SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

Commission file number 1-1143

Inco Limited

(Name of Registrant as specified in its charter)

145 King Street West, Suite 1500, Toronto, Ontario M5H 4B7*

(Address of principal executive offices, including zip code)

(416) 361-7511

(Telephone number)

     The Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 (the “Act”) during the preceding twelve months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

      Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934).

Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o

      Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes o     No þ

      Unless otherwise stated, dollar amounts in this Report are expressed in United States currency.

      Common Shares outstanding at June 30, 2006: 199,587,144 shares, no par value.

      * Notices and communications from the Securities and Exchange Commission may be sent to Simon A. Fish, Executive Vice-President, General Counsel and Secretary, 145 King Street West, Suite 1500, Toronto, Ontario M5H 4B7. His telephone number is (416) 361-7774.

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION

INCO LIMITED AND SUBSIDIARIES

Consolidated Statement of Earnings

(Unaudited)

See Notes to Consolidated Financial Statements.

INCO LIMITED AND SUBSIDIARIES

Consolidated Statement of Retained Earnings

(Unaudited)

See Notes to Consolidated Financial Statements.

INCO LIMITED AND SUBSIDIARIES

Consolidated Balance Sheet

(Unaudited)

See Notes to Consolidated Financial Statements.

INCO LIMITED AND SUBSIDIARIES

Consolidated Statement of Cash Flows

(Unaudited)

See Notes to Consolidated Financial Statements.

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

(Tabular amounts in millions of U.S. dollars except number of shares and per share amounts)

      These unaudited consolidated financial statements have been prepared in accordance with Canadian generally accepted accounting principles (“GAAP”) (see Note 17 for significant differences between Canadian GAAP and U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments considered necessary for a fair presentation of results for the periods reported have been included. These adjustments consist only of normal recurring adjustments. Results of operations for the three-month and six-month periods ended June 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006 or any other interim period. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2005 (“2005 Annual Report on Form 10-K”).

      We have adopted the Canadian Institute of Chartered Accountants Emerging Issues Committee Abstract No. 155, The Effects of Contingently Convertible Instruments on the Computation of Diluted Earnings per Share, on a retroactive basis. The new abstract, which was effective for interim and annual periods beginning after October 1, 2005, requires that the effects of contingently convertible instruments be included in the computation of diluted earnings per share regardless of whether the market price trigger has been met. The adoption of the new abstract had no impact on earnings per share for the second quarter and first six months of 2005, as the market price triggers on our contingently convertible debt had been met for this period and thus the contingently convertible instruments were already included in the computation of diluted earnings per share.

      Effective January 1, 2005, on a retroactive basis, we restated our minority interest and related current deferred income taxes to correct an error in the allocation of net earnings to minority interests. The impact on net earnings for the second quarter and first six months of 2005 was an increase of $5 million, or $0.02 per share and $9 million, or $0.05 per share, respectively. The cumulative adjustment to retained earnings to December 31, 2004 was an increase of $38 million.

      Other income, net is comprised of the following:

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

Note 4.     Income and Mining Taxes

      The reconciliation between taxes at the combined Canadian federal-provincial statutory income tax rates and the effective income and mining tax rates was as follows:

      Employer contributions in respect of our defined benefit plans during the second quarter and first six months of 2006 were $48 million (2005: $39 million) and $94 million (2005: $85 million), respectively. For the year ending December 31, 2006, we currently expect that such employer contributions will amount to approximately $170 million.

      Post-retirement benefits expense included the following components:

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      The changes in the liability for our asset retirement obligation for the first six months of 2006 were as follows:

      Our asset retirement obligation as at December 31, 2005 included a current portion of $3 million.

