SOUTHERN COPPER CORP/ - Quarter Report: 2007 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

2007 Second Quarter

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

SOUTHERN COPPER CORPORATION

(Exact name of registrant as specified in its charter)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 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. (See definition of  “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act).

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act).

 

As of July 31, 2007 there were outstanding 294,465,650 shares of Southern Copper Corporation common stock, par value $0.01 per share.

 

Southern Copper Corporation

INDEX TO FORM 10-Q

Part I. Financial Information:					Page No.
Item. 1			Condensed Consolidated Financial Statements (unaudited)
			Condensed Consolidated Statement of Earnings three and six months ended June 30, 2007 and 2006		3
			Condensed Consolidated Balance Sheet June 30, 2007 and December 31, 2006		4
			Condensed Consolidated Statement of Cash Flows three and six months ended June 30, 2007 and 2006		5-6
			Notes to Condensed Consolidated Financial Statements		7-33
Items 2 and 3.			Management’s Discussion and Analysis of Financial Condition and Results of Operations		34-50
Item 4.			Controls and Procedures		51
Report of Independent Registered Public Accounting Firm					52
Part II. Other Information:
Item 1.			Legal Procedures		53
Item 1a.			Risk factors		53
Item 6.			Exhibits		54
Signatures					55
			List of Exhibits		56
Exhibit 31.1			Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2			Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1			Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2			Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

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Part I — FINANCIAL INFORMATION

Item 1.  Condensed Consolidated Financial Statements

Southern Copper Corporation

CONDENSED CONSOLIDATED STATEMENT OF EARNINGS

(Unaudited)

		3 Months Ended						6 Months Ended
		June, 30						June 30,
		2007			2006			2007			2006
		(in thousands)
Net sales		$	1,826,462		$	1,276,749		$	3,184,799		$	2,398,040
Operating costs and expenses:
Cost of sales (exclusive of depreciation, amortization and depletion shown separately below)		562,334			521,788			1,028,979			928,732
Selling, general and administrative		25,907			23,313			49,706			47,329
Depreciation, amortization and depletion		84,466			77,982			158,564			131,085
Exploration		8,553			4,636			14,971			9,209
Total operating costs and expenses		681,260			627,719			1,252,220			1,116,355
Operating income		1,145,202			649,030			1,932,579			1,281,685
Interest expense		(30,982		)	(28,202		)	(60,788		)	(51,109		)
Capitalized interest		1,477			6,511			6,443			11,606
Loss on derivative instruments		(55,512		)	—			(76,692		)	—
Loss on debt prepayments		—			(860		)	—			(860		)
Other income (expense)		5,010			8,466			25,672			7,488
Interest income		18,076			14,303			40,004			23,608
Earnings before income taxes and minority interest		1,083,271			649,248			1,867,218			1,272,418
Income taxes		354,416			207,864			585,090			407,736
Minority interest		2,893			2,104			4,484			3,827
Net earnings		$	725,962		$	439,280		$	1,277,644		$	860,855
Per common share amounts:
Net earnings basic and diluted		$	2.465		$	1.492		$	4.339		$	2.923
Dividends paid		$	1.500		$	1.375		$	3.200		$	2.750
Weighted average common shares  outstanding (basic and diluted)		294,465			294,461			294,465			294,461

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Southern Copper Corporation

CONDENSED CONSOLIDATED BALANCE SHEET

(Unaudited)

		June 30,			December 31,
		2007			2006
		(in thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	1,013,614		$	1,022,778
Marketable securities		340,000			280,000
Accounts receivable trade (less allowance for doubtful accounts: 2007 - $5,916; 2006 - $5,948)		559,209			560,227
Accounts receivable other		75,445			43,569
Accounts receivable other, from affiliates		4,390			2,630
Inventories		471,202			413,652
Deferred income tax - current portion		33,700			65,638
Prepaid and other current assets		44,493			54,383
Total current assets		2,542,053			2,442,877
Property, net		3,578,464			3,538,295
Leachable material, net		248,791			231,516
Intangible assets, net		116,968			118,107
Deferred income tax- non-current portion		—			14,549
Other assets, net		43,068			31,070
Total Assets		$	6,529,344		$	6,376,414
LIABILITIES
Current liabilities:
Current portion of long-term debt		$	160,000		$	10,000
Accounts payable		289,709			271,064
Accrued income taxes		112,989			226,047
Due to affiliated companies		3,351			3,581
Accrued workers’ participation		157,854			299,892
Interest		36,530			37,140
Other accrued liabilities		37,192			11,847
Total current liabilities		797,625			859,571
Long-term debt		1,363,232			1,518,111
Deferred income taxes		258,167			194,759
Non-current taxes payable		50,902			—
Other liabilities		57,909			111,196
Asset retirement obligation		12,664			12,183
Total non-current liabilities		1,742,874			1,836,249
Commitments and Contingencies (Note J)
MINORITY INTEREST		15,196			13,989
STOCKHOLDERS’ EQUITY
Common stock		2,949			2,949
Additional paid-in capital		773,502			772,693
Retaining earnings		3,342,200			3,010,307
Other accumulated comprehensive loss		(23,286		)	(22,332		)
Treasury stock		(121,716		)	(97,012		)
Total Stockholders’ Equity		3,973,649			3,666,605
Total Liabilities, Minority Interest and Stockholders’ Equity		$	6,529,344		$	6,376,414

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Southern Copper Corporation

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS

(Unaudited)

		3 Months Ended June 30,						6 Months Ended June 30,
		2007			2006			2007			2006
		(in thousands)
OPERATING ACTIVITIES
Net earnings		$	725,962		$	439,280		$	1,277,644		$	860,855
Adjustments to reconcile net earnings to net cash provided from operating activities:
Depreciation, amortization and depletion		84,466			77,982			158,564			131,085
Capitalized leachable material		(19,568		)	—			(40,029		)	—
Remeasurement loss(gain)		5,249			(11,954		)	567			(11,382		)
Provision for deferred income taxes		38,094			(3,477		)	58,340			16,235
Loss on marketable securities		29,388			—			29,388			—
Unrealized loss on derivative instruments		39,029			1,818			61,717			1,818
Minority interest		2,892			2,104			4,483			3,827
Cash provided from (used for) operating assets and liabilities:
Accounts receivable		(95,037		)	(159,597		)	(14,003		)	(135,233		)
Inventories		(14,566		)	(25,193		)	(57,550		)	(65,496		)
Accounts payable and accrued liabilities		(76,484		)	(173,874		)	(321,633		)	(252,694		)
Other operating assets and liabilities		(70,551		)	(14,297		)	40,273			21,434
Net cash provided by operating activities		648,874			132,792			1,197,761			570,449
INVESTING ACTIVITIES
Capital expenditures		(93,962		)	(87,603		)	(178,992		)	(230,720		)
Purchase of marketable securities		—			—			(100,000		)	—
Sales of marketable securities		40,000			—			40,000			—
Loss on sale of marketable securities		(29,388		)	—			(29,388		)	—
Other		(145		)	3,814			736			2,003
Net cash used for investing activities		(83,495		)	(83,789		)	(267,644		)	(228,717		)
FINANCING ACTIVITIES
Debt repaid		(5,000		)	(21,510		)	(5,000		)	(21,510		)
Debt incurred		—			389,192			—			389,192
Dividends paid to common stockholders		(441,683		)	(404,877		)	(942,267		)	(809,754		)
Distributions to minority interest		(1,405		)	(1,886		)	(3,164		)	(4,871		)
Other		216			(7,704		)	277			(7,046		)
Net cash used for financing activities		(447,872		)	(46,785		)	(950,154		)	(453,989		)
Effect of exchange rate changes on cash and cash equivalents		7,257			23,105			10,873			37,204
Increase (decrease) in cash and cash equivalents		124,764			25,323			(9,164		)	(75,053		)
Cash and cash equivalents, at beginning of period		888,850			775,627			1,022,778			876,003
Cash and cash equivalents, at end of period		$	1,013,614		$	800,950		$	1,013,614		$	800,950

 

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		3 Months Ended June 30,						6 Months Ended June 30,
		2007			2006			2007			2006
		(in thousands)
Supplemental disclosure of cash flow information:
Cash paid during the period for:
Interest		$	15,019		$	2,533		$	21,505		$	21,948
Income taxes		$	296,822		$	420,311		$	561,333		$	568,735
Workers participation		$	127,415		$	62,063		$	298,851		$	158,903

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Southern Copper Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

A.          In the opinion of Southern Copper Corporation, (the “Company”, “Southern Copper” or “SCC”), the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company’s financial position as of June 30, 2007 and the results of operations and cash flows for the three and six months ended June 30, 2007 and 2006.  The condensed consolidated financial statements for the three and six month periods ended June 30, 2007 and 2006 have been subjected to a review by PricewaterhouseCoopers, the Company’s independent registered public accounting firm, whose report dated August 2, 2007, is presented on page 52.  The results of operations for the three and six months ended June 30, 2007 and 2006 are not necessarily indicative of the results to be expected for the full year.  The December 31, 2006 balance sheet data was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles in the United States of America.  The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated  financial statements at December 31, 2006 and notes included in the Company’s 2006 annual report on Form 10-K.

