increased by 56% to $112.0 million despite a drop
in tonnes of concentrate sold.

- Cash and cash equivalents increased by $23.1 million to $63.4 million.

- Total debt decreased by $3.3 million to $6.0 million.

- Contribution from mining activities set a record high by increasing to
$43.1 million.

- Drilling on the Porvenir deposit at El Toqui continued.

Outlook

- Metal prices continue to support strong operating results into the
fourth quarter.

- El Mochito and El Toqui future profits to be taxed at approximately
30% and 17% respectively.

- The Langlois mine development remains on time and on budget and is
expected to achieve full commercial production in mid-2007.


Statement of Operations Review - Three and Nine Months Ended

September 30, 2006 and 2005

The closure of Bouchard-Hebert in February and Bougrine in September of 2005 affect all aspects of the Company's financial results, which makes comparisons between quarters difficult.

Gross Sales Revenue

Gross sales revenues on the sale of zinc, copper, lead and gold concentrates for the three month period ended September 30, 2006 (the "third quarter of 2006") increased $40.1 million (56%) to $112.0 million compared with the three month period ended September 30, 2005 (the "third quarter of 2005"). Higher metal prices and a hedging gain of $0.6 million accounted for the increase partially offset by decreased concentrate sales - 61,385 tonnes in the third quarter of 2006 compared with 80,206 tonnes in the third quarter of 2005 - and a stronger Canadian dollar. The lower concentrate tonnage sold in the third quarter of 2006 was primarily due to the closure of the Bougrine mine in 2005 as well as reductions in concentrate tonnage sold at the El Mochito and El Toqui mines in the third quarter of 2006 compared with the third quarter of 2005.

Gross sales revenues for the nine month period ended September 30, 2006 (the "first nine months of 2006") increased $38.3 million (15%) to $293.9 million compared with the nine month period ended September 30, 2005 (the "first nine months of 2005"). The increase in gross sales revenues was primarily due to higher metal prices partially offset by decreased concentrate sales - 188,518 tonnes in the first nine months of 2006 compared with 306,749 tonnes in the first nine months of 2005 - a stronger Canadian dollar and losses on hedging positions of $3.8 million. The lower concentrate tonnage sold in the first nine months of 2006 compared with the first nine months of 2005 were primarily due to the same factors noted above for the quarter as well as the closure of the Bouchard-Hebert mine in 2005.



($000s) Third Quarter Change First Nine Months Change
-------------------------------------------------------------------------
Gross Sales Revenue
by Operation 2006 2005 % 2006 2005 %
-------------------------------------------------------------------------
Myra Falls 60,832 31,146 95 153,360 96,336 59
El Mochito 37,174 18,158 105 89,096 63,979 39
El Toqui 13,432 12,550 7 55,277 34,830 59
Bougrine 0 10,659 (100) (52) 35,921 (100)
Bouchard-Hébert 0 0 0 0 25,129 (100)
Corporate and Other 599 (580) n/a (3,784) (580) n/a
-------------------------------------------------------------------------
112,037 71,933 56 293,897 255,615 15
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Gross Sales
Revenue by Metal
-------------------------------------------------------------------------
Zinc (US$) 68,019 32,735 108 179,384 130,847 37
Copper (US$) 17,949 11,778 52 39,304 32,354 21
Lead (US$) 2,497 4,427 (44) 8,513 15,322 (44)
Gold (US$) 5,137 7,288 (30) 15,633 17,245 (9)
Silver (US$) 6,326 4,150 52 14,122 13,302 6
Hedging mark-to-market
and revaluation 222 (531) n/a 2,431 (503) n/a
-------------------------------------------------------------------------
Total Gross Sales
Revenue (US$) 100,150 59,847 67 259,387 208,567 24
-------------------------------------------------------------------------
Realized exchange
rate (C$/US$)
period average 1.1187 1.2019 (7) 1.1330 1.2256 (8)
-------------------------------------------------------------------------
Total Gross Sales
Revenue (C$) 112,037 71,933 56 293,897 255,615 15
-------------------------------------------------------------------------

-------------------------------------------------------------------------
Sales by Concentrate
(tonnes) Third Quarter First Nine Months
-------------------------------------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
Zinc 47,198 57,130 150,474 234,317
Copper 10,638 14,326 25,120 45,533
Lead 3,310 8,250 11,635 26,384
Gold 239 500 1,289 515
-------------------------------------------------------------------------
Total Sales 61,385 80,206 188,518 306,749
-------------------------------------------------------------------------

-------------------------------------------------------------------------
Sales by Payable Metal Third Quarter First Nine Months
-------------------------------------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
Zinc - tonnes 20,259 25,258 65,268 103,530
Copper - tonnes 2,339 3,179 5,446 9,461
Lead - tonnes 2,140 5,029 7,429 16,148
Gold - ounces 8,354 16,494 31,607 39,615
Silver - ounces 548,325 583,219 1,594,987 1,884,993

-------------------------------------------------------------------------
Realized Prices Third Quarter First Nine Months
-------------------------------------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
Zinc (US$/tonne) 3,357 1,296 2,748 1,264
Copper (US$/tonne) 7,675 3,705 7,217 3,420
Lead (US$/tonne) 1,166 880 1,146 949
Gold (US$/oz) 615 442 495 435
Silver (US$/oz) 11.54 7.12 8.85 7.06

-------------------------------------------------------------------------
Average LME Metal Prices &
Foreign Exchange Third Quarter First Nine Months
-------------------------------------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
Zinc (US$/tonne) 3,363 1,297 2,966 1,295
Copper (US$/tonne) 7,667 3,755 6,604 3,470
Lead (US$/tonne) 1,188 890 1,176 952
Gold (US$/oz) 622 439 602 432
Silver (US$/oz) 11.70 7.07 11.22 7.07
Exchange rate (US$1.00/C$) 1.1213 1.2017 1.1326 1.2238


The Company has a relatively conservative revenue recognition policy which, among other things, requires final pricing of concentrate inventories prior to recognition of revenue. Using commodity prices and exchanges rates prevailing at September 30, 2006, the following schedule provides details regarding inventories shipped but not recognized for revenue purposes and the related provisional payments.



Concentrate Net Inventory Earnings Provisional Weighted
(DMT) Smelter Value Before Payments Average
Return ($000s) Taxes ($000s) Months to
($000s) ($000s) Settlement
--------------------------------------------------------------------
Zinc 32,933 35,397 16,213 19,184 24,455 2.1
Lead 2,860 4,494 1,344 3,150 - 2.1
Gold 1,334 4,169 1,599 2,570 1,615 1.6
---------------------------------------------------------
37,127 44,060 19,156 24,904 26,070 -
---------------------------------------------------------
---------------------------------------------------------


At June 30, 2006, the Company estimated that inventories shipped but not recognized for revenue purposes had earnings before taxes of $33.0 million consisting of $57.9 million of net smelter return less $24.9 million of inventory valuation.

The Company periodically hedges against fluctuations in metal prices and foreign exchange with the use of forward sales or options.

Net Revenue

For the third quarter of 2006, net revenue, the value of concentrates sold after deducting treatment and marketing costs, was $82.7 million compared with $48.9 million in the third quarter of 2005. Total treatment and marketing costs, consisting of the amount paid to smelters for refining concentrates to produce metal, freight, shipping and marketing costs, increased to $29.4 million in the third quarter of 2006 compared with $23.0 million in the corresponding period in 2005 reflecting higher unit treatment charges and freight costs which more than offset the lower tonnes of concentrate sold. Per tonne sold, total treatment and marketing costs increased to $479 in the third quarter of 2006 from $287 in the corresponding period in 2005 as higher metal prices triggered higher costs associated with price escalator provisions in treatment charges.

For the first nine months of 2006, net revenue increased 28% to $214.1 million compared with the first nine months of 2005. Total treatment and marketing costs decreased to $79.8 million in the first nine months of 2006 compared with $87.8 million in the first nine months of 2005. The decreased treatment and marketing costs in the first nine months of 2006 was primarily due to the closure of the Bougrine and Bouchard-Hebert mines in 2005 and fewer tonnes of concentrate sold, partially offset by higher unit treatment charges and freight costs. Treatment charges and marketing costs per tonne of concentrate sold increased to $423 for the first nine months of 2006 from $286 for the first nine months of 2005 due to the impact of higher costs associated with price escalators triggered by higher metal prices and higher freight costs.