      We are authorized to issue an unlimited number of common shares without nominal or par value. Changes in common shares for the first six months of 2006 were as follows:

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      The computation of basic and diluted earnings per share was as follows:

      In May 2004, we entered into a $750 million syndicated revolving credit facility with a maturity date of May 28, 2009 (the “Credit Facility”). Subject to the approval of the lenders representing not less than 66²/3% in total commitments under the Credit Facility, the maturity date of the Credit Facility may be extended for the commitments of those lenders who have approved such extension for an additional one-year period on each May 28^th anniversary date. In May 2005, the lenders agreed to extend the maturity date from May 28, 2009 to May 28, 2010, and in May 2006, the lenders agreed to extend the maturity date from May 28, 2010 to May 28, 2011. The borrowings under the Credit Facility may be made in either Canadian dollars in the form of (a) Prime Rate Loans (as defined under the Credit Facility) or (b) Bankers’ Acceptances (as defined under the Credit Facility) or in U.S. dollars in the form of (i) U.S. Base Rate Loans (as defined under the Credit Facility) or (ii) London Interbank Offered Rate (“LIBOR”) loans (as defined under the Credit Facility). Borrowings under these facilities bear interest, when drawn, at a rate which varies based on the type of borrowing and our credit ratings at the time of borrowing. As of June 30, 2006, there were no amounts drawn under the Credit Facility. The Credit Facility provides that, so long as advances are outstanding or any

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

letters of credit or guarantees issued pursuant to the terms of the Credit Facility are outstanding, we will be required to maintain a ratio of Consolidated Indebtedness (as defined in the Credit Facility) to Tangible Net Worth (as defined in the Credit Facility) not to exceed 50:50. At June 30, 2006, the ratio of Consolidated Indebtedness to Tangible Net Worth was 22:78. The Credit Facility does not require any acceleration or prepayment of outstanding balances if our credit ratings on outstanding debt securities were downgraded or if there were a significant decline in our earnings, cash flow or in the price of our publicly traded common shares or other equity securities. A downgrade in our rating would, however, increase the interest rate payable on borrowings under the Credit Facility and, conversely, any upgrade in our rating would reduce the interest rate payable on borrowings. Currently, we are rated as investment grade by Moody’s Investors Service, Standard & Poor’s Ratings Services and Fitch Ratings, with the specific ratings being Baa3 (on review for possible downgrade) by Moody’s Investors Service, BBB- (watch developing) by Standard & Poor’s Ratings Services and BBB- (evolving watch) by Fitch Ratings. These rating agencies apply their own criteria to determine their ratings and may change those criteria at any time. Such ratings do not represent a recommendation to buy, sell or hold our debt securities, may be subject to revision or withdrawal at any time by the particular rating organization, and each rating should be evaluated independently of any other rating.

      In connection with Inco having increased the consideration payable under its proposed acquisition of Falconbridge and entered into the Combination Agreement and the Note Purchase Agreement with Phelps Dodge (see Note 18), Inco also entered into an amendment letter (the “Amendment Letter”) dated June 25, 2006 with its lead arrangers (the “Lead Arrangers”) under the term and bridge loan agreement dated as of December 22, 2005 among Inco, as borrower, Royal Bank of Canada, as administrative agent, the Lead Arrangers and the other banks and other financial institutions party thereto as lenders (such loan agreement, as amended by a First Amendment Agreement dated as of January 31, 2006 and a Second Amendment Agreement dated as of February 20, 2006, the “Existing Acquisition Facilities Credit Agreement”). The borrowings under the Existing Acquisition Facilities Credit Agreement may be made in either Canadian or U.S. dollars. Borrowings under these facilities bear interest, when drawn, at a rate which varies based on the type of borrowing and our credit ratings at the time of borrowing. The Existing Acquisition Facilities Credit Agreement provides that, so long as advances are outstanding, we will be required to maintain a ratio of Consolidated Indebtedness, as defined in the Existing Acquisition Facilities Credit Agreement to Tangible Net Worth (as defined in the Existing Acquisition Facilities Credit Agreement) not to exceed 50:50. The Existing Acquisition Facilities Credit Agreement does not require any acceleration or prepayment of outstanding balances if our credit ratings on outstanding debt securities were downgraded or if there were a significant decline in our earnings, cash flow or in the price of our publicly traded common shares or other equity securities. A downgrade in our credit rating would, however, increase the interest rate payable on borrowings under the Existing Acquisition Facilities Credit Agreement.

      The Existing Acquisition Facilities Credit Agreement was amended to provide for the following: (i) a “Change of Control” of Inco will be deemed to occur at the effective time of the Arrangement (see Note 18) and upon the consummation of the transactions contemplated by the Combination Agreement, with the result that amounts outstanding under the Existing Acquisition Facilities Credit Agreement may be required to be prepaid and the Existing Acquisition Facilities Credit Agreement terminated within 10 business days of such date, and (ii) an increase in the amount of cash which may be used by Inco to finance its increased Offer and related expenses (collectively, the “Transaction Expenses”).