B.             Change in Accounting Principle - Adoption of FIN 48:

Financial Accounting Standards Board (FASB) Interpretation No. 48 “Accounting for Uncertainty in Income Taxes”, (FIN 48) was issued in July 2006 and interprets FASB Statement of Financial Accounting Standards (SFAS) No. 109.  FIN 48 replaces SFAS No.5 with respect to accounting for all tax positions, both certain and uncertain.  FIN 48 became effective for the Company on January 1, 2007 and prescribes a comprehensive model for the recognition, measurement, financial statement presentation and disclosure of uncertain tax positions taken or expected to be taken in a tax return.  FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

The Company classifies income tax-related interest and penalties as income taxes in the financial statements.

The total amount of unrecognized tax benefits as of the January 1, 2007 date of adoption of FIN 48 was $32.0 million.  This amount related entirely to U.S. income tax matters.  The Company has no unrecognized Peruvian or Mexican tax benefits.  The cumulative effect of the implementation of FIN 48 on retained earnings was a net reduction of $3.5 million.  There were no material changes to the amount of unrecognized tax benefits during the six months ended June 30, 2007.

The amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate was $25.4 million at adoption and did not materially change by June 30, 2007.

As of the January 1, 2007 adoption of FIN 48, the Company’s liability for uncertain tax positions included accrued interest of $13.9 million.  The liability included no accrued penalties because management expects no penalties to apply to the resolution of any of its uncertain tax positions.  The amount of the increase in accrued interest during the six months ended June 30, 2007 was not material.

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Various tax positions are currently under review by the U.S. Internal Revenue Service (“IRS”) Appeals Office.  It is not likely that this review will result in a cash payment within twelve months of June 30, 2007.

Such positions include the determination of appropriate depreciation periods for fixed assets, the capitalization of costs to the copper inventory inherent in leachable dumps, and depletion deductions.

As of the January 1, 2007 adoption of FIN 48, management did not expect that a final resolution of the IRS review would result in a significant change in the Company’s liability.  The Company’s reasonable expectations about future resolutions of uncertain items did not materially change during the six months ended June 30, 2007.

The following tax years remain open to examination and adjustment by the Company’s three major tax jurisdictions:

Peru:                                                  2003 and all following years (years 1997 through 2002 have been examined by the Peruvian taxing authority and the issues raised are being contested; no new issues can be raised for these years).

U.S.:                                                    1997 and all following years

Mexico:                                   2001 and all following years

In May 2007 the FASB published FASB Staff Position (FSP) FIN 48-1, “Definition of Settlement on FASB Interpretation No. 48”  This FSP amends FIN 48 to provide a guidance on how an enterprise should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits.  This FSP makes a number of conforming changes throughout FIN-48 to the term “ultimate settlement” or “ultimately settled”:  When the term was used to describe recognition that term is replaced with “effectively settled” and when the term is used to describe measurement that term is replaced with “settlement” or “settled”.  FSP FIN 48-1 has not had an effect on the Company’s financial results.

C.             Marketable Securities:

Commencing in 2006 the Company began making short term investments (90 days to 1 year) in leveraged, indexed instruments.  The marketable securities were as follows (in millions):

		Face Value
Investment		June 30, 2007			December 31, 2006
3-month note, issued December 12, 2006, with extensions every 3 months up to a maximum of 12 months, and with an interest rate of 7%; established by a pool of Mexican and Peruvian bond issues.		$	200.0		$	200.0
3-month note, issued January 19, 2007, with extensions every 3 months up to a maximum of 12 months, and with an interest rate of 7.25%; established by a pool of Mexican and Peruvian bond issues.		100.0			100.0
180-day note, maturing June 12, 2007 with an interest rate of 6%, with barrier range of $37.669 and $69.957 of SCC stock price, NYSE symbol PCU.		—			40.0
180-day note, maturing June 28, 2007 with an interest   rate of 6%, with barrier range of $38.738 and $71.942   of SCC stock price, NYSE symbol PCU. (1)		20.0			20.0
300-day note, maturing December 24, 2007 with an   interest rate of 3.6%, with barrier range of $50.00   and $75.00 of SCC stock price, NYSE symbol PCU.		20.0			20.0
		$	340.0		$	380.0

(1) Redeemed on July 3, 2007.

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Some of these investment instruments are indexed to SCC common stock prices while others are leveraged and indexed to certain bond pools.  Both types of instruments could cause the principal of the investment to be reduced if the established ranges are breached.  Since the notes are not principal protected the Company may lose part or all of the initial investment.  These instruments have been deemed to contain embedded derivatives and have been subject to valuation using a binomial model.  Through June 30, 2007, the Company has recorded an estimated loss of $93.2 million related to these investments.  The amount of the realized loss was $29.4 million on an investment of $40.0 million which matured in June 2007. The unrealized portion of $63.8 million includes $13.8 million realized on an investment, which matured on June 28, 2007 and was redeemed on July 3, 2007, and is recorded in other accounts payable.  The loss recorded in the three months and six months ended June 30, 2007 of $58.9 million and $81.6 million, respectively, is included as loss on derivative instruments in the condensed consolidated statement of earnings.  A loss on these investments of $11.6 million was recorded in the fourth quarter 2006 results.

In the first three and six months of 2007 the Company earned interest of $6.3 million and $12.4 million on these investments, respectively, which were recorded in interest income in the condensed consolidated statement of earnings.

D.            Inventories were as follows:

(in millions)

		June 30, 2007			December 31, 2006
Metals at lower of average cost or market:
Finished goods		$	133.3		$	116.1
Work-in-process		131.0			121.9
Supplies at average cost		206.9			175.7
Total inventories		$	471.2		$	413.7

 

E.              Income taxes:

The income tax for the six months ended June 30, 2007 and 2006 was $585.1 million and $407.7 million, respectively.  These provisions include income taxes for Peru, Mexico and the United States.  The effective tax rates for the 2007 and 2006 periods are 31.3% and 32.0%, respectively.  A decrease of 1% in the statutory Mexican tax rate contributed to the decrease in the 2007 effective income tax rate.  In addition, a tax inflation adjustment and the effect of currency conversion adjustment in our Mexican operations also contributed to the reduction in the effective tax rate.

F.              Provisionally Priced Sales:

At June 30, 2007, the Company has recorded provisionally priced sales of 141.6 million pounds of copper, at an average forward price of $3.42 per pound.  Also

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the Company has recorded provisionally priced sales of 4.4 million pounds of molybdenum at the June 30, 2007 market price of $32.25 per pound.  These sales are subject to final pricing based on the average monthly LME or COMEX copper prices and Dealer Oxide molybdenum prices in the future month of settlement.

Following are the provisionally priced copper and molybdenum sales outstanding at June 30, 2007:

 

 

Management believes that the final pricing of these sales will not have a material effect on the Company’s financial position or results of operations.

G.             Derivative Instruments

The Company occasionally uses derivative instruments to manage its exposure to market risk from changes in commodity prices and interest rate risk exposure.  The Company does not enter into derivative contracts unless it anticipates a future activity that is likely to occur that will result in exposing the Company to market risk.

Copper and zinc derivatives:

From time to time the Company has entered into derivative instruments to protect a fixed copper, or zinc price for a portion of our metal sales.

In the second quarter of 2007 and 2006 the Company entered into copper collar and swaps contracts to protect a portion of its 2007 and 2006 sales of copper production. Related to the settlement of these copper swap contracts the Company recorded a gain of $3.3 million and a loss of $257.9 million in the second quarter of 2007 and 2006, respectively. These gains and losses were recorded in net sales in the condensed consolidated statement of earnings. The Company did not hold any zinc derivative contracts in the first two quarters of 2007 and 2006.