Direct Operating Costs

Direct operating costs were $34.9 million ($568 per tonne of concentrate sold) for the third quarter of 2006 compared with $33.4 million ($416 per tonne of concentrate sold) in the same period in 2005. For the nine months ended September 30, 2006, direct operating costs were $97.9 million compared with $119.8 million for the first nine months of 2005, the average cost per tonne of concentrate sold increased to $519 from $390. The average operating cost per tonne of concentrate sold was higher in both the third quarter and the first nine months of 2006 primarily due to higher costs at the Myra Falls and El Mochito mines and the closure of two lower cost mines in 2005 - Bougrine and Bouchard-Hebert.



Direct Operating Costs
-------------------------------------------------------------------------
Third Quarter 2006 Third Quarter 2005
-------------------------------------------------------------------------
Concentrate Cost Per Concentrate Cost Per
Aggregate Sold Tonne Aggregate Sold Tonne
($000s) (tonnes) ($) ($000s) (tonnes) ($)
-------------------------------------------------------------------------
Myra Falls 25,098 31,651 793 20,921 28,784 727
El Mochito 7,434 21,750 342 6,411 23,718 270
El Toqui 2,362 7,984 296 3,782 12,347 306
Bougrine 0 0 0 2,244 15,357 146
-------------------------------------------------------------------------
Total 34,894 61,385 568 33,358 80,206 416
-------------------------------------------------------------------------

Direct Operating Costs
-------------------------------------------------------------------------
First Nine Months 2006 First Nine Months 2005
-------------------------------------------------------------------------
Concentrate Cost Per Concentrate Cost Per
Aggregate Sold Tonne Aggregate Sold Tonne
($000s) (tonnes) ($) ($000s) (tonnes) ($)
-------------------------------------------------------------------------
Myra Falls 66,019 90,856 727 56,641 99,430 570
El Mochito 20,561 62,618 328 23,730 81,232 292
El Toqui 11,305 35,044 323 16,141 45,222 357
Bougrine 0 0 0 12,931 50,051 258
Bouchard-Hébert 0 0 0 10,334 30,814 335
-------------------------------------------------------------------------
Total 97,885 188,518 519 119,777 306,749 390
-------------------------------------------------------------------------


The total cash cost per pound of payable zinc sold, which includes direct operating costs and treatment and marketing costs, net of by-product credits, was US$0.57 in the third quarter of 2006 compared with US$0.36 in the third quarter of 2005 (see non-GAAP reconciliation for details). The higher total cash cost per pound of zinc sold in the third quarter of 2006 is a result of lower zinc concentrate sales and higher cash per pound of zinc sold partially offset by higher by-product credits.

Depreciation and Depletion

Total depreciation and depletion expenses were significantly lower in both the third quarter and the first nine months of 2006 primarily due to the closures of Bouchard-Hebert and Bougrine mines in 2005. On a per tonne of concentrate sold basis, depreciation and depletion expenses in the third quarter and first nine months of 2006 were $61 (2005 - $64) and $65 (2005 - $61) respectively.

Reclamation and Closure Costs

The reclamation and closure costs accrual is accreted over time increasing to the expected future costs of reclaiming the Company's mine sites. Reclamation and closure costs were lower in both the third quarter and the first nine months of 2006 compared with the corresponding periods in 2005 by $6.2 million and $8.8 million respectively due to upward adjustments in the cash flow estimate for projected reclamation costs of Nanisivik in 2005 of $6.0 million and $8.1 million respectively.

Other Expenses (Income)

Other expenses (income) in the third quarter of 2006 decreased by $0.3 million while, for the first nine months of 2006, other expense (income) increased by $4.2 million. Decreased other expenses (income) for the third quarter of 2006 were primarily due to: increased investment and other income; a foreign exchange gain; and a lower loss on gold loan, partially offset by increased general and administrative and interest and financing expenses. The increase in other expense (income) for the nine month period ended September 30, 2006 compared with the same period in 2005 was primarily due to: increased general and administrative; interest and financing; and, stock-based compensation expenses; partially offset by increased investment and other income and a foreign exchange gain.

General and administrative expenses increased in the third quarter and first nine months of 2006 compared with the corresponding periods in 2005, primarily due to increases in: accrued bonuses and salaries; consulting and audit fees associated with Sarbanes-Oxley compliance; and, insurance costs.

Higher interest and financing expenses and investment and other income for the third quarter and the first nine months of 2006 compared with the corresponding periods in 2005 were primarily due to the impact of a royalty agreement entered into in December 2005 and interest earned on bank deposits in 2006.

Exploration Costs

Exploration costs in the third quarter and the first nine months of 2006 increased by $0.4 million and $2.9 million respectively primarily due to additional exploration costs being expensed at Bouchard-Hebert and Myra Falls mines.

Other Non-producing Property (Income) Costs

Other non-producing property (income) costs include care and maintenance costs, holding costs, settlement costs and other costs associated with non-producing properties net of proceeds received from those properties related to property options sold and assets sold.

Other non-producing property costs for the third quarter and the first nine months of 2006 decreased by $14.7 million and $17.5 million respectively. The decreased other non-producing property costs for both periods were primarily due to the gain on sale of the Caribou property of $13.8 million, reduced costs at the Nanisivik and Bouchard-Hebert properties partially offset by the settlement of a legal action associated with the Caribou property.

Income and Mining Taxes Provision (Recovery)

Income and mining taxes provision increased $12.7 million in the third quarter 2006 compared with the third quarter 2005 primarily due to increased tax provisions required for the Langlois, El Mochito and El Toqui mines as well as for adjustments to the Myra Falls mine future tax asset.

For the first nine months of 2006, income and mining tax recovery increased by $9.8 million primarily due to a net future tax asset of $23.7 million related to the Myra Falls mine partially offset by the items noted above and a reversal of a future tax asset at El Mochito.

Cash Provided from Operating Activities (before changes in non-cash

working capital items)

Cash provided from operating activities (before changes in non-cash working capital items) was $38.0 million in the third quarter of 2006 compared with $1.6 million in the same period in 2005. For the first nine months of 2006, cash provided from operating activities (before changes in non-cash working capital items) increased by $75.7 million to $91.4 million. The increases for the third quarter and the first nine months of 2006 compared with the corresponding 2005 periods were primarily due to significantly higher metal prices despite selling fewer tonnes of concentrate.



-------------------------------------------------------------------------
($ millions) Third Quarter First Nine Months
-------------------------------------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
Contribution from mining
activities 43.1 3.3 101.2 17.9
Other expenses (income) (2.1) (2.4) (9.6) (5.3)
Exploration costs (0.7) (0.3) (3.1) (0.3)
Write-down of mineral
properties and fixed assets 0.0 (0.7) 0.0 (0.7)
Other non-producing property
(income) costs 12.9 (1.8) 10.2 (7.3)
Income and mining tax
(provision) recovery (12.5) 0.3 10.4 0.6
-------------------------------------------------------------------------
Net earnings 40.7 (1.6) 109.1 4.9
Closure costs and employee
future benefits (2.9) (10.5) (8.1) (21.6)
Non-cash items 0.2 13.7 (9.6) 32.4
-------------------------------------------------------------------------
Cash provided from operating
activities (before changes
in non-cash working capital
items) 38.0 1.6 91.4 15.7
-------------------------------------------------------------------------
(See non-GAAP reconciliation below)


Liquidity and Financial Position Review

Working Capital

Working capital as at September 30, 2006 was $95.1 million compared with $44.4 million at December 31, 2005, an increase of $50.7 million.

Current Assets

Total current assets increased by $58.1 million to $175.0 million at September 30, 2006 compared with December 31, 2005. The main components of current asset changes were as follows:



- Cash and cash equivalents increased by $44.7 million reflecting
improved operating cash flow generated by stronger metal prices.
- Short-term investments increased by $5.7 million primarily due to the
reclassification of the Taseko debenture from long-term investment
partially offset by the delivery in January 2006 of gold held at
December 31, 2005 for an instalment payment on the gold loan.
- Accounts receivable - concentrate decreased by $2.0 million primarily
due to a decrease in the El Toqui mine receivables and the closure of
the Bougrine mine.
- Concentrate inventory decreased by $5.7 million primarily due to a
reduction of concentrate inventories at Myra Falls partially offset by
an increase at Toqui.
- Future income tax assets increased by $17.8 million reflecting the
setup of a net $23.7 million future income tax asset for the Myra
Falls mine offset by a $5.5 million future tax asset drawdown at El
Mochito and other drawdowns of $0.5 million.