      Inco and the Lead Arrangers also agreed to amend the Existing Acquisition Facilities Credit Agreement to provide, among other things, for the following: (i) an increase in the amount of debt which may be used by Inco to finance the Transaction Expenses, with additional adjustments in the event dissent or appraisal rights are exercised in connection with Inco’s Offer, and (ii) in the event of a credit rating downgrade by two of three credit rating agencies to BB (or equivalent) or lower in respect of Inco, for an additional financial covenant and the grant of security for Inco’s obligations under the Existing Acquisition Facilities Agreement by Inco

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

and each of its subsidiaries located in the United States or Canada over all assets located in the United States or Canada. The first advance under these loan facilities is available until August 10, 2006.

      In addition, on June 25, 2006, Inco accepted an additional commitment from the Lead Arrangers to provide additional financing for the Transaction Expenses, on terms and conditions substantially similar to those under the Existing Acquisition Credit Facilities Agreement (as amended by the Amendment Letter).

      Also in connection with this pending acquisition, we have arranged a facility for the issuance of 8% convertible subordinated notes (“Notes”) due April 1, 2012, which may be issued, at Inco’s option, to Phelps Dodge Corporation up to a maximum of $3 billion. The Notes are convertible into Inco common shares at a conversion rate equal to 95% of the average closing price of the Inco common shares on the NYSE over the five trading days preceding the date of conversion provided, however, that the Notes may not be converted (i) prior to the six-month anniversary of the issuance of the Notes or (ii) if the holder of the Notes and its affiliates would own, together with any persons acting jointly or in concert with the holder and its affiliates, after such conversion, an aggregate of more than 20 per cent of the then outstanding Inco common shares. The payment of interest on the Notes may be deferred by Inco until maturity. At maturity, at our option, the Notes will be payable in cash, Inco common shares or a combination thereof. Upon redemption prior to stated maturity, the notes will be payable in cash.

      In connection with the pending acquisition of Falconbridge (see Note 18), during the second quarter, we purchased Cdn.$100 million of call options giving us the right, but not the obligation, to purchase Canadian dollars at $0.855 and forward currency contracts in the aggregate amount of Cdn.$200 million to purchase Canadian dollars at $0.895. On June 30, 2006, we had a total position of Cdn.$1,538 million comprised of Cdn.$688 million of forward currency contracts to purchase Canadian dollars at $0.870 and Cdn.$850 million of call option contracts to purchase Canadian dollars at $0.855. These derivative contracts do not qualify for hedge accounting and, accordingly, the fair value increase of $47 million during the second quarter have been recorded in earnings in other income, net (see Note 3). Subsequent to June 30, 2006, we entered into an additional Cdn.$1,360 million of forward contracts to purchase Canadian dollars at an average exchange rate of 0.899 cents.

      At June 30, 2006, we had outstanding option contracts in respect of copper to which we apply hedge accounting that expire in 2007 and 2008. In respect of 2007, we have outstanding put option contracts, giving us the right, but not the obligation, to sell 58,992 tonnes (130 million pounds) of copper at an average price of $2,205 ($1.00 per pound) per tonne and outstanding call option contracts giving the buyer the right, but not the obligation, to purchase 58,992 tonnes (130 million pounds) of copper from us at an average price of $2,988 per tonne ($1.36 per pound). In respect of 2008, we have outstanding put option contracts, giving us the right, but not the obligation, to sell 58,380 tonnes (129 million pounds) of copper at an average price of $2,254 ($1.02 per pound) per tonne and outstanding call option contracts, giving the buyer the right but not the obligation to purchase 48,384 tonnes (107 million pounds) of copper from us at an average price of $2,773 per tonne ($1.26 per pound). The option contracts for 2007 and 2008 mature evenly by month.