At June 30, 2007 the Company has copper collar contracts to protect 146.2 million pounds of copper production for the July - December 2007 period at weighted average minimum and maximum LME prices of $3.20 per pound and $4.07 per pound, respectively. If the price falls below the minimum LME price, the Company will be in a gain position. If the price exceeds the maximum LME price, the Company will be in a loss position. In addition, the Company has copper swap contracts to

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protect 7.9 million pounds of copper production for the July-August 2007 period at an average COMEX price of $3.71 per pound of copper.

Gas swaps:

The Company established long swap contracts for 900,000 MMBTUs with a fixed price of $7.525 in the first six months of 2007 and 900,000 MMBTUs with a fixed price of $4.2668 per MMBTU in the second quarter and first six months of 2006.  Related to these contracts, the Company recorded a loss of $0.9 million in the first six months of 2007 and gains of $1.3 million and $3.6 million, in the second quarter and first six months of 2006, respectively, which were included in the production cost.  At June 30, 2007, we did not hold any open gas swap contract.

Exchange rate derivatives, U.S. dollar/Mexican peso contracts:

Because more than 85% of our sales collections in Mexico are in US dollars and many of our costs are in Mexican pesos, during 2006 the Company entered into zero-cost derivative contracts with the purpose of protecting, within a range, against an appreciation of the Mexican peso to the US dollar.  In these contracts if the exchange rate settles at or below the barrier, the Company does not sell US dollars, if the exchange rate settles above the barrier price established in the contract the Company sells US dollars at the strike price established in the contract.

In the second quarter and first half of 2007 the exercise of these zero-cost derivative contracts resulted in gains of $2.6 million and $4.1 million, respectively, which was recorded as gain on derivative instruments in the condensed consolidated statement of earnings.

At June 30, 2007 the Company held the following exchange rate derivative operations:

Notional Amount (millions)		Due Date, Weekly expiration during		Strike Price (Mexican Pesos/U.S. Dollars)		Barrier Price (Mexican Pesos/U.S. Dollars)
$ 26.0		3rd Quarter 2007		11.15		10.675
$ 26.0		3rd Quarter 2007		11.52		11.15
$ 26.0		3rd Quarter 2007		11.90		11.54
$ 48.0		4th Quarter 2007		11.35		10.65
$ 48.0		4th Quarter 2007		11.65		11.35
$ 54.0		1st Quarter 2008		11.60		11.28
$ 54.0		1st Quarter 2008		11.28		10.70

 

At June 30, 2007, the fair value of the above listed exchange rate derivative contracts is a gain of $2.1 million which was recorded as gain on derivative instruments in the condensed consolidated statement of earnings.  Each notional amount includes a group of weekly transactions that have the same strike and barrier price.

Dual currency notes:

In the second quarter and first six months of 2007 the Company invested $440.0 million and $560.0 million, respectively, in dual currency notes which provided an above market interest return subject to a barrier range of the Mexican peso/US dollar exchange rates.  These investments matured in the first and second quarters of 2007.

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Related to these investments, in the second quarter of 2007 the Company realized an exchange loss of $1.3 million, which was recorded as a loss on derivative instruments in the condensed consolidated statement of earnings.

The Company also earned interest income of $1.7 million and $2.1 million in the second quarter and first half of 2007, respectively, which was recorded as interest income in the condensed consolidated statement of earnings.

There were no open positions at June 30, 2007.

Additionally, the Company holds embedded derivatives which are described in note C “Marketable Securities.”

H.            Asset Retirement Obligation:

In 2005 the Company added an estimated asset retirement obligation for its mining properties in Peru, as required by the Mine Closure Law, enacted in 2003 and regulated in 2005.  In accordance with the law a conceptual mine closure plan, without costs, was submitted to the Peruvian Ministry of Energy and Mines (“MEM”) in August 2006.  According to regulations, the plan is subject to review by MEM for 45 days.  After the MEM review the Company will have 90 days to prepare and resubmit the mine closure plan, including costs, which will then be subject to MEM approval and open to public discussion and comment in the area of the Company operations.  The Company is still awaiting MEM’s initial review.  However, as of June 30, 2007, the Company has made an estimated provision of $6.1 million for this liability in its financial statements, but believes that this estimate should be viewed with caution, pending final approval of the mine closure plan.

The closure cost recognized for this liability includes the estimated cost required at the Peruvian operations, based on the Company’s experience, and includes cost at the Ilo smelter, the tailing disposal, and dismantling the Toquepala and Cuajone concentrators, and the shops and auxiliary facilities.  Based on this, we recorded an additional asset retirement liability in 2005 of $5.2 million, which increased our previously recorded asset retirement liability to $11.2 million. This increased net property by $4.6 million.

The following table summarizes the asset retirement obligation activity for the first six months of 2007 and 2006 (in millions):

		2007			2006
Balance as of January 1,		$	12.2		$	11.2
Additions, changes in estimates		—			—
Accretion expense		0.5			0.5
Balance as of June 30,		$	12.7		$	11.7

 

I.                 Related Party Transactions:

Receivable and payable balances with affiliated companies and related parties are shown below (in millions):

		As of
		June 30, 2007			December 31, 2006
Affiliate receivable:
Mexico Proyectos y Desarrollos S.A. de C. V. and affiliates		$	4.2		$	2.6
Other		0.2			—
Total		$	4.4		$	2.6
Affiliate payable:
Grupo Mexico S.A.B. de C.V.		$	2.1		$	0.4
Ferrocarril Mexicano S.A. de C. V.		0.7			3.2
Sempertrans France Belting Tech		0.3			—
Other		0.3			—
Total		$	3.4		$	3.6

 

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The Company has entered into certain transactions in the ordinary course of business with parties that are controlling shareholders or their affiliates.  These transactions include the lease of office space, air transportation and construction services and products and services relating to mining and refining.  The Company lends and borrows funds among affiliates for acquisitions and other corporate purposes.  These financial transactions bear interest and are subject to review and approval by senior management, as are all related party transactions.  It is our policy that the Audit Committee of the Board of Directors shall review all related party transactions.  The Company is prohibited from entering or continuing a material related party transaction that has not been reviewed and approved or ratified by the Audit Committee.

Grupo Mexico, the Company’s ultimate parent and the majority indirect stockholder of the Company, and its affiliates provide various services to the Company.  These activities were principally related to accounting, legal, tax, financial, treasury, human resources, price risk assessment and hedging, purchasing, procurement and logistics, sales and administrative, and other support services.  Grupo Mexico is paid for these support services by the Company.  The total amount paid by the Company to Grupo Mexico for such services in the first six months of 2007 and 2006 was $6.9 million.  The Company expects to continue to pay $ 13.8 million per year for these services in future years.

The Company’s Mexican operations paid fees of $7.0 million and $8.9 million in the first six months of 2007 and 2006, respectively, primarily for freight services provided by Ferrocarril Mexicano, S.A. de C.V., a subsidiary of Grupo Mexico.

In addition, the Company’s Mexican operations paid fees of $7.1 million and $14.6 million in the first six months of 2007 and 2006, respectively, for construction services provided by Mexico Constructora Industrial S.A. de C.V., an indirect subsidiary of Grupo Mexico.

The Larrea family controls a majority of the capital stock of Grupo Mexico, and has extensive interests in other businesses, including oil drilling services, construction, and real estate.  The Company engages in certain transactions in the ordinary course of business with other entities controlled by the Larrea family relating to mining and refining services, the lease of office space, and air transportation and construction services.  In connection with this, the Company paid fees of $1.4 million and $0.9 million in the first six months of 2007 and 2006, respectively, for maintenance services provided by Mexico Compañia de Productos Automotrices S.A. de C.V., a company controlled by the Larrea family.  Additionally, in the third quarter of 2006, one of our Mexican subsidiaries provided a short-term interest bearing loan of $10.6 million to Mexico Transportes Aereos, S.A. de C.V. (“MexTransport”) for the purchase of an airplane, which was paid in the first quarter of 2007, Mextransport, a company controlled by the Larrea family, provides aviation services to our Mexican operations.  Our Mexican subsidiaries have provided a guaranty for a new $10.8 million loan secured by MexTransport.  The guaranty provided to MexTransport is backed up by the transport services provided by MexTransport to the Company’s Mexican subsidiaries.  The Company also paid fees of $0.4 million in the first six months of 2007 to MexTransport.