Current Liabilities

Current liabilities increased by $7.4 million to $79.9 million at September 30, 2006 compared with December 31, 2005. The main components of the current liabilities change were as follows:



- Provisional payments for concentrate inventory shipped and not priced
represent payments received for concentrate shipments that were not
recognized as revenue. The balance as at September 30, 2006 was
$26.1 million. Please refer to the table in Gross Sales Revenue
section of this MD&A for additional details. The December 2005 balance
of $14.8 million was for payments for zinc concentrate shipments from
the Myra Falls mine.
- Short-term debt decreased by $9.8 million primarily due to accelerated
repayment of the $1.5 million prepayment facility and repayment of the
gold loan partially offset by a new loan facility established in 2006
of which $2.5 million was outstanding at September 30, 2006.
- Income and mining taxes payable increased by $4.4 million primarily
due to full utilization of loss carry forwards at El Mochito mine
resulting in a tax provision being required in the third quarter of
2006.


Restricted Cash and Reclamation Deposits

At September 30, 2006, the Company had restricted cash of $1.7 million, a decrease of $2.3 million from December 31, 2005. The reduction in restricted cash was primarily due to the receipt of $1.3 million from the gold loan collateral funds and receipt of $1.1 million held by the Province of Quebec.

At September 30, 2006, the Company had reclamation deposits of $13.5 million, an increase of $6.7 million from December 31, 2005. The increase was primarily due to $13.4 million of reclamation deposits held under a safe keeping agreement for the benefit of the British Columbia government in support of reclamation requirements at Myra Falls entered into in the first quarter of 2006 partially offset by reimbursement of $5.9 million for reclamation deposits previously held by the Province of New Brunswick as reclamation security on sale of the Caribou property in August 2006.

Long-term Investment

At September 30, 2006, long-term investment increased by $3.5 million to $9.1 million from $5.6 million at December 31, 2005. As part of the consideration received on the sale of the Caribou property on August 1, 2006, the Company received a convertible debenture in Blue Note Metals Inc. in the amount of $15.0 million which the Company valued at $9.1 million. At December 31, 2005, long-term investment consisted of a $5.6 million convertible debenture of Taseko. In the first quarter of 2006, this investment was reclassified to short term investments.

Restricted Promissory Note

The Company held two restricted promissory notes at the end of September 30, 2006 and December 31, 2005 for a total of $62.3 million related to the 2004 and 2005 Red Mile transactions.

Deferred Income

Deferred income was $6.4 million at September 30, 2006 compared with $6.9 million at the end of 2005. At September 30, 2006, $5.1 million related to the indemnity agreement fees and interest that the Company received as part of the Red Mile transactions in 2004 and 2005; these amounts will be brought into income over the expected ten year lives of the two agreements. The balance is a US$1.0 million advance of a non-refundable royalty payment received on the sale of the Lapa properties in June 2003. In accordance with the original agreement, this amount will be included in income only when the Lapa properties are put into production.

Royalty Obligation

The Royalty Obligation of $62.5 million relates to the royalty amounts received from the 2004 and 2005 Red Mile transactions.

Debt

Total debt at September 30, 2006 was $5.3 million, a reduction of $13.4 million compared with $18.7 million at the end of 2005.

In the first quarter of 2006, the Company obtained a prepayment facility of US$1.4 million to buy back calls on 10,000 ounces of gold. The prepayment facility has scheduled principal repayments of US$0.7 million from the proceeds of the delivery of the gold forward sales in each of September and October 2006. The initial repayment for September 2006 was made. In the second quarter of 2006, the Company entered into a supplementary repayment facility with the same lender of US$1.5 million which is secured by a promissory note due December 2006.

In August 2005, the Company completed a Gold Based Pre-production Advance Facility. Under the terms of this facility, the Company received US$10.0 million gold equivalent (sufficient gold was borrowed and then sold at the prevailing spot price of US$431 per ounce to provide the dollar value of the facility). The term of this facility was 13 months with six principal payments commencing October 2005 and ending August 2006. The repayments were in the form of gold and as at September 30, 2006, this loan had been repaid in full.

The Company entered into a concentrate prepayment contract with a customer in May 2005 whereby the customer advanced the Company US$5.0 million against future deliveries of zinc concentrate. Given the Company's strong cash flow, it elected to fully repay this prepayment facility in May 2006.

Reclamation and Closure Cost Accrual

Reclamation and closure costs represent the Company's obligation for future reclamation and severance costs accrued for its mine sites. At September 30, 2006, total accrued reclamation and closure costs were $41.3 million compared with $50.3 million at December 31, 2005.



Reclamation and Closure Cost Accrual at September 30, 2006

-------------------------------------------------------------------------
($ millions) Current Long-term Total
-------------------------------------------------------------------------
Myra Falls 2.0 25.1 27.1
El Mochito 0.0 1.3 1.3
El Toqui 0.0 3.9 3.9
Langlois 0.0 1.3 1.3
Bougrine 1.8 0.4 2.2
Bouchard-Hébert 2.6 0.1 2.7
Nanisivik 2.4 0.4 2.8
-------------------------------------------------------------------------
Total 8.8 32.5 41.3
-------------------------------------------------------------------------


Future Income Tax Liabilities

At September 30, 2006, future income tax liabilities were $7.1 million, an increase of $5.2 million from December 31, 2005. The increase in future tax liabilities was primarily due to setting up Quebec mining duties related to the Langlois mine.

Equity

Shareholders' equity at September 30, 2006 was $267.7 million compared with $162.7 million at December 31, 2005, an increase of $105.0 million primarily due to net earnings of $109.1 million in the period.



----------------------
Shareholders' Equity
-------------------------------------------------------------------------
($000s) Cumulative Total
Contri- Retained Trans- Share-
Capital buted Earnings lation holders'
Stock Warrants Surplus (Deficit) Account Equity
-------------------------------------------------------------------------
As at December 31,
2005 335,512 8,561 3,300 (172,928) (11,699) 162,746
Reduction of
stated capital (169,628) - (3,300) 172,928 - -
Value ascribed to
options exercised
under stock-based
compensation 400 - (400) - - -
Employee share
option plan -
proceeds of
options exercised 766 - - - - 766
Employee share
purchase plan 108 - - - - 108
Exercise of warrants 190 - - - - 190
Settlement of liability 848 - - - - 848
Renunciation of
flow-through
share value (2,345) - - - - (2,345)
Stock-based
compensation - - 1,201 - - 1,201
Net earnings - - - 109,069 - 109,069
Cumulative translation
adjustments - - - - (4,884) (4,884)
-------------------------------------------------------------------------
As at September 30,
2006 165,851 8,561 801 109,069 (16,583) 267,699
-------------------------------------------------------------------------


At the annual and special meeting held on June 8, 2006, the shareholders approved a special resolution to reduce the stated capital of the Company by an amount of $172.9 million, which is equal to the accumulated deficit as at December 31, 2005. The capital stock was reduced by $169.6 million, contributed surplus was reduced by $3.3 million and the deficit was reduced by $172.9 million.

For the first nine months of 2006, the Company issued the following Common Shares: 1,541,067 following the exercise of employee share options; 131,221 pursuant to the Company's employee share purchase plan; 1,000,000 pursuant to warrants exercised; and, 750,000 in settlement of an outstanding lawsuit.

Capital Expenditures

The Company invested $22.9 million in mineral properties and fixed assets in the third quarter of 2006. The majority of the capital was spent as follows:



- Myra Falls - $4.7 million; $2.8 million on mine development and the
new surface ramp and $1.0 million on mill improvements including the
new lead circuit and $0.9 million on a surface project.
- El Mochito - $3.0 million; $0.8 million on the tailing facilities,
$1.2 million for mine development, $0.1 million on mobile equipment
and $0.9 million on exploration.
- El Toqui - $3.0 million; $1.8 million on mine development including
the initial development of the Concordia mine, ($0.4) million on
equipment disposal and $1.6 million on exploration.
- Langlois - $11.0 million; $7.0 million on mine development and
$4.0 million on exploration.
- Bougrine - $0.3 million on exploration.
- Other projects - $0.9 million on exploration expenses.


Financial Capability

With the existing working capital, the current metal prices and current US$/C$ exchange rate, the Company is well positioned to carry out its operating, capital, exploration and environmental programs as presently contemplated for the balance of 2006.

The Company's financial capability is sensitive to metal prices and the US$/C$ exchange rate (please see page 9 of the Company's 2005 annual report).