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      Changes in the equity component of our convertible debt for the first six months of 2006 were as follows:

      Changes in our outstanding warrants for the first six months of 2006 were as follows:

      The following table summarizes as of June 30, 2006 payments due under certain of our long-term contractual obligations and commercial commitments for 2006 and each of the next four years and thereafter:

      We are subject to routine claims and litigation relating to our business and to various environmental proceedings. Environmental proceedings currently pending or threatened against us include (1) proceedings, including a proceeding brought under the Ontario class action legislation, covering claims relating to an alleged decline in property values near a site in Port Colborne, Ontario where we operated a nickel refinery over the 1918-1984 period, (2) claims for personal injuries allegedly due to exposure to our products, (3) enforcement actions, (4) alleged violations of certain environmental laws and regulations applicable to our operations in Canada and elsewhere, including exceeding certain regulatory limits relating to discharges, and (5) certain claims dating back a number of years as a “potentially responsible party” under the U.S. federal environmental law known as “Superfund” or “CERCLA”. We believe that the ultimate resolution of such

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

proceedings, claims and litigation will not significantly impair our operations or have a material adverse effect on our financial position or results of operations.

      Reference is made to Note 20 of our 2005 Annual Report on Form 10-K for a discussion of certain guarantees in respect of our Girardin Act tax-advantaged lease financing program and an electricity supply agreement, both in respect of our Goro project.

      We are a leading producer of nickel and nickel specialty products and an important producer of copper, precious metals and cobalt. Our operations consist of three segments: (1) the finished products segment, which comprises our mining and processing operations in Ontario, Manitoba and Newfoundland and Labrador, Canada, and refining operations in the United Kingdom and interests in refining operations in Japan and other Asian countries, (2) the intermediates segment, which comprises our mining and processing operations in Indonesia, where nickel-in-matte, an intermediate product, is produced and sold primarily into the Japanese market, and (3) the development projects segment, which comprises our Goro nickel-cobalt project under development in the French overseas territorial community (collectivité territoriale) of New Caledonia, a nickel processing plant being built in Dalian, China, an expansion of our facilities in Indonesia and the next phase of development at our Voisey’s Bay project (consisting of feasibility work for a nickel processing plant and underground mine development).

      Data by operating segment as of and for the periods indicated was as follows:

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      Certain supplemental information in connection with our Consolidated Balance Sheet is set forth below:

      Capital expenditures for the second quarter and first six months of 2006 included capitalized interest costs of $19 million (2005: $27 million) and $35 million (2005: $51 million), respectively.

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      Deferred charges and other assets is comprised of the following:

      For the second quarter and first six months of 2006, an expense of $2 million (2005: $4 million) and $4 million (2005: $7 million), respectively was charged to earnings with an equivalent offset credited to contributed surplus to reflect the vested portion of the fair value of stock options granted to employees in 2005. For the first six months of 2006, a transfer of $4 million (2005: $2 million) was made from contributed surplus to common shares in respect of exercised options. No options were granted during the first six months of 2006. For 2005, the fair value of each stock option granted was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:

      Our unaudited consolidated financial statements are prepared in accordance with Canadian GAAP. The differences between Canadian GAAP and U.S. GAAP, insofar as they affect our consolidated financial statements, are discussed below.

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      The following table reconciles results as reported under Canadian GAAP with those that would have been reported under U.S. GAAP:

      For Canadian GAAP reporting purposes, we amortize the excess of the net unrecognized actuarial and investment gains and losses, if such gain or loss is over 10%, of the greater of (i) the post-retirement benefits obligation and (ii) the fair value of plan assets. Such excess is amortized over the expected average remaining service life of employees. For U.S. GAAP reporting purposes, we amortize net unrecognized actuarial and investment gains and losses systematically over the expected average remaining service life of employees. Reference is made to a discussion concerning restatements below.

      Under Canadian GAAP, development costs are deferred and amortized if the development project meets certain generally accepted criteria for deferral and amortization. Property, plant and equipment, may be acquired or constructed in order to provide facilities for a research and development project. The use of such assets will extend over a number of accounting periods and, accordingly, such costs are capitalized and amortized over their useful lives. Under U.S. GAAP, research and development costs are charged to expense in the period incurred.

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      Under Canadian GAAP, capitalized exploration expenditures are classified under property, plant and equipment with the related mineral claim. For U.S. GAAP, exploration expenditures are not capitalized unless estimated proven and probable ore reserves to which they relate have been established by a feasibility study.