The Company purchased $2.9 million and $2.5 million in the first six months of 2007 and 2006, respectively, of industrial materials from companies in which Mr. Carlos Gonzalez

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has a proprietary interest.  Mr. Carlos Gonzalez is the son of SCC’s Chief Executive Officer.  In addition, the Company purchased $0.5 million and $0.3 million in the first six months of 2007 and 2006, respectively, of industrial material from companies in which Mr. Alejandro Gonzalez is employed as a sales representative.  Mr. Alejandro Gonzalez is the son of SCC’s Chief Executive Officer

It is anticipated that in the future the Company will enter into similar transactions with such parties.

J.                Employee Benefit Plan:

SCC Defined Benefit Pension Plan-

The components of the net periodic benefit costs for the six months ended June 30 are as follows ($ in millions):

		2007			2006(1)
Interest cost		$	0.3		$	0.3
Expected return on plan assets		(0.3		)	(0.3		)
Amortization of net loss		—			—
Net periodic benefit cost		$	—		$	—

(1)             2006 quarter based on average of annual amount.

SCC Post-retirement Health Care Plan-

The components of the net period benefit costs for the post-retirement health care plan for the six months ended June 30, 2007 and 2006 are individually, and in total, less than $0.1 million.

Minera Mexico Pension Plans-

The components of the net periodic benefit costs for the six month ended June 30 are as follows ($ in millions):

		2007			2006
Interest cost		$	0.9		$	0.9
Service cost		1.0			1.0
Expected return of plan assets		(1.0		)	(1.0		)
Net periodic benefit cost		$	0.9		$	0.9

 

Minera Mexico Post-retirement Health Care Plan-

The components of the net periodic cost for the six months ended June 30, 2007 and 2006 are as follows ($ in millions):

		2007			2006
Interest cost		$	1.2		$	1.1
Service cost		0.2			0.2
Net periodic benefit cost		$	1.4		$	1.3

 

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K.            Comprehensive Income:

		Three months ended						Six months ended
		June 30,						June 30,
		2007			2006			2007			2006
Net income		$	725,962		$	439,280		$	1,277,644		$	860,855
Other comprehensive income (loss) net of tax:
(Realized)unrealized gain on investments		2			607			(954		)	1,708
Comprehensive income		$	725,964		$	439,887		$	1,276,690		$	862,563

 

The realized (unrealized) gains on investment activity in the 2007 periods are due to the realized gains on the sale of our investment in Promotora y Operadora de Infraestructura, S.A. de C.V, formerly known as Grupo Tribasa S.A. de C.V. (TRIBASA), a Mexican construction company. The 2006 activity was due to the unrealized gain on this investment.

L.              Commitments and Contingencies

Peruvian Operations

Regional development contribution:

On December 28, 2006, the Company’s Peruvian branch signed a contract with the Peruvian government that commits the Company to make annual contributions for five years for the regional development of Peru.  This has been in response to an appeal by the president of Peru to the mining industry.  The Company, as well as the mining industry, has responded positively to help with this cause.  The programs envisioned will focus initially on nutrition for young children and expectant mothers, education and health services.  The Company has a program of contributions, starting in 2007 with a contribution of $16.1 million, calculated based on 2006 Peruvian earnings after income tax.  In accordance with the agreement, the contribution from 2006 earnings was segregated from the Branch’s resources by April 30, 2007.  The funds were deposited with a separate entity, the “Asociación Civil Ayuda del Cobre” which will make disbursements for approved investments in accordance with the agreement.  The following four years’ contributions could increase or decrease depending on copper prices. If the copper price drops below $1.79 per pound the contribution will cease.   The Company made a provision of $6.4 million in the first six months of 2007 based on Peruvian branch earnings.

Royalty charge:

In June 2004, the Peruvian Congress enacted legislation imposing a royalty charge to be paid by mining companies in favor of the regional governments and communities where mining resources are located.  Under this law, the Company is subject to a 1% to 3% royalty, based on sales, applicable to the value of the concentrates produced in our Toquepala and Cuajone mines.  The Company made provisions of $27.2 million and $28.2 million in the first six months of 2007 and 2006, respectively, for this royalty.  These provisions are included in “Cost of sales (exclusive of depreciation, amortization and depletion)” in the condensed consolidated statement of earnings.

In 2005, a Constitutional Tribunal ruled the law constitutional and additionally stated that the royalty charge applies to all concessions held in the mining industry, implying that those entities with tax stability contracts are subject to this charge.  In 1996, the Company entered into a tax stability contract with the Peruvian government (a “Guarantee and Promotional Measures for Investment Contract”), relating to our solvent extraction and electrowinning (“SX/EW”) production, which agreement 

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purports to, among other things, fix tax rates and other charges relating to such production.  The Company believes that the Constitutional Tribunal’s interpretation relating to entities with tax stability contracts is incorrect and intends to protest the imposition of the royalty charge on SX/EW production, when and if assessed.  Provisions made by the Company for the royalty charge do not include approximately $17.9 million of additional potential liability relating to its SX/EW production from June 30, 2004 through June 30, 2007.

Power purchase agreement:

In 1997, SCC sold its Ilo power plant to an independent power company, Enersur S.A. (“Enersur”).  In connection with the sale, a power purchase agreement was also completed under which SCC agreed to purchase all of its power needs for its Peruvian operations from Enersur for twenty years, commencing in 1997.

In 2003 the agreement was amended releasing Enersur from its obligation to construct additional capacity to meet the Company’s increased electricity requirements.  SCC believes it can satisfy the need for increased electricity requirements from other sources, including local power providers.

Environmental matters:

The Company has instituted extensive environmental conservation programs at its mining facilities in Peru and Mexico.  The Company’s environmental programs include water recovery systems to conserve water and minimize impact on nearby streams, reforestation programs to stabilize the surfaces of the tailings dams, and the implementation of scrubbing technology in the mines to reduce dust emissions.

Peruvian operations:

The Company’s operations are subject to applicable Peruvian environmental laws and regulations.  The Peruvian government, through its Ministerio de Energia y Minas (the Ministry of Energy and Mines, or “MEM”) conducts annual audits of the Company’s Peruvian mining and metallurgical operations.  Through these environmental audits, matters related to environmental commitments, compliance with legal requirements, atmospheric emissions, and effluent monitoring are reviewed.  The Company believes that it is in material compliance with applicable Peruvian environmental laws and regulations.

In accordance with Peruvian regulations, in 1996 SCC submitted its Programa de Adecuación y Manejo Ambiental (the Environmental Compliance and Management Program, known by its Spanish acronym, PAMA) to the MEM. A third-party environmental audit was conducted in order to elaborate the PAMA.  The PAMA applied to all current operations that did not have an approved environmental impact study at the time.  SCC’s PAMA was approved in January 1997 and contained 34 mitigation measures and projects necessary to (1) bring the existing operations into compliance with the environmental standards established by the MEM and (2) identify areas impacted by operations that were no longer active and needed to be reclaimed.  By the end of the first quarter of 2007, all PAMA related projects were completed.

With the smelter modernization project, the Company increased sulfur capture over the 92% requirement established by the PAMA.  The new smelter maintains production at current levels.  We are currently eliminating some glitches in the process to reach maximum production.  The nominal and design capacity for the Isasmelt furnace was reached in less than 45 days; compared with other smelting furnaces using this technology, the start-up of the Ilo smelter has been achieved in the shortest time.  Also, the sulfur capture during the second quarter was over the 92% required by Peruvian regulations.

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As of June 30, 2007, spending on this project was $570.5 million, including $58.5 million of capitalized interest.

In 2003, the Peruvian Congress published a new law announcing future closure and remediation obligations for the mining industry.  The law was amended in 2004 and again in 2005.  The current modification establishes that mining companies must submit their mine closure plans within one year of publication of final regulations.  In August 2005 final regulations were published and the Company initiated the preparation of the required mine closure plan.  This plan, in its final form, will include the estimated cost required for the Peruvian operations, including cost at the Ilo smelter and refinery, tailings disposal, and the dismantling of the Toquepala and Cuajone concentrators, shops and auxiliary facilities.

The conceptual plan, without costs, was submitted to MEM in August 2006 and, according to regulations, is subject to review by MEM for 45 days.  After the MEM review (which is still pending) the Company will have 90 days to prepare and resubmit the mine closure plan, including costs, which is then subject to approval by MEM and open to public discussion and comment in the area of the Company’s operations.  Additionally, the law requires companies to provide financial guarantees to insure that remediation programs are completed.  The Company believes the liability for these asset retirement obligations cannot currently be precisely measured, or estimated, until the Company has completed its final mine closure plan and is reasonably confident that it will be approved by MEM in most material respects.  However, the Company has made a preliminary estimate of this liability and has recorded such amount in its financial statements.  As of June 30, 2007, the Company has recorded $6.1 million for this liability.  The Company believes that this estimate should be viewed with caution, pending final approval of its mine closure plan.