Operating Review for the Three Months Ended September 30, 2006

-------------------------------------------------------------------------
Contribution
(Loss) From Non-cash Capital
Net Revenue Mining Costs(2) Expenditures
Activities(1)
-------------------------------------------------------------------------
($ millions) 2006 2005 2006 2005 2006 2005 2006 2005
-------------------------------------------------------------------------
Myra Falls 44.1 23.0 16.5 0.2 2.5 1.9 4.7 4.4
El Mochito 29.5 11.7 20.7 4.1 1.3 1.2 3.0 1.7
El Toqui 8.5 8.1 5.6 3.5 0.5 0.7 3.1 1.0
Langlois 0.0 0.0 0.0 0.0 0.0 0.0 10.6 1.7
Bougrine 0.0 6.7 0.0 2.6 0.1 2.0 0.3 0.0
Bouchard-Hébert 0.0 0.0 (0.1) (0.2) 0.1 0.2 0.0 (0.1)
Nanisivik 0.0 0.0 (0.1) (6.1) 0.1 6.1 0.0 0.0
Other 0.6(3) (0.6)(3) 0.5 (0.8) 0.0 0.1 1.2 0.0
-------------------------------------------------------------------------
Total 82.7 48.9 43.1 3.3 4.6 12.2 22.9 8.7
-------------------------------------------------------------------------
(1) After non-cash costs.
(2) Depreciation, depletion and reclamation and closure costs.
(3) Net realized from metal hedging activities.


Operating Review for the Nine Months Ended September 30, 2006

-------------------------------------------------------------------------
Contribution
(Loss) From Non-cash Capital
Net Revenue Mining Costs(2) Expenditures
Activities(1)
-------------------------------------------------------------------------
($ millions) 2006 2005 2006 2005 2006 2005 2006 2005
-------------------------------------------------------------------------
Myra Falls 112.0 66.6 38.8 1.8 7.1 8.1 13.2 12.1
El Mochito 68.7 41.0 43.9 13.0 4.3 4.3 8.3 5.9
El Toqui 37.2 20.3 23.3 0.8 2.6 3.3 9.7 5.3
Langlois 0.0 0.0 (0.1) (0.1) 0.1 0.1 19.0 4.4
Bougrine 0.0 22.3 (0.1) 5.4 0.1 3.9 0.7 0.1
Bouchard-Hébert 0.0 18.3 (0.3) 6.4 0.3 1.6 0.0 0.6
Nanisivik 0.0 0.0 (0.2) (8.4) 0.2 8.5 0.0 0.0
Other (3.8)(3) (0.6)(3) (4.1) (1.0) 0.3 0.4 1.4 0.0
-------------------------------------------------------------------------
Total 214.1 167.9 101.2 17.9 15.0 30.2 52.3 28.4
-------------------------------------------------------------------------
(1) After non-cash costs.
(2) Depreciation, depletion and reclamation and closure costs.
(3) Net realized from metal hedging activities.


Production Results

Consolidated production is set forth in the following table.

-------------------------------------------------------------------------
All Mines Third Quarter First Nine Months
---------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
Ore Milled (tonnes) 455,650 568,074 1,475,625 1,927,616
Zinc (%) 6.3 6.3 6.0 6.6
Concentrate Production
(tonnes)
Zinc 50,241 59,074 153,277 212,112
Copper 4,156 6,091 17,219 27,951
Lead 4,252 9,442 12,024 24,961
Gold 771 1,407 2,935 3,031
Total 59,420 76,014 185,455 268,055
Metal in Concentrates
Zinc (tonnes) 25,752 30,983 78,884 111,786
Copper (tonnes) 958 1,433 4,066 6,412
Lead (tonnes) 2,922 6,202 8,211 16,617
Gold (ounces) 12,160 17,822 43,762 58,472
Silver (ounces) 674,161 695,149 2,023,048 2,301,906
Total Cash Costs
Per lb. payable zinc
produced (US$) 0.74 0.39 0.60 0.39


Aggregate production of zinc in concentrate in the third quarter of 2006 was 56.8 million pounds compared with 68.3 million pounds in the third quarter of 2005, a 17% reduction. The reduced zinc production during the quarter reflects lower zinc head grades at Myra Falls and Mochito, lower milled tonnes at Myra Falls, and the end of production at the now closed Bougrine mine.

Total cash costs per pound of payable zinc produced ("TCC") increased by $0.35 and $0.21 per pound in the third quarter and first nine months of 2006 respectively. Total aggregate cost of zinc production increased primarily due to higher aggregate direct operating costs in general and the impact of higher commodity prices increasing treatment costs associated with price escalator provisions in smelter contracts and higher Toqui net smelter return royalties partially offset by higher by-product credits. The TCCs increased significantly in the third quarter and the first nine months of 2006 as the higher aggregate costs of zinc production noted above were incurred over a lower production level relative to the comparable periods in 2005.

The following table sets forth zinc production at each site for the third quarter and the first nine months of 2006 together with the change from the prior period.



-------------------------------------------------------------------------
Zinc Production
(million pounds
of zinc Third Quarter First Nine Months
contained in ---------------------------------------------------------
concentrate) 2006 2005 % 2006 2005 %
-------------------------------------------------------------------------
Myra Falls 17.6 20.3 (13.3) 59.6 82.7 (27.9)
El Mochito 18.3 23.4 (21.8) 61.9 69.6 (11.1)
El Toqui 20.9 15.1 38.4 52.4 45.3 15.7
Bougrine - 9.5 - - 35.0 -
Bouchard-Hébert - - - - 13.9 -
-------------------------------------------------------------------------
Total zinc
production 56.8 68.3 (16.8) 173.9 246.5 (29.5)
-------------------------------------------------------------------------

Production of copper in concentrate decreased 34% in the third quarter of
2006 from the same period in 2005 due to lower milled tonnes and lower
copper grades at Myra Falls.

-------------------------------------------------------------------------
Copper Production
(million pounds
of copper Third Quarter First Nine Months
contained in ---------------------------------------------------------
concentrate) 2006 2005 % 2006 2005 %
-------------------------------------------------------------------------
Myra Falls 2.1 3.2 (34.4) 10.1 13.1 (22.9)
Bouchard-Hébert - - - - 1.0 -
-------------------------------------------------------------------------
Total copper
production 2.1 3.2 (34.4) 10.1 14.1 (28.4)
-------------------------------------------------------------------------

Despite higher lead production at El Mochito, production of lead in
concentrate decreased 53% during the third quarter of 2006 due to the
closure of Bougrine.

-------------------------------------------------------------------------
Lead Production
(million pounds
of lead Third Quarter First Nine Months
contained in ---------------------------------------------------------
concentrate) 2006 2005 % 2006 2005 %
-------------------------------------------------------------------------
El Mochito 6.4 6.3 1.6 18.0 17.4 3.4
Bougrine - 7.4 - - 19.2 -
-------------------------------------------------------------------------
Total lead
production 6.4 13.7 (53.3) 18.0 36.6 (50.8)
-------------------------------------------------------------------------

Gold in concentrate decreased 40% in the third quarter of 2006 from the
same period in 2005 due to lower milled tonnes at Myra Falls and less gold
production from El Toqui.

-------------------------------------------------------------------------
Gold Production
(ounces of gold Third Quarter First Nine Months
contained in ---------------------------------------------------------
concentrate) 2006 2005 % 2006 2005 %
-------------------------------------------------------------------------
Myra Falls 3,736 5,278 (29.2) 15,282 23,490 (34.9)
El Toqui 6,929 12,544 (44.8) 26,985 32,338 (16.6)
Bouchard-Hébert - - - - 2,644 -
-------------------------------------------------------------------------
Total gold
production 10,665 17,822 (40.2) 42,267 58,472 (27.7)
-------------------------------------------------------------------------

Silver in concentrate decreased 3% quarter-over-quarter due to lower
tonnes milled and lower silver grades from Mochito and lower silver
production at El Toqui.

-------------------------------------------------------------------------
Silver Production
(ounces of silver Third Quarter First Nine Months
contained in -------------------------------------------------------
concentrate) 2006 2005 % 2006 2005 %
-------------------------------------------------------------------------
Myra Falls 237,348 177,751 33.5 685,074 878,502 (22.0)
El Mochito 421,510 483,666 (12.9) 1,287,073 1,277,380 0.8
El Toqui 15,303 33,732 (54.6) 50,901 106,011 (52.0)
Bouchard-Hébert - - - - 40,013 -
-------------------------------------------------------------------------
Total silver
production 674,161 695,149 (3.0) 2,023,048 2,301,906 (12.1)
-------------------------------------------------------------------------

Myra Falls Production
---------------------

The following table sets forth Myra Falls' production for the periods
ented.