      Under Canadian GAAP, convertible debt is bifurcated between debt and equity, the equity portion representing the value of the holder conversion options. Under U.S. GAAP, convertible debt would be accounted for as debt and, accordingly, the measurement of interest and the amortization of debt issuance costs are not the same. Also, for U.S. GAAP, the convertible debt is classified as current debt in the twelve month periods in advance of the special conversion dates and as long-term debt during the remainder of its term.

      Under U.S. GAAP, each of our convertible debt securities meets the conditions necessary as set out in paragraphs 12-33 of EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock, for the embedded conversion option to be exempt from the requirement to be treated as a derivative under Statement of Financial Accounting Standard (“SFAS”) No. 133.

      Under U.S. GAAP, most derivative contracts, whether designated as effective hedging relationships or not, are required to be recorded on the balance sheet at fair value. Under Canadian GAAP, for effective hedging relationships, we continue to recognize gains and losses on derivative contracts in income concurrently with the recognition of the transactions being hedged. Under U.S. GAAP, if a portion of a derivative contract is excluded for purposes of effectiveness testing, such as time value, the value of such excluded portion is included in earnings. Under Canadian GAAP, the excluded portion is not included in earnings if the derivative contract is otherwise determined to be effective. The requirements for documentation and effectiveness testing, however, are substantially the same under both Canadian and U.S. GAAP.

      The principal unrealized non-cash currency translation adjustments included in the determination of earnings arose from the translation into U.S. dollars of the Canadian dollar denominated deferred income and mining tax liabilities established in 1996 upon the acquisition of the Voisey’s Bay deposits. For Canadian GAAP reporting purposes, these unrealized non-cash translation gains and losses have been deferred and included in property, plant and equipment as part of development costs in respect of the Voisey’s Bay mineral properties in the development phase. Capitalization of such gains and losses ceases when the development phase of the mineral properties are substantially complete and available for use.

      In 2005, although not significant, for comparative purposes, we restated our prior period currency translation gains and losses to also include the currency translation gains and losses on other foreign currency denominated assets and liabilities as determined under U.S. GAAP, primarily post-retirement benefits and the related tax balances.

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      In 2002, we recorded an asset impairment charge in respect of our Voisey’s Bay project. At the time, United States and Canadian GAAP had a difference which resulted in a larger asset impairment charge for U.S. GAAP. Consequently, our property, plant and equipment in respect of the Voisey’s Bay project under U.S. GAAP reporting is lower than that under Canadian GAAP. Also U.S. GAAP requires the expensing of start-up costs and the commencement of depreciation and depletion when the asset is available for use. Under Canadian GAAP, start-up costs are capitalized and depreciation and depletion begins when commercial production is achieved. As a result, such costs are higher under U.S. GAAP than under Canadian GAAP during the initial production period.

      U.S. GAAP for equity investments, set out in SFAS No. 115 Accounting for Certain Investments in Debt and Equity Securities, requires that certain equity investments not held for trading be recorded at fair value with unrealized holding gains and losses excluded from the determination of earnings and reported as a separate component of other comprehensive income.

      U.S. GAAP for reporting comprehensive income is set out in SFAS No. 130 Reporting Comprehensive Income. Comprehensive income represents the change in equity during a reporting period from transactions and other events and circumstances from non-owner sources. Components of comprehensive income include items such as net earnings (loss), changes in the fair value of investments not held for trading, minimum pension liability adjustments and gains and losses on derivative instruments. For Canadian GAAP reporting purposes, there is currently no requirement to record other comprehensive income.

      Changes in retained earnings (deficit) and accumulated other comprehensive loss under U.S. GAAP were as follows:

      Effective January 1, 2006, we adopted, for U.S. GAAP reporting purposes, SFAS No. 123R, Share-Based Payment. The primary impact on us is the elimination of the intrinsic value method for valuing stock-based employee compensation which will impact the manner in which expense is determined for stock

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

appreciation rights. As we adopted the fair value method in 2003 and ceased issuing stock appreciation rights in 2004, the adoption did not have a significant impact on earnings and no significant difference is reported herein.