For the Company’s Peruvian operations, environmental capital expenditures were $21.1 million and $86.4 million in the first six months of 2007 and 2006, respectively.

Mexican operations:

The Company’s operations are subject to applicable Mexican federal, state and municipal environmental laws, to Mexican official standards, and to regulations for the protection of the environment, including regulations relating to water supply, water quality, air quality, noise levels and hazardous and solid waste.  Some of these laws and regulations are relevant to legal proceedings pertaining to the Company’s San Luis Potosi copper facilities.

The principal legislation applicable to the Company’s Mexican operations is the federal Ley General del Equilibrio Ecologico y la Proteccion al Ambiente (the “General Law of Ecological Balance and Environmental Protection”, or the “Environmental Law”), which is enforced by the Procuraduria Federal de Proteccion al Ambiente (“Federal Bureau of Environmental Protection” or the “PROFEPA”).  The PROFEPA monitors compliance with environmental legislation and enforces Mexican environmental laws, regulations and official standards.  PROFEPA may initiate administrative proceedings against companies that violate environmental laws, which in the most egregious cases may result in the temporary or permanent closing of non-complying facilities, the revocation of operating licenses and/or other sanctions or fines.  Also, according to the Codigo Penal Federal (Federal Criminal Code), the PROFEPA must inform corresponding authorities regarding environmental non-compliance.

Mexican environmental regulations have become increasingly stringent over the last decade, and this trend is likely to continue and has been influenced by the environmental treaty entered into by Mexico, United States and Canada in connection with NAFTA in February 1999.  However, the Company’s management does not believe that continued compliance with the Environmental Law or Mexican State environmental laws will have a material adverse effect on the Company’s business, properties, results of operations, financial condition or prospects or will result in material capital

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expenditures.  Although the Company believes that all of its facilities are in material compliance with applicable environmental, mining and other laws and regulations, the Company cannot assure that future laws and regulations would not have a material adverse effect on the Company’s business, properties, results of operations, financial condition or prospects.

Due to the proximity of certain facilities of Minera Mexico to urban centers, the authorities may implement certain measures that may impact or restrain the operation of such facilities.

For the Company’s Mexican operations, environmental capital expenditures were $12.8 million and $2.5 million in the first six months of 2007 and 2006, respectively.

Litigation matters:

Peruvian operations:

Garcia-Ataucuri and Others vs. SCC:  In April 1996, the Company was served with a complaint filed in Peru by approximately 800 former employees seeking the delivery of a substantial number of “labor shares” (acciones laborales) of its Peruvian Branch plus dividends on such shares, to be issued in a proportional way to each former employee in accordance with their time of work with SCC’s Branch in Peru.

The Company conducts its operations in Peru through a registered Branch.  Although the Branch has neither capital nor liability separate from that of the Company, under Peruvian law it is deemed to have an equity capital for purposes of determining the economic interest of the holders of the labor shares.  The labor share litigation is based on claims of former employees for ownership of labor shares issued during the 1970s until 1989 under a former Peruvian mandated profit sharing system. In 1971, the Peruvian Government enacted legislation providing that workers in the mining industry would participate in the pre-tax profits of the enterprises for which they worked at a rate of 10%.  This participation was distributed 40% in cash and 60% as an equity interest in the enterprise. Under the law, the equity participation was originally delivered to the “Mining Community”, an organization representing all workers.  The cash portion was distributed to the workers after the close of the year.  The accrual for this participation was (and continues to be) a current liability of the Company, until paid.  In 1978, the law was amended and the equity distribution was calculated at 5.5% of pre-tax profits and was made to individual workers of the enterprise in the form of “labor shares” to be issued in Peru by the Peruvian Branch of SCC.  These labor shares represented an equity interest in the enterprise.  In addition, according to the 1978 law, the equity participations previously distributed to the “Mining Community” were returned to the Company and redistributed in the form of labor shares to the individual employees or former employees.  The cash participation was adjusted to 4.0% of pre-tax earnings and continued to be distributed to employees following the close of the year.  Effective in 1992, the law was amended to its present status, and the workers’ participation in pre-tax profits was set at 8%, with 100% payable in cash.  The equity participation component was eliminated from the law.

In 1995, the Company offered to exchange new common shares of the Company for the labor shares issued under the prior Peruvian law.  Approximately 80.8% of the issued labor shares were exchanged for the Company’s common shares, greatly reducing the minority interest on the Company’s balance sheet.  What remains of the workers’ equity participation is now included in the consolidated balance sheet under the caption “Minority Interest”.

In relation to the issuance of “labor shares” by the Branch in Peru, the Company is a defendant in the following lawsuits:

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1) As stated above, in April 1996, the Company was served with a complaint filed in Peru by approximately 800 former employees, (Garcia Ataucuri and others vs. SCC), seeking the delivery of 38,763,806.80 “labor shares” (acciones laborales) (or S/. 3,876,380,679.56), as required by Law # 22333, to be issued in a proportional way to each former employee or worker in accordance with their time of work with SCC’s Branch in Peru, plus dividends on such shares.  The amount claimed corresponds to the total number of labor shares for all of the Company’s Peruvian workers.  In December 1999, a civil court of first instance of Lima decided against the Company, ordering the delivery of the labor shares and dividends to the plaintiffs.  The Company appealed this decision in January 2000.  On October 10, 2000, the Superior Court of Lima affirmed the lower court’s decision, which had been adverse to the Company.  On appeal by the Company, the Peruvian Supreme Court annulled the proceeding noting that the civil courts lacked jurisdiction and that the matter had to be decided by a labor court.  On March 8, 2002, Mr. García Ataucuri restated the claim to comply with Peruvian labor law and procedure requirements, and increased the number of plaintiffs to approximately 958 ex-workers.  The lower labor judge dismissed the lawsuit in January 2005 on procedural grounds without deciding on the merits of the case.  In March 2005, the plaintiffs appealed to the Lima Labor Superior Court.  The Superior Court annulled the appeal due to procedural defects and remanded the case to the lower court for further proceedings.  The lower court, on motions from the plaintiffs, reinstated the appeal of the dismissal of the case of seven plaintiffs that had cured the procedural defects. As of June 30, 2007, the case remains open with no further new developments.

2) Additionally, on May 10, 2006, the Company was served with a new complaint filed in Peru, this time by 44 former employees, (Cornejo Flores and others vs. SCC), seeking delivery of (1) labor shares (or shares of whatever other current legal denomination)corresponding to years 1971 to December 31,1977 (we understand the plaintiffs are seeking the same 38,763,806.80 labor shares mentioned in the prior lawsuit), that should have been issued in accordance with Law # 22333, plus interest” and (2) labor shares resulting from capital increases made by the Branch in 1980 “ for the amount of the workers’ participation of S/.17,246,009,907.20, equivalent to 172,460,099.72 labor shares”, plus dividends.  On May 23, 2006, the Company answered this new complaint, denying the validity of the claim. As of June 30, 2007 the case remains in the discovery stage.

The Company asserts that the claims are without merit and that the labor shares were distributed to the former employees in accordance with the profit sharing law then in effect.  We do not believe that an unfavorable outcome is reasonably possible.  The Company has not made a provision for these lawsuits because it believes that it has meritorious defenses to the claims asserted in the complaints.

Mineria Integral S.A.C.:

In January 2007, the Company was served with three claims filed in Peru by Mineria Integral S.A.C.  The claims allege that the Company has trespassed on certain mining rights of the plaintiff, in Ilo, Department of Moquegua, and seek that the Company desist from the trespass and pay compensation in the amount of $49,139,476.  The Company believes that these administrative procedures are without merit and is vigorously defending itself against these actions.

Class actions

Three purported class action derivative lawsuits have been filed in the Delaware Court of Chancery (New Castle County) late in December 2004 and early January 2005 relating to the acquisition of Minera Mexico by SCC.  On January 31, 2005, the three actions Lemon Bay, LLP v. Americas Mining Corporation, et

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al., Civil Action No. 961-N, Therault Trust v. Luis Palomino Bonilla, et al., and Southern Copper Corporation, et al., Civil Action No. 969-N, and James Sousa v. Southern Copper Corporation, et al., Civil Action No. 978-N were consolidated into one action titled, In re Southern Copper Corporation Shareholder Derivative Litigation, Consol.  C. A. No. 961-N and the complaint filed in Lemon Bay was designated as the operative complaint in the consolidated lawsuit.  The consolidated action purports to be brought on behalf of the Company’s common stockholders.