-------------------------------------------------------------------------
Third Quarter First Nine Months
---------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
Ore Milled (tonnes) 151,838 187,511 548,255 685,694
-------------------------------------------------------------------------
Zinc (%) 6.0 5.8 5.7 6.3
-------------------------------------------------------------------------
Copper (%) 0.9 1.2 1.0 1.3
-------------------------------------------------------------------------
Silver (g/t) 61 48 50 52
-------------------------------------------------------------------------
Gold (g/t) 1.5 1.8 1.6 1.8
-------------------------------------------------------------------------
Concentrate Production
-------------------------------------------------------------------------
Zinc (tonnes) 15,373 17,241 51,952 70,145
-------------------------------------------------------------------------
Recovery (%) 87.5 85.4 86.1 86.8
-------------------------------------------------------------------------
Grade (%) 52.0 53.5 52.1 53.5
-------------------------------------------------------------------------
Copper (tonnes) 4,156 6,091 17,219 24,923
-------------------------------------------------------------------------
Recovery (%) 67.6 63.2 73.4 69.0
-------------------------------------------------------------------------
Grade (%) 23.0 23.5 23.6 23.8
-------------------------------------------------------------------------
Gold (tonnes) 1.3 6.9 12.7 24.8
-------------------------------------------------------------------------
Recovery (%) 10.4 17.1 10.9 19.5
-------------------------------------------------------------------------
Grade (g/t) 10,629 8,010 9,534 9,480
-------------------------------------------------------------------------
Metal in Concentrates
-------------------------------------------------------------------------
Zinc (tonnes) 7,992 9,228 27,057 37,493
-------------------------------------------------------------------------
Copper (tonnes) 958 1,433 4,066 5,942
-------------------------------------------------------------------------
Silver (ounces) 237,348 177,751 685,074 878,502
-------------------------------------------------------------------------
Gold (ounces) 5,231 5,278 16,777 23,490
-------------------------------------------------------------------------
Total Cash Costs
-------------------------------------------------------------------------
Per lb. payable zinc
produced (US$) 0.88 0.63 0.75 0.49
-------------------------------------------------------------------------


Zinc head grades were higher in the third quarter of 2006 from the same period in 2005 due to increased mining in the higher grade Battle/Gap Zone. Milled tonnage decreased during the third quarter of 2006 compared with the same period in 2005. Production was hindered during the quarter due to the lack of working areas underground, delays in improving the Battle Gap underground infrastructure and problems with underground equipment availability.

Myra Falls Outlook

Principally, ventilation requirements in the western extensions of the mine has slowed, and will continue to slow, production improvements in the short term. The surface ramp continues on plan and the breakthrough into the mine ventilation system is anticipated in early November.

The mill upgrades are on schedule and on budget. The new copper and zinc circuits have been commissioned resulting in improved recoveries for copper and zinc.

The development out to the Marshal zone continues on the 24 level. Diamond drilling began with one Company owned drill during the third quarter. An additional contract diamond drill will begin drilling in the fourth quarter.

El Mochito Production

---------------------

The following table sets forth El Mochito's production for the periods presented.



-------------------------------------------------------------------------
Third Quarter First Nine Months
---------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
Ore Milled (tonnes) 166,723 183,188 518,874 514,593
-------------------------------------------------------------------------
Zinc (%) 5.5 6.4 6.0 6.7
-------------------------------------------------------------------------
Lead (%) 2.1 1.9 2.0 1.9
-------------------------------------------------------------------------
Silver (g/t) 90 94 89 88
-------------------------------------------------------------------------
Concentrate Production
-------------------------------------------------------------------------
Zinc (tonnes) 15,855 20,134 53,687 60,154
-------------------------------------------------------------------------
Recovery (%) 90.1 91.1 90.6 91.6
-------------------------------------------------------------------------
Grade (%) 52.2 52.7 52.3 52.5
-------------------------------------------------------------------------
Lead (tonnes) 4,252 4,192 12,024 11,588
-------------------------------------------------------------------------
Recovery (%) 81.7 81.1 81.0 81.2
-------------------------------------------------------------------------
Grade (%) 68.7 67.8 68.3 68.3
-------------------------------------------------------------------------
Metal in Concentrates
-------------------------------------------------------------------------
Zinc (tonnes) 8,282 10,601 28,068 31,551
-------------------------------------------------------------------------
Lead (tonnes) 2,922 2,841 8,211 7,909
-------------------------------------------------------------------------
Silver (ounces) 421,510 483,666 1,287,073 1,277,380
-------------------------------------------------------------------------
Total Cash Costs
-------------------------------------------------------------------------
Per lb. payable zinc
produced (US$) 0.55 0.32 0.43 0.34
-------------------------------------------------------------------------


Zinc head grades were lower in the third quarter of 2006 from the same period in 2005 due to optimising the recovery of mineral reserves in the lower grade skarn areas such as Salva Vida and La Leona which are economic at current metal prices. The lower tonnage mined and milled was mainly a result of delays in sand filling several important zones during the quarter. Early in the quarter, the main line supplying sandfill into the mine was plugged for several days resulting in the sand fill schedule to the higher grade mining areas being delayed. This situation impacted tonnage mined and zinc head grades well into August.

During the third quarter of 2006, the Company experienced a delay in commissioning the new tailings facility. Storm damage necessitated a repair to the geomembrane liner which delayed commissioning of the facility into 2007. No production delays were experienced and none are anticipated.

El Mochito Outlook

During the third quarter of 2006, the Company continued to explore, develop and delineate new mineral resources and reserves along extensions of the productive Salva Vida and Santo Nino trends. Drilling at Barbasco continues to show a possible connection with the Imperial zone to the north. During the quarter, a decision was made to access the north eastern side of the past producing San Juan deposit to explore for material left behind from the old longhole stopes between levels 2350 and 2550. Exploration and delineation drilling of the La Leona deposit also continued to show promising results with increases expected in resources and reserves in this area.

During the third quarter of 2006, the Company continued its surface exploration program at El Mochito. Diamond drilling commenced on a second surface target near the San Juan called Bonanza. The first hole at Bonanza intersected the Mochito shales where it encountered the presence of skarn alteration, however, no economic mineralization was found. A second diamond drill hole on the Bonanza target intersected mineralization grading 2.2% lead, 6.0% zinc and 95 g/t silver over 4.6 metres. This target will be investigated further from underground. Surface diamond drilling at Caliche continued during the quarter with two holes completed. Both holes intersected unmineralized limestone without reaching the Mochito shales. Collection of geochemical soil samples over the Santa Barbara mountain continued during the quarter. As well, samples were also collected over two new targets, ML2 and ML3, which will be diamond drilled. These target areas are located at the projected intersections of fault zones located to the north of the current underground workings.

El Toqui Production

-------------------

The following table sets forth El Toqui's production for the periods presented.



-------------------------------------------------------------------------
Third Quarter First Nine Months
---------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
Ore Milled (tonnes) 137,089 134,174 408,496 391,573
-------------------------------------------------------------------------
Zinc (%) 7.6 5.7 6.4 5.8
-------------------------------------------------------------------------
Gold (g/t) 1.8 3.3 2.3 3.0
-------------------------------------------------------------------------
Concentrate Production
-------------------------------------------------------------------------
Zinc (tonnes) 19,013 13,761 47,638 41,102
-------------------------------------------------------------------------
Recovery (%) 91.0 90.4 90.7 90.3
-------------------------------------------------------------------------
Grade (%) 49.9 49.7 49.9 50.0
-------------------------------------------------------------------------
Gold (tonnes) 770 1,400 2,922 3,006
-------------------------------------------------------------------------
Recovery (%) 71.4 55.6 69.5 52.0
-------------------------------------------------------------------------
Grade (g/t) 198.1 199.7 206.3 236.5
-------------------------------------------------------------------------
Metal in Concentrates
-------------------------------------------------------------------------
Zinc (tonnes) 9,478 6,865 23,759 20,561
-------------------------------------------------------------------------
Gold (ounces) 6,929 12,544 26,985 32,338
-------------------------------------------------------------------------
Silver (ounces) 15,303 33,732 50,901 106,011
-------------------------------------------------------------------------
Total Cash Costs
-------------------------------------------------------------------------
Per lb. payable zinc
produced (US$) 0.79 0.28 0.64 0.34
-------------------------------------------------------------------------


The milled tonnage and zinc grades at El Toqui increased in the third quarter of 2006 compared with the same period in 2005. The increase in production was due to a higher number of available working areas and higher zinc head grades at the Estatuas and Dona Rosa deposits. The decrease in the milled gold grade is due to a decision to stockpile Aserradero material until commissioning of the Gekko Intense Leach Reactor commences at the end of the fourth quarter. The Aserradero deposit has high gold grades with the mill producing a gold concentrate as well as a zinc concentrate.

El Toqui Outlook

During the third quarter of 2006, ramp development to access the Concordia deposit continued with a total of 343 metres of development completed. The Concordia project is on schedule with production expected by mid-2007.

During the third quarter of 2006, drilling continued on the Porvenir deposit. The Company expects to release updated exploration results in the fourth quarter of 2006.

Langlois

--------

Langlois, which is situated in north-western Quebec approximately 213 kilometres north of Val-d'Or, is currently being developed to reach commercial production in mid-2007.

Production has commenced in Zones 3 and 4. To October 19, 2006, approximately 25,000 tonnes of material had been broken of which 20,000 tonnes had been hoisted to surface and stockpiled pending commissioning of the mill. It is estimated that a total of 66,500 tonnes of material from Zones 3 and 4 will be mined during the second half of 2006, with a total of 50,000 tonnes being milled.

During the third quarter, development continued on the Grevet B deposit, located three kilometres south-east of the Langlois mine. The access road and power line are complete and the ramp has advanced a total of 174 metres. We expect to mine and mill 15,000 tonnes in the fourth quarter of 2006. Capital and operating costs for the bulk sample are estimated to total $6.2 million.

During the third quarter, the Company issued an improved production forecast for Langlois for 2006 of 10.6 million pounds of payable zinc, 0.5 million pounds of payable copper and 29,600 ounces of payable silver. Langlois continues to be on track to achieve full commercial production in mid-2007.

The Company continues to conduct its exploration program on the property.

Other

-----

The reclamation work is largely complete at the Bouchard-Hebert, Bougrine and Nanisivik properties, with Nanisivik to be fully reclaimed in 2007. The mills at Bouchard-Hebert and Bougrine remain intact pending exploration results.

Non-GAAP Reconciliations

Cash provided from operating activities (before changes in non-cash working capital items) and total cash cost per pound of payable zinc sold are furnished to provide additional information and are non-GAAP measures. These measures should not be considered in isolation as a substitute for measures of performance prepared in accordance with GAAP and are not necessarily indicative of cash provided from operating activities and operating expenses respectively as determined under GAAP. These measures are intended to provide investors with information about the cash generating capabilities of the Company's operating activities in a given period which is the same purpose that the Company uses this information for. Mining operations are capital intensive and the cash provided from operating activities (before changes in non-cash working capital items) measure excludes financing activities, investing activities and changes in non-cash working capital. Similarly, the total cash cost per pound of payable zinc sold measure excludes capital expenditures. The MD&A and the consolidated financial statements discuss the components not included in these non-GAAP measures.



-------------------------------------------------------------------------
Non-GAAP Reconciliation of Cash Provided from Operating Activities
(before changes in non-cash working capital items) to Consolidated
Financial Statements
-------------------------------------------------------------------------
Third Quarter First Nine Months
------------------------------------------
($ millions) 2006 2005 2006 2005
-------------------------------------------------------------------------
Net Cash Provided by Operating
Activities per Consolidated
Statements of Cash Flows 39.9 4.3 115.4 26.4
Less changes in non-cash
working capital 1.9 2.7 24.0 10.7
-------------------------------------------------------------------------
Cash Provided from Operating
Activities (before changes
in non-cash working
capital items) 38.0 1.6 91.4 15.7
-------------------------------------------------------------------------


-------------------------------------------------------------------------
Non-GAAP Reconciliation of Total Cash Cost per Pound of Payable Zinc Sold
to Consolidated Financial Statements
-------------------------------------------------------------------------
Third Quarter First Nine Months
-------------------------------------------------------------------------
2006 2005 2006 2005
-------------------------------------------------------------------------
By-Product Credit ($ millions)
------------------------------
Gross sales revenue per
financial statements (112.0) (71.9) (293.9) (255.6)
Less zinc sales revenue 76.5 39.1 203.2 160.3
-------------------------------------------------------------------------
(35.5) (32.8) (90.6) (95.3)
Treatment Charges ($ millions)
per financial statements 29.4 23.0 79.8 87.8
Direct operating costs
($ millions) per financial
statements 34.9 33.4 97.8 119.8

-------------------------------------------------------------------------
Total cash costs - Canadian
($ millions) 28.8 23.7 87.0 112.3
-------------------------------------------------------------------------

-------------------------------------------------------------------------
Exchange rate C$/US$ 1.1230 1.1820 1.1390 1.2230
-------------------------------------------------------------------------

-------------------------------------------------------------------------
Total cash costs -
US ($ millions) 25.6 20.0 76.4 91.8
-------------------------------------------------------------------------

-------------------------------------------------------------------------
Zinc pounds sold (millions) 44.7 55.7 143.9 228.2
-------------------------------------------------------------------------

-------------------------------------------------------------------------
Total cash cost per pound
of payable zinc sold (US$)
-------------------------------------------------------------------------
By-Product Credit (0.70) (0.50) (0.56) (0.34)
-------------------------------------------------------------------------
Treatment and marketing costs 0.58 0.35 0.49 0.31
-------------------------------------------------------------------------
Direct operating costs 0.69 0.51 0.60 0.43
-------------------------------------------------------------------------
Total 0.57 0.36 0.53 0.40
-------------------------------------------------------------------------


Summary of Quarterly Results

-------------------------------------------------------------------------
2004 2005
-------------------------------------------------------------------------
Q4 Q1 Q2 Q3 Q4
-------------------------------------------------------------------------
Gross Sales Revenue
($ millions) 61.5 91.3 92.4 71.9 57.4
-------------------------------------------------------------------------
Net Earnings (Loss)
($ millions) (6.3) 4.1 2.4 (1.6) 9.8
-------------------------------------------------------------------------
Basic Earnings
per Share ($0.02) $0.01 $0.01 $0.00 $0.03
-------------------------------------------------------------------------
Weighted-average
Number of Common
Shares Outstanding
(millions) 363.0 365.7 367.4 369.5 374.2
-------------------------------------------------------------------------
Basic Earnings Per
Share Fully Diluted ($0.02) $0.01 $0.01 $0.00 $0.02
-------------------------------------------------------------------------
Realized Exchange
Rate C$/US$ 1.2290 1.2274 1.2429 1.2019 1.1744
-------------------------------------------------------------------------
Average Realized
Zinc Price (US$/t) 1,095 1,256 1,252 1,296 1,502
-------------------------------------------------------------------------
Average Realized
Zinc Price (C$/t) 1,345 1,542 1,556 1,558 1,764
-------------------------------------------------------------------------
Concentrate Tonnes
Sold 79,854 108,507 118,022 80,196 60,391
-------------------------------------------------------------------------
Concentrate Tonnes
Produced 106,241 103,259 88,782 76,014 68,841
-------------------------------------------------------------------------


---------------------------------------------------
2006
---------------------------------------------------
Q1 Q2 Q3
---------------------------------------------------
Gross Sales Revenue
($ millions) 80.7 101.2 112.0
---------------------------------------------------
Net Earnings (Loss)
($ millions) 38.9 29.5 40.7
---------------------------------------------------
Basic Earnings
per Share $0.10 $0.08 $0.11
---------------------------------------------------
Weighted-average
Number of Common
Shares Outstanding
(millions) 382.0 383.8 384.3
---------------------------------------------------
Basic Earnings Per
Share Fully Diluted $0.09 $0.07 $0.10
---------------------------------------------------
Realized Exchange
Rate C$/US$ 1.1559 1.1239 1.1187
---------------------------------------------------
Average Realized
Zinc Price (US$/t) 2,221 2,895 3,363
---------------------------------------------------
Average Realized
Zinc Price (C$/t) 2,567 3,226 3,762
---------------------------------------------------
Concentrate Tonnes
Sold 67,355 59,779 61,385
---------------------------------------------------
Concentrate Tonnes
Produced 66,129 59,906 59,420
---------------------------------------------------


The quantity and mix of the concentrates sold directly affects gross sales revenue. The recognition of revenue from the sale of concentrates can vary from quarter to quarter based on customer agreements, the availability of ships and compliance with the Company's revenue recognition policy. As all sales are based in US dollars, the impact of the US dollar weakening against the Canadian dollar over the past eight quarters has reduced the realized Canadian dollar gross sales revenue.

Critical Accounting Estimates

Asset Impairment

The carrying values of producing mineral properties, including properties placed on care and maintenance and related deferred expenditures, are reviewed regularly and, where necessary, are written down to the estimated net recoverable amounts. Estimated future net cash flows, on an undiscounted basis, are calculated for each property using: estimated recoverable reserves, on the basis of current proven and probable reserves, except for the Langlois mine where the conversion of resources was considered, taking into account the cost of conversion; estimated future metal price realization (considering historical and current prices, price trends and related factors); and estimated operating and capital cash flows. Estimates of future cash flows are subject to risks and uncertainties. It is possible that changes could occur that may affect the recoverability of the carrying value of mineral properties. No write downs were required in 2005 or during 2006.

Reserves

Every year the Company estimates its proven and probable mineral reserves (the "Reserves") in accordance with National Policy 43-101 ("NI 43-101"), a rule adopted by Canadian securities administrators as the standard of disclosure for mineral projects. This estimate is used to determine mine viability, mine life and amortization rates. The estimation of Reserves is based on drill hole information, historical mining results, historical metallurgical results, estimated future operating costs and estimated future metal prices. A "Qualified Person", as defined by NI 43-101, performs the Reserves estimate. As all of the Company's operations have had significant operating history, the factor that could have the greatest impact on the Reserves estimate is future metal prices.

Amortization

The Company uses the units of production method for amortization of Mineral Properties and some of its Fixed Assets based on the Reserves. Any significant changes in the Reserves could impact the amount of annual amortization.

Inventory

The Company values its concentrate inventories at the lower of cost or realizable value at the end of the reporting period. Costs represent the average cost, and include direct labour and materials costs, mine site overhead and depreciation and amortization. Realizable value includes metal prices, net of treatment charges and freight. Metal prices can be subject to significant change from period to period.

Future Tax Assets and Liabilities

Future tax assets and liabilities are calculated using the asset and liability method. 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 current tax rates. The effect on future tax assets and liabilities of a change in tax rates is recognized in income in the period the change is known. To the extent that the Company considers it to be more likely than not that a future tax asset will be recovered, a tax asset will be setup, otherwise it provides a valuation allowance against the excess. It is possible that changes could occur in the future that may affect the recoverability of the carrying value of future tax assets and a write-down may be required.

Reclamation

The Company provides for the fair value of liabilities and capitalized costs for asset retirement obligations in the period in which they are incurred. Over time, the liability is accreted to its present value and the capitalized cost is amortized over the useful life of the related asset. Asset retirement obligations are obligations of the Company that arise as a result of an existing law, regulation or contract related to asset retirements. Estimates of the liability associated with the retirement of an asset are based on current laws and regulations and the expected resulting costs, all of which are subject to change. If actual costs of reclamation exceed the recorded amount, Breakwater will record a loss. Alternatively, if reclamation costs incurred are less than those recorded, the Company will record a gain. Currently, the Company is not able to setup a liability for reclamation at El Mochito as there is no law, regulation or contract related to this asset's retirement.

Outstanding Share Data and Full Dilution Calculation

The Company is authorized to issue an unlimited number of Common Shares and 200,000,000 preferred shares, issueable in series; there are no preferred shares outstanding. Each Common Share entitles the holder of record thereof to one vote at all meetings of shareholders of the Company, except at meetings at which only holders of another class or series of shares of the Company are entitled to vote. The table set forth below summarizes the Capital Stock. For a more complete description of certain elements please refer to note 12 to the consolidated interim financial statements of the Company for the periods ended September 30, 2006.



-------------------------------------------------------------------------
Common Shares or Securities Convertible
into Common Shares October 31, 2006
-------------------------------------------------------------------------
Issued and Outstanding Common Shares 384,690,712
-------------------------------------------------------------------------
Share Option Plan - Option Weighted average
exercise price $0.93 9,918,933
-------------------------------------------------------------------------
Warrants granted at $0.20, 15,400,705 each expiring
on March 2, 2007 and May 2, 2007. 30,801,410
-------------------------------------------------------------------------
Warrants granted at $1.00, expiring January 28, 2009 -
traded on TSX 33,571,429
-------------------------------------------------------------------------
Fully Diluted 458,982,484
-------------------------------------------------------------------------


Risks, Uncertainties and Other Information

Exploration for, and development and mining of, metals involve numerous inherent risks. Such risks include, but are not limited to: fluctuations in the currency markets; fluctuations in commodity prices; risks arising from holding derivative instruments (such as credit risk, market liquidity risk and mark to market risk); changes in national and local government legislation, taxation, controls, regulations and political or economic developments in Canada, Chile, Honduras (further described below), Tunisia or other countries in which we do or may carry on business in the future; business opportunities that may be presented to, or pursued by, us; our ability to successfully integrate acquisitions; operating or technical difficulties in connection with mining or development activities; employee relations; the speculative nature of exploration and development, including the risks of obtaining necessary licences and permits; diminishing quantities or grades of reserves; adverse changes in our credit rating; and contests over title to properties, particularly title to undeveloped properties. In addition, there are risks and hazards associated with the business of exploration, development and mining, including environmental hazards, industrial accidents, unusual or unexpected formations, pressures, cave-ins, flooding (and the risk of inadequate insurance, or inability to obtain insurance, to cover these risks).

There have been recent political and legislative developments that may affect mining in Honduras. The principal legislation governing mining in Honduras is the General Mining Act (the "Mining Act") which was approved by the National Congress in 1998. Subsequently, a Commission for the Reform of the General Mining Act was appointed by the National Congress and in 2005 congressional debates, focused primarily on environmental and fiscal and taxation provisions, were held. No amendments were passed. In early October 2006, in response to a petition by private parties, the Honduran Supreme Court of Justice ruled that certain articles of the Mining Act were unconstitutional and suggested several guidelines to be followed in any reform of the legislation. The articles that were ruled unconstitutional include, amongst others, provisions on environmental, fiscal and taxation, registration and transferability of mining concessions, and surface rights. In accordance with Honduran law and procedure, the Supreme Court decision is not effective against third parties until it is published by the National Congress in La Gaceta, the official government bulletin. As at October 30, 2006, the decision has not been published and the National Congress has not taken any legislative action regarding reforms. It is not clear if and when amendments to the Mining Law will be proposed in the National Congress and if so, when any such proposals will become effective. At present therefore, the financial implications and market-related risks, if any, that may be brought about by Mining Law reform in Honduras cannot be accurately predicted or assessed. The Company continues to monitor the situation closely.

Readers are encouraged to read and consider the risk factors, and additional information regarding the Company, included in its most recent Annual Report and Form 40-F/Annual Information Form filed with the Canadian securities regulators and the United States Securities and Exchange Commission, a copy of which is posted on the SEDAR website at www.sedar.com.

Cautionary Statement on Forward-Looking Information

Certain information contained in or incorporated by reference in this third quarter report, including any information as to our future financial or operating performance and other statements that express management's expectation or estimates of future performance, constitute "forward-looking statements". All statements, other than statements of historical fact, are forward-looking statements. The words "believe", "expect", "anticipate", "contemplate", "target", "plan", "intends", "continue", 'budget", "estimate", "may", "will", "schedule" and similar expressions identify forward-looking statements. Forward-looking statements are necessarily based upon a number of estimates and assumptions that, while considered reasonable by us, are inherently subject to significant business, economic and competitive uncertainties and contingencies. Known and unknown factors could cause actual results to differ materially from those projected in the forward-looking statements. Such factors include, but are not limited to: fluctuations in the currency markets; fluctuations in commodity prices; risks arising from holding derivative instruments (such as credit risk, market liquidity risk and mark to market risk); changes in national and local government legislation, taxation, controls, regulations and political or economic developments in Canada, Chile, Honduras, Tunisia or other countries in which we do or may carry on business in the future; business opportunities that may be presented to, or pursued by, us; our ability to successfully integrate acquisitions; operating or technical difficulties in connection with mining or development activities; employee relations; the speculative nature of exploration and development, including the risks of obtaining necessary licences and permits; diminishing quantities or grades of reserves; adverse changes in our credit rating; and contests over title to properties, particularly title to undeveloped properties. In addition, there are risks and hazards associated with the business of exploration, development and mining, including environmental hazards, industrial accidents, unusual or unexpected formations, pressures, cave-ins, flooding (and the risk of inadequate insurance, or inability to obtain insurance, to cover these risks). Many of these uncertainties and contingencies can affect our actual results and could cause actual results to differ materially from those expressed or implied in any forward-looking statements made by, or on behalf of, us. Readers are cautioned that forward-looking statements are not guarantees of future performance. All of the forward-looking statements made in this third quarter report are qualified by these cautionary statements. Specific reference is made to the Company's most recent Form 40F/Annual Information Form on file with the SEC and Canadian provincial securities regulatory authorities for a discussion of some of the factors underlying forward-looking statements. We disclaim any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise, except to the extent required by applicable laws.



Breakwater Resources Ltd.
Consolidated Balance Sheets
As at September 30, 2006 and December 31, 2005
(expressed in thousands of Canadian dollars)
(unaudited)
-------------------------------------------------------------------------
September 30, December 31,
2006 2005
-------------------------------------------------------------------------
Assets

Current Assets
Cash and cash equivalents $ 63,433 $ 18,749
Restricted cash 1,678 3,929
Short-term investments 8,174 2,523
Accounts receivable - concentrate 981 3,027
Other receivables 10,065 9,369
Concentrate inventory 41,805 47,501
Materials and supplies inventory 20,623 21,388
Prepaid expenses and other current assets 3,954 3,934
Future income tax assets 24,306 6,517
-------------------------------------------------------------------------
175,019 116,937
Deferred Financing Fees - 344
Reclamation Deposits 13,535 6,808
Mineral Properties and Fixed Assets 202,030 165,168
Long-term Investment 9,089 5,615
Restricted Promissory Note 62,285 62,285
-------------------------------------------------------------------------
$ 461,958 $ 357,157
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Liabilities

Current Liabilities
Accounts payable and accrued liabilities $ 35,646 $ 32,797
Provisional payments for concentrate
inventory shipped and not priced 26,070 14,807
Short-term debt including current portion of
long-term debt 4,765 14,585
Income and mining taxes payable 4,566 164
Current portion of reclamation, closure cost
accruals and other environmental obligations 8,843 10,165
-------------------------------------------------------------------------
79,890 72,518
Deferred Income 6,430 6,888
Long-term Lease Obligations 736 984
Royalty Obligation 62,479 62,479
Long-term Debt 500 4,143
Reclamation, Closure Cost Accruals and Other
Environmental Obligations 32,487 40,099
Employee Future Benefits 4,648 5,379
Future Income Tax Liabilities 7,089 1,921
-------------------------------------------------------------------------
194,259 194,411
-------------------------------------------------------------------------
Shareholders' Equity

Capital stock 165,851 335,512
Warrants 8,561 8,561
Contributed surplus 801 3,300
Retained earnings (deficit) 109,069 (172,928)
Cumulative translation adjustments (16,583) (11,699)
-------------------------------------------------------------------------
267,699 162,746
-------------------------------------------------------------------------
$ 461,958 $ 357,157
-------------------------------------------------------------------------
-------------------------------------------------------------------------


Breakwater Resources Ltd.
Consolidated Statements of Operations
and Retained Earnings (Deficit)

For the Periods Ended
September 30, 2006 and 2005
(expressed in thousands of Canadian dollars except
share and per share amounts)
(unaudited)
-------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
-------------------------------------------------------------------------

Gross sales revenue $ 112,037 $ 71,933 $ 293,897 $ 255,615
Treatment and
marketing costs 29,380 23,022 79,769 87,756
-------------------------------------------------------------------------
Net revenue 82,657 48,911 214,128 167,859
-------------------------------------------------------------------------

Operating Costs
Direct operating costs 34,894 33,358 97,885 119,777
Depreciation and
depletion 3,754 5,113 12,289 18,700
Reclamation and
closure costs 866 7,095 2,751 11,502
-------------------------------------------------------------------------
39,514 45,566 112,925 149,979
-------------------------------------------------------------------------
Contribution from
Mining Activities 43,143 3,345 101,203 17,880
-------------------------------------------------------------------------
Other Expenses (Income)
General and
administrative 3,021 1,913 9,219 5,917
Stock-based
compensation 182 205 1,201 650
Interest and financing 1,071 291 4,009 795
Investment and other
income (1,933) (835) (5,236) (2,743)
Loss on gold loan 55 863 1,131 863
Foreign exchange gain
on US dollar
denominated debt (19) (322) (330) (535)
Other foreign exchange
(gain) loss (233) 307 (398) 401
-------------------------------------------------------------------------
2,144 2,422 9,596 5,348
-------------------------------------------------------------------------
Earnings Before the
Following: 40,999 923 91,607 12,532
-------------------------------------------------------------------------

Exploration costs 651 272 3,145 272
Write-down of mineral
properties and fixed
assets - 692 - 692
Other non-producing
property (income)
costs (12,867) 1,807 (10,200) 7,286
Income and mining tax
provision (recovery) 12,468 (269) (10,407) (646)
-------------------------------------------------------------------------
252 2,502 (17,462) 7,604
-------------------------------------------------------------------------
Net Earnings (Loss) 40,747 (1,579) 109,069 4,928
Retained Earnings
(Deficit) - Beginning
of Period 68,322 (181,160) (172,928) (187,667)
Reduction in Stated
Share Capital and
Contributed Surplus - - 172,928 -
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Retained Earnings
(Deficit) - End of
Period $ 109,069 $ (182,739) $ 109,069 $ (182,739)
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Basic Earnings per
Common Share $ 0.11 $ (0.00) $ 0.28 $ 0.01
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Diluted Earnings per
Common Share $ 0.10 $ (0.00) $ 0.26 $ 0.01
-------------------------------------------------------------------------
-------------------------------------------------------------------------
Basic Weighted-Average
Number of Common
Shares Outstanding 384,335,000 369,513,000 383,323,000 367,535,000
-------------------------------------------------------------------------
-------------------------------------------------------------------------


Breakwater Resources Ltd.
Consolidated Statements of Cash Flows
For the Periods Ended September 30, 2006 and 2005
(expressed in thousands of Canadian dollars)
(unaudited)
-------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Cash Provided by
(Used in) Operating
Activities
Net earnings (loss) $ 40,747 $ (1,579) $ 109,069 $ 4,928
-------------------------------------------------------------------------
Non-cash items:
Depreciation and
depletion 3,754 5,113 12,289 18,700
Gain on sale of
investment - - - (851)
Unrealized (gain)
loss on gold loan (276) 863 - 863
Foreign exchange loss
(gain) on US dollar
denominated loans 37 (322) (33) (535)
Other non-cash items (751) (362) (442) (25)
Stock-based
compensation 182 205 1,201 650
Deferred income (152) 19 (458) -
Future income taxes 9,720 (41) (12,621) 95
Reclamation, closure
cost accruals and
other environmental
obligations 866 7,095 2,751 11,502
Employee future
benefits 636 421 1,523 1,263
Gain on sale of
Caribou and
Restigouche mines (13,818) - (13,818) -
Write-down of mineral
properties and fixed
assets - 692 - 692
-------------------------------------------------------------------------
198 13,683 (9,608) 32,354
-------------------------------------------------------------------------
Payment of reclamation,
closure costs accruals
and other environmental
obligations (2,137) (9,922) (5,858) (19,924)
Payment of employee
future benefits (764) (582) (2,254) (1,707)
Changes in non-cash
working capital items 1,832 2,649 24,095 10,712
-------------------------------------------------------------------------
Net cash provided by
operating activities 39,876 4,249 115,444 26,363
-------------------------------------------------------------------------
Financing Activities
Decrease in restricted
cash 2,474 3,383 2,251 457
Issue of common shares
for cash 75 1,419 1,065 2,625
Issue of common shares
to settle liability - - 848 -
Renunciation of flow-
through share value - - (2,345) -
Deferred financing
fees - (422) (223) (422)
Decrease in long-term
lease obligations - - (248) -
(Decrease) increase
in short-term debt (2,492) 12,161 (13,417) 14,005
Increase in long-term
debt - - - 4,757
-------------------------------------------------------------------------
Net cash provided by
(used in) financing
activities 57 16,541 (12,069) 21,422
-------------------------------------------------------------------------
Investing Activities
Reclamation deposits 5,952 (288) (6,727) (7,733)
Mineral properties
and fixed assets (22,893) (8,749) (52,258) (28,358)
Proceeds from sale of
fixed assets and
mineral properties 86 54 294 100
-------------------------------------------------------------------------
Net cash provided by
(used in) investing
activities (16,855) (8,983) (58,691) (35,991)
-------------------------------------------------------------------------
Increase in Cash 23,078 11,807 44,684 11,794
Cash and Cash
Equivalents - Beginning
of Period 40,355 12,654 18,749 12,667
-------------------------------------------------------------------------
Cash and Cash
Equivalents - End of
Period $ 63,433 $ 24,461 $ 63,433 $ 24,461
-------------------------------------------------------------------------
-------------------------------------------------------------------------

Supplemental Disclosure
of Cash Flow
Information
Cash paid for:
Interest $ 47 $ 41 $ 630 $ 129
Income and mining
taxes $ 82 $ 50 $ 425 $ 452


Contact Information

  • Breakwater Resources Ltd.
    E. Ann Wilkinson
    Vice President, Investor Relations
    (416) 363-4798 Ext. 277
    Email: awilkinson@breakwater.ca