      We have restated our prior period results to reflect currency translation gains and losses on other foreign currency denominated assets and liabilities as determined under U.S. GAAP, primarily post-retirement benefits and the corresponding tax balances. Previously, these currency translation effects were not recorded due to their insignificance but they have become more significant due to the continued strengthening of the Canadian dollar. The impact of this restatement for first six months of 2005 was a gain of $2 million. Also, we have corrected an error in the determination of post-retirement benefits expense. For the first six months of 2005, post-retirement benefits expense was increased by $8 million and the related tax recovery was increased by $3 million.

      On October 11, 2005, we announced our offer to purchase all the outstanding common shares of Falconbridge by way of a friendly take-over bid (the “Offer”). On October 24, 2005, we mailed our formal offer to Falconbridge common shareholders together with the related take-over bid circular, letter of transmittal and notice of guaranteed delivery (collectively, the “Offer Documents”). The Offer has been extended by notices of variation and/or extension dated December 14, 2005, January 19, 2006, February 27, 2006, May 29, 2006, June 29, 2006, July 13, 2006 and July 16, 2006. The extensions were made in order to provide us with additional time to obtain competition approvals from regulatory authorities in Europe and the United States and/or in connection with variations to the terms of the Offer. The Offer currently consists of, at the election of each Falconbridge shareholder, (a) Cdn.$60.20 in cash, or (b) 0.80312 of an Inco common share plus Cdn.$0.05 in cash, for each Falconbridge common share, subject in each case to proration. The maximum amount of cash available under the Offer is approximately Cdn.$7.1 billion and the maximum number of Inco common shares available under the Offer is approximately 213 million. The consideration payable under the Offer will be prorated as necessary to ensure that the total aggregate consideration will not exceed these maximum amounts. The Offer is subject to certain conditions of completion, including acceptance of the Offer by Falconbridge common shareholders owning not less than 50.01% of the Falconbridge common shares on a fully diluted basis (as defined in the Offer Documents). Once the conditions to the Offer have been met or waived and we have taken up and paid for at least 50.01% of Falconbridge’s common shares as described in the Offer Documents, we intend to take certain steps to acquire all of the remaining outstanding Falconbridge common shares. The support agreement dated October 10, 2005 between Inco and Falconbridge, as amended from time to time subsequent to that date (the “Support Agreement”), provides for certain termination and expense payments by Falconbridge to Inco of up to $450 million in certain specified circumstances, including the termination of the Support Agreement under certain circumstances and the Offer not being completed in certain circumstances.

      For further information on the definitive arrangements which we have entered into in respect of the financing of the cash portion of the Offer, see Note 8.

      On June 23, 2006, we announced that Inco and Falconbridge reached a definitive agreement with the U.S. Department of Justice (“DOJ”) on a remedy intended to address competition concerns previously identified by the DOJ and the European Commission with respect to our pending acquisition of Falconbridge whereby Falconbridge’s Nikkelverk refinery in Norway and the Falconbridge marketing and custom feed

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

organizations that market and sell the finished nickel and other products produced at the Nikkelverk refinery and that obtain third party feeds for the Nikkelverk refinery (collectively, the “Nikkelverk Assets”) would be sold to LionOre Mining International Ltd. (“LionOre”). The remedy was also agreed to by the European Commission on July 4, 2006.

      We reached a definitive agreement with Falconbridge and LionOre (the “LionOre Agreement”) on June 7, 2006 covering the sale of the Nikkelverk Assets to LionOre for a $650 million acquisition price to be satisfied by the payment of $400 million in cash and by the issuance and delivery of $250 million of common shares of LionOre. The purchase price is subject to certain adjustments tied to changes in the final working capital levels of the operations to be sold to LionOre and certain other adjustments. Inco has also agreed to supply up to 60,000 tonnes of nickel in matte annually, approximately equivalent to the current volume of feed provided by Falconbridge’s operations to the Nikkelverk refinery, for up to ten years. The closing of the sale of the Nikkelverk Assets is subject to the satisfaction of certain conditions, including the attainment of all applicable approvals and consents necessary to permit the pending acquisition of Falconbridge by Inco, Inco taking up and paying for Falconbridge common shares pursuant to the Offer and certain other standard terms and conditions to closing. In the event that our acquisition of Falconbridge is not completed and the LionOre Agreement is therefore terminated, we have agreed to pay LionOre a break-up fee of $32.5 million.