The consolidated complaint alleges, among other things, that the acquisition of Minera Mexico is the result of breaches of fiduciary duties by the Company’s directors and is not entirely fair to the Company and its minority stockholders.  The consolidated complaint seeks, among other things, a preliminary and permanent injunction to enjoin the acquisition, the award of damages to the class, the award of damages to the Company and such other relief that the court deems equitable, including interest, attorneys’ and experts’ fees and costs.  The Company believes that this lawsuit is without merit and is vigorously defending itself against this action.

The Company’s management believes that the outcome of the aforementioned legal proceeding will not have a material adverse effect on the Company’s financial position or results of operations.

Mexican operations-

The Mexican Geological Services (MGS) Royalties:

In August 2002, MGS (formerly named Council of Mineral Resources (“COREMI”)) filed with the Third Federal District Judge in Civil Matters, an action demanding from Mexcobre the payment of royalties since 1997.  In December 2005, Mexcobre signed an agreement with MGS.  Under the terms of this agreement the parties established a new procedure to calculate the royalty payments applicable for 2005 and the following years, and the Company paid in January 2006, $6.9 million of royalties for 2005 and $8.5 million as payment on account of royalties from the third quarter 1997 through the last quarter of 2004.  We estimate that the payment made on January 11, 2006 will cover 100% of the royalty payments required for 2004 and prior periods.  On January 22, 2007 the Third Federal District Judge issued a ruling regarding the payment related to the period from the third quarter of 1997 through the fourth quarter of 2004.  This ruling was appealed by both parties in February 2007. The appeal is still pending.  The Company believes that the payment made on account for this period is correct.

On an ongoing basis the Company will be required to pay a 1% royalty on La Caridad’s copper production value after deduction of treatment and refining charges and certain other carrying costs.

San Luis Potosi Facilities:

The municipality of San Luis Potosi has granted Desarrolladora Intersaba, S.A. de C.V. (“Intersaba”), licenses for use of land and construction of housing and/or commercial zones in the former Ejido Capulines zone, where the residential project “Villa Magna” is expected to be developed in the near future.

The “Villa Magna” residential project will be developed within an area that IMMSA’s Risk Analysis approved by SEMARNAT (the federal environmental authority), has secured as a safeguard and buffer zone due to the use by IMMSA of anhydrous ammonia gas.

Based on the foregoing, IMMSA has initiated two different actions regarding this matter.  First, against the municipality of San Luis Potosi, requesting the annulment of the authorization and licenses granted to Intersaba to develop “Villa Magna” within

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the zinc plant’s safeguard and buffer zone; and second, filed before SEMARNAT for the declaration of a safeguard and buffer zone surrounding IMMSA’s zinc plant.

In August 2006, the first action was resolved by a Federal Court, which denied IMMSA’s request. In September 2006, IMMSA sumbmitted its final appeal to the Supreme Court of Justice and in February 2007, the court ruled against IMMSA.

IMMSA believes that while this outcome was adverse to its interests, the construction of the “Villa Magna” housing and commercial development will not, in itself, affect the operations of IMMSA’s zinc plant.

Intersaba has filed a lawsuit against IMMSA, requesting payment of damages in the amount of approximately $11.0 million supposedly caused by IMMSA during these proceedings.  IMMSA intends to vigorously defend against this lawsuit.

In addition to the foregoing, IMMSA has initiated a series of legal and administrative procedures against the Municipality of San Luis Potosi due to its refusal to issue IMMSA’s use of land permit (licencia de uso de suelo) in respect to its zinc plant.  A federal judge ruled that IMMSA’s use of land permit should be granted.

Tax contingency matters-

The Company is regularly audited by federal, state and foreign tax authorities, both, in the United States and internationally.  The amount of unrecognized tax benefits resulting from uncertain tax positions has been developed in consultation with legal and tax counsel and in accordance with the requirements of FIN 48, which was adopted effective January 1, 2007, see Note B above.

U.S. Internal Revenue Service (IRS)

IRS audits can result in proposed assessments.  In 2002, the IRS issued a preliminary Notice of Proposed Adjustment for the years 1994 through 1996.  In 2003, the Company settled these differences with the IRS and made a payment of $4.4 million, including interest.  The years 1994 through 1996 are now closed to further adjustment.

In the second quarter of 2007, the IRS completed field audit work for the years 2003 and 2004. Issues raised were the same as those pending resolution from prior audits. No new issues were raised and no new federal audits have been scheduled.

During the audit of the tax years 1997 through 1999, the IRS questioned the Company’s accounting policy for determination of useful lives for depreciable property, the calculation of deductible and creditable Peruvian taxes, the methodology of capitalizing interest and the capitalizing of certain costs (drilling, blasting and hauling) into inventory value as items for possible adjustment.  In 2003, the Company and the IRS jointly requested technical advice from the IRS National Office to help resolve the inventory value dispute.  In 2005 the National Office of the IRS responded to the request for technical advice with the issuance of a technical advice memorandum (TAM).  This TAM allowed the IRS to close the field audit work for the audit cycles 1997 through 1999 and 2000 through 2002.  The TAM accepts the position of the IRS field office and concludes that the Company is required to capitalize the drilling, blasting and hauling costs of material transported to its leach dumps based on the weight of material moved, without regard to metal content or recoverability.

In October 2005, the Company filed two formal protests, covering the years 1997 through 2002, with the IRS to appeal the proposed changes with respect to the TAM conclusion, as well as other items of adjustment proposed by the IRS field audit group.

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These other adjustments include the methodology of capitalizing interest, the determination of useful lives for depreciable property, the calculation of deductible and creditable Peruvian taxes and the established service fee between the Company and related parties.  Discussions with the Appeals Office representatives have begun and the parties have agreed to working through the protested issues and concluding the appeals process as soon as practicable.  During the quarter ending June 30, 2007 the Company and the IRS continued to exchange information aimed at settling the disputes.

On June 12, 2007 the Company filed a formal protest with the IRS to appeal the proposed changes raised from the 2003 and 2004 audit.  Although no new issues were identified, the application of the prior cycle issues to new years did give rise to additional proposed adjustments. The resulting liability amounts for these probable proposed adjustments were included within the FIN 48 liability.

Peruvian operations:

In Peru the Superintendencia Nacional de Administracion Tributaria (“SUNAT”), the Peruvian Tax Administration, regularly audits the Company.  These audits can result in proposed assessments.

In 2002, the Company received assessments and penalties from SUNAT for fiscal years 1996 through 1999, in which several deductions taken were disallowed.  After appeal, the Company settled many of the issues with SUNAT in 2003.  However, the portion of the assessment related to the disallowance of financial expenses is still pending resolution.  In addition, the Company has not recognized a liability for penalties and interest related to the portion of the assessments settled in 2003 or for the pending assessment related to financial expenses, as it considers that they are not applicable.  The status of these pending issues as well as other tax contingencies is as follows:

a) Year 1996:  With regard to the appeal of the penalty related to fiscal year 1996, the Company was required to issue a letter of credit to SUNAT of $3.4 million, which was issued in July 2003.  This deposit is recorded in other assets in the condensed consolidated balance sheet.  The Company was not required to issue a deposit for the appeal of the assessments and rulings with respect to any other year.  In February 2004, the Peruvian tax court denied the Company’s appeal.  Consequently, in April 2004, the Company filed a lawsuit against the Peruvian tax court and SUNAT before the Superior Court of Peru.  In September 2005, the Superior Court declared the Company’s claim valid.  SUNAT appealed this decision to the Peruvian Supreme Court in Lima.  In December 2006, the Peruvian Supreme Court confirmed the opinion of the lower court that declared valid SPCC’s claim.  SUNAT has not appealed this decision and in March 2007 issued a resolution in favor of SPCC’s claim. The Company is awaiting the refund of $3.4 million plus interest.

b) Year 1997:  In November 2002, with regard to the penalty issued by SUNAT related to fiscal year 1997, the Peruvian tax court indicated that the penalty needed to be modified and declared the previously issued penalty null.  Consequently, SUNAT issued a new penalty in December 2003.  This penalty had been protested before SUNAT.  The Company’s appeal before the Peruvian tax court related to the assessments (pertaining to the deduction of certain financial expense) for fiscal year 1997 was denied.  In May 2003, the Company filed a lawsuit before the Superior Court against SUNAT and the Peruvian tax court, seeking the reversal of the ruling of the tax court.  In July 2005 the Superior Court decided in favor of the Company and remanded the case to SUNAT for a new pronouncement.  SUNAT has appealed the court’s decision to the Peruvian Supreme Court in Lima.  In December 2006, the Supreme Court declared null the lower court’s opinion and remanded the case back to the lower court for final resolution.

In March 2007 the lower court declared null the original resolutions issued by SUNAT and the tax court, found in SPCC’s favor, and ordered SUNAT to accept the 1997 interest deduction.  SUNAT has appealed this decision.  This decision, if it

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is affirmed on appeal, is very important for SPCC as assessments related to the years 1998 through 2001 are based on SUNAT’s disallowance of similar interest expense deductions.

c) Years 1998 and 1999: In August 2006, SUNAT ruled on the part of the 1998/1999 issues related to payment of commissions to certain financial institutions.  The ruling resolved one issue in favor of the Company and other issues against the Company.  The Company has appealed before the Peruvian tax court the portion of the claim decided against the Company.

In July 2007, SUNAT ruled on the remaining 1998/1999 issues related to financial deductions. The ruling resolved one issue in favor of the Company and other issue against the Company. The Company will continue to contest the adverse portion of this ruling.

d) Years 2000 and 2001: In December 2004 and January 2005, the Company received assessments and penalties from SUNAT for fiscal years 2000 and 2001, in which certain deductions taken by the Company were disallowed.  SUNAT has objected to the Company’s method of deducting vacation pay accruals in 2000, a deduction in 2000 for a fixed asset write-off, as well as certain other deductions in both years.  The Company has appealed these assessments and resolution is still pending.  Additionally, the Company received penalties and assessments from SUNAT relating to treatment of foreign exchange differences for 2000 and 2001.  The Company has appealed these assessments before the Peruvian tax court and resolution is still pending.

In June 2006, a tax court decision was published with regards to another company, which states that profits related to foreign exchange differences need not be included in calculations for monthly advance tax payments.  The tax court has indicated that this decision is applicable to all future cases that are similar. In view of this, the Company expects that the portion of the 2000/2001 tax assessment related to foreign exchange difference will be removed from the assessment.

In September 2006, SUNAT declared invalid the Company’s claim related to the income tax rate applied to commissions paid to certain financial institutions.  The Company has appealed SUNAT’s decision before the Peruvian tax court.

e) Year 2002: In December 2006, the Company received assessments and penalties from SUNAT for fiscal year 2002 disallowing the income tax rate applied to services received from non domiciled companies and certain deductions taken.  In February 2007, the Company filed a protest before SUNAT regarding these assessments.

Mexican Operations:

MM is regularly examined by the Servicios de Administracion Tributaria (“SAT”), the Mexican tax administration.  These examinations can result in proposed assessments.

a) Year 1995: In March 2001, SAT issued an assessment related to the 1995 tax year, disallowing certain deductions related to the Company’s housing and local travel expenses.  The Company has appealed this assessment.  The tax court ruled against the Company.  In March 2007, SAT made the final liquidation of MM’s consolidated income tax and the Company paid $0.9 million.  With this payment the case is closed.

b) Year 1999:  In May 2005 SAT issued an assessment against MM claiming that MM understated the asset value used in the determination of the asset tax.  In addition, SAT claimed that MM improperly reduced its consolidated results through the consolidation of two subsidiaries.

MM believes that the 1999 SAT assessment is not legal.  Accordingly, in July 2005, MM filed a nullity motion with the Metropolitan Regional Tax Court, Exchequer Division,

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against the assessment, which is currently at the stage of submission of expert and documentary evidence.

Labor matters:

In recent years the Company has experienced a number of strikes or other labor disruptions that have had an adverse impact on its operations and operating results.

During 2006, there were a number of work stoppages at some of the Company’s Mexican operations.  While some of these work stoppages were of a short-term nature with little or no production loss, others have been more disruptive.  A strike at the La Caridad copper mine in Sonora began in the first quarter of 2006 and ended in July 2006.  A strike at the San Martin polymetallic complex in Zacatecas commenced in the first quarter of 2006 and ended in May 2006.  Workers at the Cananea copper mine went on a strike on June 1, 2006, returning to work six weeks later on July 17, 2006.  These work stoppages were declared illegal by the Mexican authorities.  On June 9, 2006, the Company announced the closing of the La Caridad mine as picketing workers made it impossible to continue operations.  As a result of these strikes, the Company declared “force majeure” on certain of its June and July copper contracts.  On July 14, 2006, with the approval of a labor court, the Company dismissed the La Caridad workers. Individual work agreements, and the collective union contract, were terminated in compliance with the provisions of the ruling rendered by federal labor authorities. On July 26, 2006, the installations were returned to the Company and the Company commenced to hire workers to resume operations.  In July 2006, the Company reopened the La Caridad mine and in the fourth quarter of 2006 restored production to 100% capacity.

Collective bargaining agreements with the Company’s nine Peruvian labor unions were due to expire in 2007. As a result, on April 28, 2007 the workers of a newly unified workers union at our Peruvian smelter in Ilo initiated a strike to demand better wages and benefits.  In addition, on April 30, 2007 Peru’s largest mining union launched a nationwide strike to demand better job benefits.  The workers at our two Peruvian mines joined the nationwide miners’ strike and also supported the unified Ilo union.  The labor minister declared the strike inappropriate and the workers returned to work after five days when the nationwide strike was resolved by the government.  The workers received guarantees from the government over working conditions and contracts.

On June 9, 2007 the workers of the Toquepala employees union signed a five year and nine month collective bargaining agreement with the Company. This agreement includes a salary increase of 11% retroactive to December 1, 2006.

On June 23, 2007 the unionized workers at some of our Peruvian operations initiated a strike demanding better wages and benefits.  At the request of the Peruvian labor authorities, the workers returned to work after five days to restart negotiations with the Company.

During these brief strikes at the Peruvian operations, the Company continued normal operations with the support of staff and administrative personnel and contractors.

On July 11, 2007 the workers of four Peruvian unions, the Ilo workers union, the refinery employees union, and the unified workers of Toquepala and Cuajone unions, signed a six year agreement with the Company. These agreements include a salary increase of 41.67% over the six years, 11% of which is for the first year retroactive to December 1, 2006. In addition, each worker will receive a one time payment of approximately $5,000 upon subscribing.

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Related to our Mexican operations, ten of the eleven collective bargaining agreements were satisfactorily negotiated. The Company expects to complete negotiation with the remaining union in August.

On July 30, 2007 three of our Mexican mining units, Cananea, Taxco and San Martín, suspended operations due to work stoppages organized by a minority of the units’ workers. Based on several procedural shortcomings, the Company considers that these stoppages are illegal. The Company has asked the authorities to promptly declare these work stoppages illegal.

Mine accident:

On February 19, 2006 an explosion occurred at the IMMSA unit’s Pasta de Conchos coal mine, located in San Juan de Sabinas, Coahuila, Mexico. Immediately thereafter and for 14 months, IMMSA conducted a comprehensive rescue effort.  Federal and local governmental help and support was received.  As a result of the accident eight miners were injured and 65 perished.

Both the Coahuila Public District Attorney (Procurador de Justicia) and the Federal Attorney’s Office (Procuraduria Federal de la Republica) initiated investigations to establish the causes of the accident and the responsible party.  A local judge at San Juan de Sabinas ordered five mine representatives to stand trial for the accident.  On April 16, 2007 the judge terminated the case due to the indemnification for damages to the families of the victims.  Recovery efforts have stopped due to increased hazards and potential health risks for the recovery workers. Federal labor officials are evaluating the conditions of the mine.

Other legal matters:

The Company is involved in various other legal proceedings incidental to its operations, but the Company does not believe that decisions adverse to it in any such proceedings individually or in the aggregate would have a material adverse effect on its financial position or results of operations.

Our direct and indirect parent corporations, including AMC and Grupo Mexico, have from time to time been named parties in various litigations involving Asarco.  In August 2002 the U.S. Department of Justice brought a claim alleging fraudulent conveyance in connection with AMC’s then-proposed purchase of SCC from Asarco.  That action was settled pursuant to a Consent Decree dated February 2, 2003.  In March 2003, AMC purchased its interest in SCC from Asarco.  In October 2004, AMC, Grupo Mexico, Mexicana de Cobre and other parties, not including SCC, were named in a lawsuit filed in New York State court in connection with alleged asbestos liabilities, which lawsuit claims, among other matters, that AMC’s purchase of SCC from Asarco should be voided as a fraudulent conveyance.  The lawsuit filed in New York State court was stayed as a result of the August 9, 2005 Chapter 11 bankruptcy filing by Asarco, as described below.  On February 2, 2007 a complaint was filed by Asarco, the debtor in possession, alleging many of the matters previously claimed in the New York State lawsuit, including that AMC’s purchase of SCC from Asarco should be voided as a fraudulent conveyance.  While Grupo Mexico and its affiliates believe that these claims are without merit, we cannot assure you that these or future claims, if successful, will not have an adverse effect on the Company’s parent corporation or the Company.  Any increase in the financial obligations of the Company’s parent corporation, as a result of matters related to Asarco or otherwise could, among other effects, result in the Company’s parent corporation attempting to obtain increased dividends or other funding from the Company.  In 2005, certain subsidiaries of Asarco filed bankruptcy petitions in connection with alleged asbestos liabilities.  In July 2005, the unionized workers of Asarco commenced a work stoppage.  As a result of various factors, including the above-mentioned work stoppage, on August 9, 2005 Asarco

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filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code before the U.S. Bankruptcy Court in Corpus Christi, Texas.  Asarco’s bankruptcy case is being joined with the bankruptcy cases of its subsidiaries.  Asarco’s bankruptcy could result in additional claims being filed against Grupo Mexico and its subsidiaries, including SCC, Minera Mexico or its subsidiaries.

M.         Segment and Related Information:

The Company operates in a single industry, namely mining copper.  Prior to the April 1, 2005 acquisition of Minera Mexico, the Company determined that its operations in Peru fell within one segment.  With the acquisition of Minera Mexico the Company continues to operate principally in one industry, the mining of copper.  However, because of the demands of managing operations in two countries, effective April 1, 2005 Company management views the new Southern Copper as having three operating segments and manages the Company on the basis of these segments.  Additionally, in mining copper, the Company produces a number of by-products, most important of which are molybdenum, silver and zinc.  The significant increase in the price of molybdenum over recent years has had an important impact on the Company’s earnings.  Nevertheless, the Company continues to manage its operations on the basis of the three copper segments.  Added to the segment information is the information regarding the Company’s molybdenum sales.  The segments identified by the Company are:

1.               Peruvian operations, which include the Toquepala and Cuajone mine complexes and the smelting and refining plants, industrial railroad and port facilities which service both mines.

2.               Mexican open pit copper mines, which include La Caridad and Cananea mine complexes and the smelting and refining plants and support facilities which service both mines.

3.               Mexican underground mining operations, which include five underground mines that produce zinc, copper, silver and gold, a coal and coke mine, and several industrial processing facilities for zinc and copper.  This group is identified as the IMMSA unit.

The Chief Operating Officer of the Company focuses on operating income as a measure of performance to evaluate different segments, and to make decisions to allocate resources to the reported segments.

Financial information relating to Southern Copper’s segments is as follows:

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		Three Months Ended June 30, 2007 (in millions)
		Mexican Open Pit			Mexican IMMSA Unit			Peruvian Operations			Corporate and other Eliminations			Consolidated
Net sales outside of segments		$	688.3		$	184.3		$	953.9		$	—		$	1,826.5
Intersegment sales		78.2			29.3						(107.5		)	—
Cost of sales (exclusive of depreciation, amortization and depletion)		209.4			107.5			358.1			(112.7		)	562.3
Selling, general and administrative expense		10.5			7.3			10.1			(2.0		)	25.9
Depreciation, amortization and depletion		44.0			9.9			30.0			0.6			84.5
Exploration		1.8			2.1			4.7			—			8.6
Operating income		$	500.8		$	86.8		$	551.0		$	6.6		1,145.2
Less:
Interest, net														(11.4		)
Loss on derivative instruments														(55.5		)
Other income (expense)														5.0
Taxes on income														(354.4		)
Minority interest														(2.9		)
Net earnings														$	726.0
Capital expenditure		$	41.9		$	2.8		$	49.0		$	0.3		$	94.0
Property, net		$	1,585.7		$	259.2		$	1,665.0		$	68.6		$	3,578.5
Total assets		$	3,239.9		$	712.7		$	3,134.3		$	(557.6	)	$	6,529.3

 

		Three Months Ended June 30, 2006 (in millions)
		Mexican Open Pit			Mexican IMMSA Unit			Peruvian Operations			Corporate and other Eliminations			Consolidated
Net sales outside of segments		$	336.5		$	153.5		$	786.7		$	—		$	1,276.7
Intersegment sales		63.7			8.3			—			(72.0		)
Cost of sales (exclusive of depreciation, amortization and depletion)		200.7			86.8			286.7			(52.4		)	521.8
Selling, general and administrative expense		8.5			5.2			9.7			(0.1		)	23.3
Depreciation, amortization and depletion		50.1			7.2			20.3			0.4			78.0
Exploration		0.1			1.3			3.2			—			4.6
Operating income		$	140.8		$	61.3		$	466.8		$	(19.9	)	649.0
Less:
Interest, net														(7.3		)
Loss on debt prepayment														(0.9		)
Other income (expense)														8.5
Taxes on income														(207.9		)
Minority interest														(2.1		)
Net earnings														$	439.3
Capital expenditures		$	37.2		$	11.8		$	38.6		$	—		$	87.6
Property, net		$	1,588.7		$	272.5		$	1,552.5		$	28.8		$	3,442.5
Total assets		$	2,531.6		$	561.5		$	3,101.0		$	(569.8	)	$	5,624.3

 

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		Six Months Ended June 30, 2007 (in millions)
		Mexican Open Pit			Mexican IMMSA Unit			Peruvian Operations			Corporate and other Eliminations			Consolidated
Net sales outside of segments		$	1,202.0		$	312.8		$	1,670.0		$	—		$	3,184.8
Intersegment sales		147.9			51.5			—			(199.4		)	—
Cost of sales (exclusive of depreciation, amortization and depletion)		397.7			172.1			662.4			(203.3		)	1,028.9
Selling, general and administrative expense		20.9			12.8			20.1			(4.1		)	49.7
Depreciation, amortization and depletion		87.0			17.7			53.3			0.6			158.6
Exploration		2.6			4.0			8.4			—			15.0
Operating income		$	841.7		$	157.7		$	925.8		$	7.4		1,932.6
Less:
Interest, net														(14.4		)
Loss on derivative instruments														(76.7		)
Other income (expense)														25.7
Taxes on income														(585.1		)
Minority interest														(4.5		)
Net earnings														$	1,277.6
Capital expenditure		$	62.3		$	9.5		$	80.4		$	26.8		$	179.0
Property, net		$	1,585.7		$	259.2		$	1,665.0		$	68.6		$	3,578.5
Total assets		$	3,239.9		$	712.7		$	3,134.3		$	(557.6	)	$	6,529.3

 

		Six Months Ended June 30, 2006 (in millions)
		Mexican Open Pit			Mexican IMMSA Unit			Peruvian Operations			Corporate and other Eliminations			Consolidated
Net sales outside of segments		$	725.4		$	270.1		$	1,402.5		$	—		$	2,398.0
Intersegment sales		159.6			25.4			—			(185.0		)
Cost of sales (exclusive of depreciation, amortization and depletion)		384.6			161.7			554.2			(171.8		)	928.7
Selling, general and administrative expense		16.3			9.0			19.0			3.0			47.3
Depreciation, amortization and depletion		76.8			14.1			40.1			0.1			131.1
Exploration		0.6			3.0			5.6			—			9.2
Operating income		$	406.7		$	107.7		$	783.6		$	(16.3	)	1,281.7
Less:
Interest, net														(15.9		)
Loss on derivative instruments														(0.9		)
Loss on debt prepayment														7.5
Other income (expense)														(407.7		)
Taxes on income														(3.8		)
Minority interest														$	860.9
Net earnings
Capital expenditures		$	88.0		$	19.6		$	123.1		$	—		$	230.7
Property, net		$	1,588.7		$	272.5		$	1,552.5		$	28.8		$	3,442.5
Total assets		$	2,531.6		$	561.5		$	3,101.0		$	(569.8	)	$	5,624.3

 

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