      On June 26, 2006, Inco and Phelps Dodge Corporation (“Phelps Dodge”) announced that they had entered into an agreement (the “Combination Agreement”) under which a newly-formed, wholly-owned subsidiary of Phelps Dodge will acquire all of Inco’s outstanding common shares under a plan of arrangement (the “Arrangement”) for a combination of cash and common shares of Phelps Dodge. On July 16, 2006, Inco and Phelps Dodge announced that we had entered into a waiver and amendment to the Combination Agreement, pursuant to which, among other things, Phelps Dodge increased the consideration payable under the proposed Arrangement by Cdn.$2.75 in cash, from (i) Cdn.$17.50 in cash and 0.672 of a Phelps Dodge Share to (ii) Cdn.$20.25 in cash and 0.672 of a Phelps Dodge Share. Upon the closing of the Phelps Dodge-Inco combination, shareholders of Falconbridge who have been issued Inco common shares in the Inco-Falconbridge transaction will be entitled to receive for those shares the same package of cash and Phelps Dodge shares as will other Inco shareholders. Inco may be required to pay a break-up fee to Phelps Dodge under certain circumstances equal to $475 million, and such amount will be increased to $925 million from the date Inco acquires at least 50.01% of the outstanding common shares of Falconbridge. Inco has also given Phelps Dodge certain other customary rights, including a right to match competing offers. Phelps Dodge has agreed to pay Inco a $500 million break-up fee under certain circumstances. Each of Phelps Dodge and Inco may be required to pay the other party a break-up fee of $125 million in certain specified circumstances. The completion of the transactions contemplated by the Combination Agreement is subject to certain conditions, including, among others, certain approvals of shareholders of both companies.

      Phelps Dodge has entered into a definitive agreement under which, subject to certain conditions, it may be required to purchase up to $3 billion of convertible subordinated notes issued by Inco (the “Notes”) to help fund Inco’s purchase of Falconbridge common shares or to satisfy related dissent rights, as needed. The Notes will be redeemable for cash at any time by Inco and may be converted in whole or in part at any time beginning six months after issuance by the holder at a conversion rate equal to 95% of the average closing price on the NYSE over the five trading days preceding the date of conversion plus accrued and unpaid interest of the security at the time of conversion. The Notes will bear an 8% coupon. The payment of interest on the Notes may be deferred by Inco until stated maturity. At stated maturity, the Notes will be payable in cash, common shares of Inco or a combination thereof. The transaction between Phelps Dodge and Inco is not conditioned upon the completion of the Inco and Falconbridge combination. Thus, in the event that the Inco-Falconbridge merger is not completed, Inco shareholders will receive the same 0.672 of a share of Phelps Dodge stock and Cdn.$20.25 per share in cash that they would have received in the proposed three-way combination.

INCO LIMITED AND SUBSIDIARIES

Notes to Consolidated Financial Statements — (Continued)

      An unsolicited offer by Teck Cominco Limited (“Teck”) to purchase all of the common shares of Inco that it does not already own (the “Teck Offer”) was mailed to Inco shareholders on May 23, 2006 and remains outstanding. On July 21, 2006, Teck extended the expiry time of the Teck Offer until 8:00 p.m. (Toronto time) on August 16, 2006.

      Inco’s Board of Directors has unanimously recommended that Inco’s shareholders reject the Teck Offer and not tender their Inco shares to the Teck Offer. For more information, see Inco’s Directors’ Circular and Solicitation/ Recommendation Statement on Schedule 14D-9 filed with the SEC on May 31, 2006.

      On July 20, 2006, Inco and Teck consented to a cease trade order (the “Order”) by the Ontario Securities Commission whereby Inco’s shareholder rights plan will cease to apply as of 4:30 p.m. (Toronto time) on Wednesday, August 16, 2006. The Order was made on July 20, 2006.

Overview

      Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our interim consolidated financial statements and notes for the three-month and six-month periods ended June 30, 2006. This discussion contains certain forward-looking statements based on our current expectations. The forward-looking statements entail various risks and uncertainties, as disclosed in our 2005 Annual Report on Form 10-K, which could cause actual results to differ materially from those reflected in these forward-looking statements. Reference is also made to the “Cautionary Notice Regarding Forward-Looking Statements” below.

      We are a leading producer of nickel and value-added specialty nickel products. We are also an important producer of copper, precious metals and cobalt. We also produce sulphuric acid and liquid sulphur dioxide as by-products from our processing operations in Sudbury, Ontario. Our principal mines and processing operations are located in the Sudbury area of Ontario, the Thompson area of Manitoba, Voisey’s Bay in Newfoundland and Labrador, and, through a subsidiary in which we have an equity interest of approximately 61%, PT International Nickel Indonesia Tbk (“PT Inco”), on the Island of Sulawesi, Indonesia. We also operate additional wholly-owned metals refineries at Port Colborne, Ontario and in the United Kingdom at Clydach, Wales and Acton, England. We also have interests in nickel refining capacity in the following Asian countries: in Japan, through Inco TNC Limited, in which we have an equity interest of approximately 67%; in Taiwan, through Taiwan Nickel Refining Corporation, in which we have an equity interest of 49.9%; and in South Korea, through Korea Nickel Corporation, in which we have an equity interest of 25%. In addition, we have a 65% equity interest in Jinco Nonferrous Metals Co., Ltd., a company that produces nickel salts in Kunshan City, People’s Republic of China (“China”). We also have two joint venture operations in China that produce nickel foam products for the global rechargeable battery market: Inco Advanced Technology Materials (Dalian) Co., Ltd., in which we have a total direct and indirect equity interest of 81.6%, and Inco Advanced Technology Materials (Shenyang) Co., Ltd., in which we have a total direct and indirect equity interest of 82%. In March 2005, Shenyang acquired substantially all of the assets which represented the nickel foam business of Shenyang Golden Champower New Materials Corp., a leading Chinese producer of nickel foam. We also have a shearing and packaging operation in China for certain nickel products to meet the specific needs of this geographic market.

      Our business consists of three segments: (1) a finished products segment that represents our mining and processing operations in Ontario, Manitoba and Newfoundland and Labrador, our refining operations in the United Kingdom and interests in refining operations in Japan and other Asian countries, (2) an intermediates segment that represents PT Inco’s mining and processing operations in Indonesia, where nickel-in-matte, an intermediate product, is produced and sold primarily into the Japanese market, and (3) a development projects segment that represents our Goro nickel-cobalt project in the French overseas territorial community (collectivité territoriale) of New Caledonia (consisting of an open-pit mine and processing facility having an expected annual capacity of 60,000 tonnes of nickel), a nickel processing plant being built in Dalian, China to process primarily Goro-source feed, an expansion of our facilities in Indonesia and the next phase of development at our Voisey’s Bay project (consisting of feasibility work for a nickel processing plant and an underground mine). In the fourth quarter of 2005, production of nickel and copper concentrates commenced at the first phase of our Voisey’s Bay project, consisting of an open-pit mine and concentrator. Accordingly, the assets relating to the first phase of the Voisey’s Bay project were reclassified from the development projects segment to the finished products segment.

      The price of nickel has represented, and is currently expected to continue to represent, the principal determinant of our profitability and cash flow from operations. Accordingly, our financial performance has been, and is expected to continue to be, closely linked to the price of nickel and, to a lesser extent, the price of

copper and other primary metals produced by us. Historically, the demand for nickel has been closely correlated to industrial production in the world’s major industrialized regions, in particular North America and Europe and more recently Asia, and we expect this correlation to continue.

      For the second quarter, the London Metal Exchange (“LME”) benchmark cash nickel price rose to a record quarterly average of $20,036 per tonne ($9.09 per pound), compared with the first quarter 2006 average of $14,811 per tonne ($6.72 per pound). The LME cash nickel price set a record high of $29,850 per tonne ($13.54 per pound) on July 17, 2006. On July 24, 2006, the LME cash nickel price was $27,355 per tonne ($12.41 per pound). We believe that the recent price rise was due primarily to strong nickel market fundamentals.

      On June 22, 2006, we announced that we had increased our projection of the 2006 global nickel market deficit to 30,000 tonnes. We continue to expect that the second half of 2006 will not see a repeat of the weaker market conditions that occurred in the second half of 2005. We are projecting a very strong market for the remainder of 2006, based on the following ten factors: