SOUTHERN COPPER CORP/ - Quarter Report: 2008 June (Form 10-Q)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended			JUNE 30, 2008
or
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from					to
Commission File Number:				1-14066

 

SOUTHERN COPPER CORPORATION

(Exact name of registrant as specified in its charter)

 

 

(602) 494-5328

Registrant’s telephone number, including area code

 

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.

x  Yes

o  No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

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

Yes  o

No  x

 

As of July 31, 2008 there were outstanding 883,410,150 shares of Southern Copper Corporation common stock, par value $0.01 per share.

 

 

Table of Contents

 

Southern Copper Corporation

 

INDEX TO FORM 10-Q

 

		Page No.
Part I.  Financial Information:
Item. 1	Condensed Consolidated Financial Statements (unaudited)
	Condensed Consolidated Statement of Earnings for the three and six months ended June 30, 2008 and 2007	3
	Condensed Consolidated Balance Sheet June 30, 2008 and December 31, 2007	4
	Condensed Consolidated Statement of Cash Flows for the three and six months ended June 30, 2008 and 2007	5-6
	Notes to Condensed Consolidated Financial Statements	7-30
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	31-46
Item 3.	Quantitative and Qualitative Disclosure about Market Risk	47-49
Item 4.	Controls and Procedures	50
Report of Independent Registered Public Accounting Firm		51
Part II. Other Information:
Item 1.	Legal Proceedings	52
Item 1A.	Risk factors	52
Item 4.	Submission of Matters to a Vote of Security Holders	53
Item 6.	Exhibits	54
	Signatures	55
	List of Exhibits	56
Exhibit 3.1	Certificate of Amendment of Amended and Restated Certificate of Incorporation	1
Exhibit 15	Independent Accountants’ Awareness Letter	1
Exhibit 31.1	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	1-2
Exhibit 31.2	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	1-2
Exhibit 32.1	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	1
Exhibit 32.2	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	1

 

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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,
		2008			2007			2008			2007
		(in thousands)
Net sales		$	1,461,796		$	1,826,462		$	2,961,002		$	3,184,799
Operating costs and expenses:
Cost of sales (exclusive of depreciation, amortization and depletion shown separately below)		550,458			562,334			1,071,047			1,028,979
Selling, general and administrative		26,726			25,907			51,381			49,706
Depreciation, amortization and depletion		83,199			84,466			164,395			158,564
Exploration		8,996			8,553			17,052			14,971
Total operating costs and expenses		669,379			681,260			1,303,875			1,252,220
Operating income		792,417			1,145,202			1,657,127			1,932,579
Interest expense		(27,487		)	(30,982		)	(56,415		)	(60,788		)
Capitalized interest		1,441			1,477			2,529			6,443
Gain (loss) on derivative instruments		(1,487		)	(55,512		)	1,440			(76,692		)
Other income (expense)		3,146			5,010			(354		)	25,672
Interest income		12,181			18,076			29,596			40,004
Earnings before income taxes and minority interest		780,211			1,083,271			1,633,923			1,867,218
Income taxes		228,892			354,416			514,914			585,090
Minority interest		2,852			2,893			5,559			4,484
Net earnings		$	548,467		$	725,962		$	1,113,450		$	1,277,644
Per common share amounts:
Net earnings basic and diluted		$	0.62		$	0.82		$	1.26		$	1.45
Dividends paid		$	0.57		$	0.50		$	1.03		$	1.07
Weighted average common shares outstanding (basic and diluted)		883,401			883,392			883,399			883,388

 

The accompanying notes are an integral part of these condensed consolidated financial statements. All the shares and per share amounts for prior periods have been restated to reflect the common stock split. See note P.

 

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Southern Copper Corporation

 

CONDENSED CONSOLIDATED BALANCE SHEET

(Unaudited)

 

		June 30,			December 31,
		2008			2007
		(in thousands)
ASSETS
Current assets:
Cash and cash equivalents		$	1,150,259		$	1,409,272
Short-term investments		97,515			117,903
Accounts receivable trade, less allowance for doubtful accounts (2008 - $4,553; 2007 - $4,585)		513,262			385,611
Accounts receivable other (including affiliates 2008 - $1,381; 2007 - $1,644)		27,527			77,167
Inventories		491,578			448,283
Deferred income tax - current portion		51,242			72,303
Other current assets		100,161			124,970
Total current assets		2,431,544			2,635,509
Property, net		3,618,852			3,568,311
Leachable material, net		186,770			220,243
Intangible assets, net		114,946			115,802
Other assets, net		53,025			40,693
Total Assets		$	6,405,137		$	6,580,558
LIABILITIES
Current liabilities:
Current portion of long-term debt		$	10,000		$	160,000
Accounts payable		267,344			255,070
Accrued income taxes		62,518			132,175
Due to affiliated companies		9,105			3,870
Accrued workers’ participation		151,851			313,251
Interest		31,854			37,325
Other accrued liabilities		36,331			25,499
Total current liabilities		569,003			927,190
Long-term debt		1,284,850			1,289,754
Deferred income taxes		193,594			219,501
Non-current taxes payable		161,216			154,721
Other liabilities and reserves		116,320			111,442
Asset retirement obligation		14,251			13,145
Total non-current liabilities		1,770,231			1,788,563
Commitments and Contingencies (Note M)
MINORITY INTEREST		15,780			16,685
STOCKHOLDERS’ EQUITY
Common stock		8,846			8,846
Additional paid-in capital		856,701			819,646
Retained earnings		3,421,295			3,220,857
Accumulated other comprehensive loss		(26,545		)	(26,554		)
Treasury stock		(210,174		)	(174,675		)
Total Stockholders’ Equity		4,050,123			3,848,120
Total Liabilities, Minority Interest and Stockholders’ Equity		$	6,405,137		$	6,580,558

 

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,
		2008			2007			2008			2007
		(in thousands)
OPERATING ACTIVITIES
Net earnings		$	548,467		$	725,962		$	1,113,450		$	1,277,644
Adjustments to reconcile net earnings to net cash provided from operating activities:
Depreciation, amortization and depletion		83,199			84,466			164,395			158,564
Capitalized leachable material		—			(19,568		)	(2,246		)	(40,029		)
Loss on currency translation effect		3,430			5,249			22,031			567
Provision for deferred income taxes		23,322			38,094			(14,730		)	58,340
Loss on sale of short-term investment		—			29,388			—			29,388
Unrealized loss on derivative instruments		10,336			36,929			2,099			59,617
Minority interest		2,852			2,893			5,559			4,484
Cash provided from (used for) operating assets and liabilities:
Accounts receivable		45,070			(95,037		)	(85,755		)	(14,003		)
Inventories		(36,267		)	(14,566		)	(43,295		)	(57,550		)
Accounts payable and accrued liabilities		(222,604		)	(109,965		)	(200,754		)	(294,872		)
Other operating assets and liabilities		(53,040		)	(34,971		)	(52,687		)	15,611
Net cash provided by operating activities		404,765			648,874			908,067			1,197,761
INVESTING ACTIVITIES
Capital expenditures		(130,876		)	(93,962		)	(180,770		)	(178,992		)
Purchase of short-term investments		—			—			—			(100,000		)
Net proceeds from sale of short-term investments		15,163			10,612			20,388			10,612
Other		5,097			(145		)	4,280			736
Net cash used for investing activities		(110,616		)	(83,495		)	(156,102		)	(267,644		)
FINANCING ACTIVITIES
Debt repaid		(155,025		)	(5,000		)	(155,025		)	(5,000		)
Dividends paid to common stockholders		(500,592		)	(441,683		)	(912,894		)	(942,267		)
Distributions to minority interest		(3,576		)	(1,405		)	(6,736		)	(3,164		)
Other		733			216			794			277
Net cash used for financing activities		(658,460		)	(447,872		)	(1,073,861		)	(950,154		)
Effect of exchange rate changes on cash and cash equivalents		41,789			7,257			62,883			10,873
(Decrease) increase in cash and cash equivalents		(322,522		)	124,764			(259,013		)	(9,164		)
Cash and cash equivalents, at beginning of period		1,472,781			888,850			1,409,272			1,022,778
Cash and cash equivalents, at end of period		$	1,150,259		$	1,013,614		$	1,150,259		$	1,013,614

 

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					3 Months Ended June 30,						6 Months Ended June 30,
					2008			2007			2008			2007
					(in thousands)
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest					$	11,311		$	15,019		$	64,016		$	65,380
Income taxes					$	332,149		$	296,822		$	548,343		$	561,333
Workers participation					$	174,209		$	127,415		$	290,039		$	298,851
Non cash transactions:
Common stock split:
Increase in Common stock		$	5,897
Decrease in Additional paid-in capital		$	5,897

 

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, 2008 and the results of operations and cash flows for the three and six months ended June 30, 2008 and 2007.  The condensed consolidated financial statements for the three and six months ended June 30, 2008 and 2007 have been subject to a review by PricewaterhouseCoopers, the Company’s independent registered public accounting firm, whose report dated August 1, 2008, is presented on page 51.  The results of operations for the three and six months ended June 30, 2008 and 2007 are not necessarily indicative of the results to be expected for the full year.  The December 31, 2007 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 combined financial statements at December 31, 2007 and notes included in the Company’s 2007 annual report on Form 10-K.

 

B.             Adoption of New Accounting Standards:

 

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS No. 159”).  SFAS No. 159 permits companies, at their election, to measure specified financial instruments and warranty and insurance contracts at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings each reporting period.  The election, called the “fair value option,” will enable some companies to reduce the volatility in reported earnings caused by measuring related assets and liabilities differently, and it is easier than using the complex hedge-accounting requirements in SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”), to achieve similar results.  Subsequent changes in fair value for designated items will be required to be reported in earnings in the current period.  SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and therefore became effective for the Company as of January 1, 2008.  The Company has not elected to measure any eligible items at fair value.  Accordingly, the adoption of SFAS No. 159 has not impacted the Company’s results of operations and financial position.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles, and expands disclosures about fair value measurements.  SFAS No. 157 does not require any new fair value measurements; rather, it applies under other accounting pronouncements that require or permit fair value measurements.  The provisions of SFAS No. 157 are to be applied prospectively as of the beginning of the fiscal year in which it is initially applied, with any transition adjustment recognized as a cumulative-effect adjustment to the opening balance of retained earnings.  The provisions of SFAS No. 157 were adopted by the Company on January 1, 2008 and do not have any effect on its overall financial position or results of operations.  All fair value adjustments at June 30, 2008 represent assets measured at fair value on a recurring basis.  Fair values as of June 30, 2008 were calculated as follows (in million):

 

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		Balance at June 30, 2008			Quoted Prices in Active Markets for Identical Assets			Significant Other Observable Inputs			Significant unobservable inputs
					(Level 1)			(Level 2)			(Level 3)
Short-term Investments		$	97.5		$	97.5		—			—
Derivative Instruments:
Exchange rate derivative, dollar/peso		(0.1		)	—			(0.1		)	—
Copper derivative		(2.0		)	—			(2.0		)	—
Total		$	95.4		$	97.5		$	(2.1	)	—

 

C.             Short-term Investments:

 

The balance of short-term investments was as follows (in millions):

 

		As of
Investments		June 30, 2008			December 31, 2007
Short-term investments in securities issued by public companies with a weighted average interest rate of 2.72%.		$	97.5		$	117.9

 

Short-term investments in securities consist of trading securities issued by public companies.  Each security is independent of the others.

 

In the second quarter and six months of 2008, the Company earned interest of $1.4 million and $2.3 million, respectively, related to these investments which were recorded as interest income in the condensed consolidated statement of earnings.  In addition, in the second quarter and first six months of 2008, the Company redeemed $14.8 million and $20.1 million, respectively, of these investments.

 

At June 30, 2008 the mark to market adjustment of these investments was $2.1 million which was recorded as interest expense in the condensed consolidated statement of earnings.

 

D.            Inventories were as follows:

 

(in millions)		June 30, 2008			December 31, 2007
Metals at lower of average cost or market:
Finished goods		$	65.2		$	65.7
Work-in-process		181.6			140.7
Supplies at average cost		244.8			241.9
Total inventories		$	491.6		$	448.3

 

E.              Financing

 

On April 1, 2008, the Company paid $150.0 million of the remaining balance of its series A Yankee bonds.  With this payment the series A Yankee bonds were fully repaid.  In both June 2008 and 2007, the Company paid $5.0 million of its Mitsui loan.

 

F.              Income taxes:

 

The income tax for the six months ended June 30, 2008 and 2007 were $514.9 million and $585.1 million, respectively.  These provisions include income taxes

 

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for Peru, Mexico and the United States. The effective tax rates for the 2008 and 2007 periods are 31.5% and 31.3%, respectively.  The estimated annual effective tax rate for 2008 is 32.5%, compared with 34.7% in 2007.  The decrease in the estimated annual effective tax rate is largely due to the incremental U.S. tax on dividend income in 2007.  The dividend income was eliminated in financial consolidation (book income) but was taxable in the U.S. at the difference between the 35% U.S. statutory rate and the foreign tax credit rate of 28% on the dividend.  In addition, the variability in the dollar relative to the Mexican peso and the Peruvian nuevo sol caused a decrease in the estimated effective tax rate.  In addition, the inclusion of loss carryforwards of some of Minera Mexico’s subsidiaries in the Mexican tax calculation also contributed to the rate decrease.

 

On October 1, 2007, the Mexican government enacted a new tax law, which took effect on January 1, 2008.  The law introduced a flat tax, which replaced Mexico’s asset tax and applies to taxpaying entities along with Mexico’s regular income tax.  In general Mexican companies are subject to paying the greater of the flat tax or the income tax; the application of this rule resulted in a provision in the first six months of 2008 based upon the regular income tax calculation.  This tax law change did not have an effect on the Company’s first six months 2008 deferred tax position.

 

The flat tax is calculated by applying a 16.5% tax rate in 2008, a 17% tax rate in 2009, and a 17.5% tax rate in 2010 and the following years.  Although the flat tax is defined as minimum tax it has a wider taxable base as many of the tax deductions allowed for income tax purposes are not allowed for the flat tax.

 

FIN No. 48 - Accounting for Uncertainty in Income Taxes.

 

There were no material changes in the unrecognized tax benefits in the first six months of 2008.

 

G.             Provisionally Priced Sales:

 

At June 30, 2008, the Company has recorded provisionally priced sales of 96.7 million pounds of copper, at an average forward price of $3.90 per pound.  Also the Company has recorded provisionally priced sales of 3.5 million pounds of molybdenum at the June 30, 2008 market price of $33.35 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, 2008:

 

Copper (million lbs.)		Priced at		Month of Settlement
64.2		3.911940		July 2008
12.6		3.890245		August 2008
12.5		3.873624		September 2008
7.4		3.859014		October 2008
96.7		3.900108

 

Molybdenum (million lbs.)		Priced at		Month of Settlement
1.7		33.350000		July 2008
1.5		33.350000		August 2008
0.3		33.350000		September 2008
3.5		33.350000

 

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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.

 

H.            Derivative Instruments

 

The Company occasionally uses derivative instruments to manage its exposure to market risk from changes in commodity prices, interest rate and exchange rate risk exposures and to enhance return on assets.  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 derivatives:

 

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

 

In the first six months of 2008, the Company entered into copper collar and swap contracts to protect a portion of its 2008 sales of copper production.  As a result, the Company recorded a gain of $10.6 million in the second quarter and first six months of 2008 compared with a gain of $1.3 million in the second quarter and first six months of 2007.  Related to the fair value of these copper derivative contracts the Company recorded an unrealized loss of $2.0 million at the end of June 2008 and a gain of $2.1 million at the end of June 2007.  These losses/gains were recorded in net sales in the condensed consolidated statement of earnings.

 

At June 30, 2008 the Company has copper collar contracts to protect 132.3 million pounds of copper production for the July-December 2008 period at weighted average minimum and maximum LME prices of $3.40 per pound and $4.23 per pound, respectively.  If the LME price falls below the minimum price, the Company will be paid the difference between the minimum price and the actual price.  If the LME price exceeds the maximum price, the Company will pay the difference between the maximum price and the actual price.  In addition, the Company has copper swap contracts to protect 61.6 million pounds of copper production for the July-August 2008 period at an average COMEX price of $3.86 per pound.

 

Gas swaps:

 

In the first quarter of 2007 the Company entered into a gas swap contract to protect part of its gas consumption for 900,000 MMBTUs with a fixed price of $7.525.  Related to the settlement of this gas swap contract the Company recorded a loss of $0.9 million in the first quarter of 2007 which was charged to production cost.  The Company did not hold any gas swap derivatives in the first six months of 2008.

 

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

 

Because more than 85% of the Company’s sales collections in Mexico are in US dollars and many of its costs are in Mexican pesos, 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.

 

At June 30, 2008 the Company held two types of exchange rate derivative contracts:

 

In the first type of exchange rate derivative contract, if the exchange rate settles at or below the barrier price, the Company does not sell US dollars, if the exchange rate settles above the barrier price and below the strike price established in the contract, the Company sells the notional amount of US dollars

 

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settling in the week at the strike price. If the exchange rate settles above the strike price established in the contract, the Company sells double the notional amount of US dollars settling in the week at the strike price established in the contract. At June 30, 2008, the Company held the following contracts of this type:

 

Notional Amount (millions)			Underlying amount (millions)			Due Date, Weekly expiration during		Strike Price (Mexican Pesos/U.S. Dollars)		Barrier Price (Mexican Pesos/ U.S. Dollars)
$	30.0		$	1.3		4th Quarter 2008		11.32		10.60
$	45.0		$	1.3		1st Quarter 2009		11.25		10.60

 

In the second type of exchange rate derivative contract, if the exchange rate is less than or equal to the strike price, the Company sells US dollars in an amount equal to the underlying amount for the 14 day period at the strike price. The difference between the strike price and the market exchange rate is considered a gain to the Company.  The total accumulated gain over the life of the contract cannot exceed 200 cents per dollar transacted. If the exchange rate is above the strike price, the Company sells dollars in an amount equal to 2 times the underlying amount for the 14 days period at the strike price and the loss does not reduce the accumulated gain. At June 30, 2008, the Company held the following contracts of this type:

 

Notional Amount (millions)			Underlying amount (millions)			Due Date, 14 days expiration between		Strike Price (Mexican Pesos / U.S. Dollars)
$	22.5		$	2.5		July 16, 2008 and November 5, 2008		10.85
$	42.5		$	2.5		December 3, 2008 and July 1, 2009		10.55
$	25.0		$	1.0		June 18, 2008 and June 3, 2009		10.95

 

In the second quarter and first six months of 2008 the exercise of some of these zero-cost derivative contracts resulted in gains of $0.4 million and $1.5 million, respectively, compared with gains of $2.6 million and $4.1 million in the second quarter and first six months of 2007, respectively, which were recorded as gain on derivative instruments in the condensed consolidated statement of earnings.

 

At June 30, 2008, the fair value of the above listed exchange rate derivative contracts is a loss of $0.1 million which was recorded as Gain (loss) 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.

 

The $53.0 million exchange derivative contract held at December 31, 2007 was cancelled in the first quarter 2008 and the Company recognized a gain of $0.3 million, which is included in the $4.1 million noted above.

 

I.                 Asset Retirement Obligation:

 

The Company maintains an estimated asset retirement obligation for its mining properties in Peru, as required by the Peruvian Mine Closure Law.  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.  While the plan was subject to a MEM review in 45 days, the Company did not receive the MEM response until November 2007.  The Company responded to MEM’s review in March 2008.  In June 2008, the MEM requested additional information regarding the closure plan.  The Company has complied with this request in July 2008.  The Company response will then be subject to approval by MEM and open to public discussion and comment

 

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in the area of Company operations.  However, as of June 30, 2008, the Company has made an estimated provision of $7.6 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.  In the second quarter of 2008, the Company recorded an additional asset retirement liability of $0.7 million based on the new Mine Closure Plan submitted to MEM.

 

The following table summarizes the asset retirement obligation activity for the first six months of 2008 and 2007 (in millions):

 

		2008			2007
Balance as of January 1		$	13.1		$	12.2
Additions, changes in estimates		0.7			—
Accretion expense		0.5			0.5
Balance as of June 30,		$	14.3		$	12.7

 

J.                Related Party Transactions:

 

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

 

		As of
		June 30, 2008			December 31, 2007
Affiliate receivable:
Grupo Mexico S.A.B de C.V. and affiliates		$	0.8		$	1.5
Ferrocarril Mexicano, S.A. de C.V.		0.3			—
Other		0.3			0.1
		$	1.4		$	1.6
Affiliate payable:
Grupo Mexico S.A.B. de C.V. and affiliates		$	9.1		$	3.0
Ferrocarril Mexicano, S.A. de C.V.		—			0.9
		$	9.1		$	3.9

 

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 services are 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.  The Company pays to Grupo Mexico Servicios S.A de C.V., a subsidiary of Grupo Mexico for these services.  The total amount paid by the Company for such services in the first six months of

 

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2008 and 2007 was $6.9 million.  The Company expects to continue to pay for these services in the future.

 

The Company’s Mexican operations paid fees of $4.8 million and $7.0 million in the first six months of 2008 and 2007, 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 $5.5 million and $7.1 mi1lion in the first six months of 2008 and 2007, 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, aviation, 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, sale of vehicles and air transportation and construction services.  In connection with this, the Company paid fees of $1.1 million and $1.4 million in the first six months of 2008 and 2007, respectively, for maintenance services and sale of vehicles provided by Mexico Compañia de Productos Automotrices, S.A. de C.V., a company controlled by the Larrea family.  Additionally, our Mexican subsidiaries have provided a guaranty for a $10.8 million loan obtained by Mexico Transportes Aereos, S.A. de C.V. (“MexTransport”).  MexTransport, a company controlled by the Larrea family, provides aviation services to our Mexican operations.  The guaranty provided to MexTransport is backed up by the transport services provided by MexTransport to the Company’s Mexican subsidiaries.  The Company paid fees of $1.6 million and $0.4 million in the first six months of 2008 and 2007, respectively, to MexTransport for aviation services.

 

The Company purchased $2.6 million in both first six months of 2008 and 2007 of industrial materials from Higher Technology S.A.C in which Mr. Carlos Gonzalez, son of SCC’s Chief Executive Officer, has a proprietary interest.  The Company paid fees of $0.5 million and $0.3 million in the first six months of 2008 and 2007, respectively, for maintenance services provided by Servicios y Fabricaciones Mecanicas S.A.C., a company in which Mr. Carlos Gonzalez has a proprietary interest.

 

The Company purchased $0.7 million and $0.5 million in the first six months of 2008 and 2007, respectively, of industrial material from Sempertrans France Belting Technology, in which Mr. Alejandro Gonzalez, son of SCC’s Chief Executive Officer, is employed as a sales representative.  Also, the Company purchased $0.3 million and $0.1 million in the first six months of 2008 and 2007, respectively, of industrial material from PIGOBA, S.A. de C.V., a company in which Mr. Alejandro Gonzalez has a proprietary interest.

 

The Company purchased $1.6 million and $2.3 million in the first six months of 2008 and 2007, respectively, of industrial material and services from Breaker, S.A. de C.V., a company in which Mr. Jorge Gonzalez, son-in-law of SCC’s Chief Executive Officer, has a proprietary interest.

 

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

 

K.            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):

 

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		2008				2007
Interest cost		$		0.4		$		0.3
Expected return on plan assets		(0.3			)	(0.3			)
Net periodic benefit cost		$	0.1			$	—

 

SCC Post-retirement Health Care Plan-

 

The components of the net periodic benefit costs for the post-retirement health care plan for the six months ended June 30, 2008 and 2007 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 months ended June 30, 2008 and 2007 are as follows ($ in millions):

 

		2008			2007
Interest cost		$	1.0		$	0.9
Service cost		1.2			1.0
Expected return on plan assets		(1.5		)	(1.0		)
Net periodic benefit cost		$	0.7		$	0.9

 

Minera Mexico Post-retirement Health Care Plan-

 

The components of the net periodic cost for the six months ended June 30, 2008 and 2007 are as follows ($ in millions):

 

		2008			2007
Interest cost		$	0.8		$	1.2
Service cost		0.1			0.2
Net periodic benefit cost		$	0.9		$	1.4

 

L.              Comprehensive Income (in millions):

 

		Three months ended						Six months ended
		June 30,						June 30,
		2008			2007			2008			2007
Net income		$	548.5		$	726.0		$	1,113.5		$	1,277.6
Other comprehensive income (loss) net of tax:
Unrealized gain (loss) on investments		—			—			—			(1.0		)
Comprehensive income		$	548.5		$	726.0		$	1,113.5		$	1,276.6

 

The unrealized loss on investment activity in the 2007 period was related to an investment in a Mexican construction company which was sold in 2007.  This investment was accounted for as an available for-sale investment.

 

M.         Commitments and Contingencies

 

Environmental matters:

 

The Company has instituted extensive environmental conservation programs at its mining facilities in Peru and Mexico.  The Company’s environmental programs include,

 

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among other things, 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 the 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 the first quarter of 2007, with the completion of the Ilo smelter modernization, the Company completed a 10-year environmental program agreed to with the Peruvian government in 1997.  This program applied to all of the Company’s Peruvian operations 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.

 

In 2003 the Peruvian congress published a new law announcing future closure and remediation obligations for the mining industry.  In August 2006 and March 2008, in accordance with this law and its amendments the Company prepared and submitted to MEM a closure plan.  In June 2008, the MEM requested additional information regarding the closure plan.  The Company has complied with this request in July 2008.  The Company response will then be subject to approval by MEM and open to public discussion and comment in the area of Company operations.  See note I “Asset Retirement Obligation” for further disclosure of this matter.

 

For the Company’s Peruvian operations, environmental capital expenditures were $3.0 million and $21.2 million in the first six months of 2008, and 2007, respectively.  The Company expects to spend approximately $14.1 million for environmental capital expenditures in 2008.

 

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 General Law of Ecological Balance and Environmental Protection, which is enforced by the Federal Bureau of Environmental Protection (“PROFEPA”).  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 extreme 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 Federal Criminal Code, 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 1999.  However, the Company’s management does not believe that continued

 

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compliance with the federal 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 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 $4.2 million and $12.8 million in the first six months of 2008 and 2007, respectively. Approximately, $45.2 million has been budgeted for environmental capital expenditures in 2008.

 

Litigation matters:

 

Peruvian operations

 

Garcia-Ataucuri and Others against 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 Peruvian Branch.

 

The Company conducts its operations in Peru through a registered Branch.  Although the Peruvian 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

 

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participation is now included on 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:

 

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), now “investment shares” (acciones de inversion) (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.  In 2000 SCC appealed an adverse decision of an appellate civil court, affirming a decision of a lower civil court, to the Peruvian Supreme Court.  On September 19, 2001, the Peruvian Supreme Court annulled the proceedings 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 procedural requirements, and increased the number of plaintiffs to approximately 958 ex-workers.  In January 2005, the lower labor judge dismissed the lawsuit on procedural grounds without deciding on the merits of the case.  In March 2005, the plaintiffs appealed this decision but the appellate court dismissed the appeal due to procedural defects and remanded the case to the lower labor court for further proceedings.  The lower labor 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, 2008, the case remains open with no further new developments.  The labor court has temporarily lost jurisdiction over this case until the Supreme Court decides on the Constitutional Tribunal’s decision described below.

 

In October 2007, in a separate proceeding initiated by Mr. García Ataucuri against the justices of the Peruvian Supreme Court, the Peruvian Constitutional Court nullified the Peruvian Supreme Court decision issued on September 19, 2001 because it had violated Mr. Garcia-Ataucuri’s constitutional due process rights by obliging him and the other plaintiffs to commence a new proceeding before the labor courts when they had litigated against the Company in civil courts for over 10 years.  The Peruvian Constitutional Court ordered the Supreme Court to decide again on the merits of the case accepting or denying the Company’s 2000 appeal.

 

Although the Company was not formally a party to the Garcia Ataucuri proceedings before the Peruvian Constitutional Court, the nullity of the favorable decision of the Supreme Court, issued on September 19, 2001, is final and cannot be appealed by the Company.

 

It is uncertain how the Peruvian Supreme Court will decide on the Company’s 2000 appeal and the merits of the case in view of the decision of the Peruvian Constitutional Court.

 

2)              On May 10, 2006, the Company was served with a second 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 (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, 2008 the case remains in the discovery stage.

 

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3)              Additionally, on June 27, 2008, the Company was served with a new complaint filed in Peru, this time by 82 former employees, (Alejandro Zapata Mamani and others vs. SPCC), seeking delivery of labor shares (or shares of whatever other current legal denomination) corresponding to years 1971 to December 31, 1977 (the plaintiffs are seeking the same 38,763,806.80 labor shares mentioned in the two previous labor share lawsuits), that should have been issued in accordance with Law # 22333, plus interest, and labor shares resulting from capital increases, plus dividends.  The Company answered this new complaint, denying the validity of the claim.

 

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.  The Company does 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 $49.1 million.  The Company believes that these administrative procedures are without merit and is vigorously defending itself against these actions.

 

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 (La Caridad) 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.  The Company estimates 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 was lost by the Company in October 2007.  The Company filed a protective action (Amparo) before the First Unitary Tribunal of the First Circuit.  The Company believes that the payment made on account for this period is correct.  On an ongoing basis the Company is 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 some residential projects like “Villa Magna” and other new residential projects are being developed within an area that IMMSA’s Risk Analysis, which was approved by SEMARNAT (the federal environmental authority), has secured as a safeguard and buffer zone due to IMMSA’s use 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 all the authorizations and licenses granted within 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 action regarding the annulment of Villa Magna licenses was decided by a federal appeals court, which denied IMMSA’s request.  In September 2006,

 

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IMMSA submitted 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 has vigorously taken all necessary steps to defend against this lawsuit.  A decision is expected in the near future.

 

Also, new lawsuits were filed by IMMSA against the Municipality of San Luis Potosi challenging the new licenses granted in the safeguard area.

 

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.  The municipal authorities are evaluating how to comply with the ruling.

 

Finally, Ejido Capulines, an agricultural community, filed a protective action (Amparo) against IMMSA’s risk analysis authorization granted by SEMARNAT.  As previously indicated, this authorization provides the safeguard and buffer zone around the San Luis facilities. IMMSA has taken all necessary steps to defend against the action.

 

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.

 

Peruvian Operations

 

Collective bargaining agreements with the Company’s Peruvian labor unions expired in early 2007.  A number of strikes were initiated by the Company’s labor unions, demanding wage increases and better benefits.  In addition, some of the unions went on strike in support of national union strikes.  These strikes were generally of a brief nature and the Company was able to continue normal operations with the support of staff and administrative personnel and contractors.  New collective bargaining agreements, for periods ranging from three to six years were signed by the end of third quarter 2007 with all of the Company’s Peruvian unions.

 

Mexican operations -

 

In the last seven years the Cananea mine has experienced more than nine labor stoppages totaling more than 450 days of inactivity.  Beginning on July 30, 2007, our Cananea mine in Mexico started a work stoppage.  On January 11, 2008 the Mexican Federal Labor Court declared the Cananea strike illegal and ordered the workers to return to work within 24 hours.  This matter is under appeal upon the Company’s action and will be solved by a Federal Upper Court.  The workers partially returned to work and the Company resumed operations.  However, on April 11, 2008 the workers restarted the labor stoppage and shut down production.  The Company has tried unsuccessfully to resolve the current labor stoppage that obstructs production at Cananea, hence in the second quarter 2008, the Board of Directors decided to offer all employees a severance payment in accordance with the collective bargaining agreement and applicable law.  This was offered in order to award the employees a significant severance payment that allows them to choose the labor alternative that is best for each of them.  During the second quarter of 2008, a group of employees was liquidated at a cost to the Company of $10.8 million, which was recorded in cost of sales on the condensed

 

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consolidated statement of earnings.  The Company anticipates that additional liquidations will occur in the second half of 2008.  In accordance with SFAS No. 112, the Company has estimated a liability of $52.0 million which have been recorded on the condensed consolidated balance sheet.  It is expected that production at Cananea will remain suspended until these labor issues are resolved.

 

Additionally, our Taxco and San Martin mines have been on strike since July 2007.  It is expected that operations at these mines will remain suspended until these labor issues are resolved.  However, the Company believes that the strike activity will not result in an impairment of assets.

 

Other legal matters

 

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 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 defendants believe that this lawsuit is without merit and are vigorously defending themselves against the 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.

 

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.

 

The Company’s direct and indirect parent corporations, including AMC and Grupo Mexico, have from time to time been named parties in various litigation involving Asarco LLC (“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 a subsidiary of 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 2005 Chapter 11 bankruptcy filing by Asarco, as described below.  However, on November 16, 2007, this lawsuit after being removed to federal court was transferred to the United States District Court for the Southern District of Texas in Brownsville, Texas, for resolution in conjunction with a new lawsuit filed by Asarco, the debtor in possession, as described below.  On February 2, 2007 a complaint was filed by Asarco, the debtor in possession,

 

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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.  In June 2008 the lawsuit was concluded in Brownsville, Texas.  A decision is expected in the near future.  While Grupo Mexico and its affiliates believe that these claims are without merit, the Company 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, in August 2005 Asarco 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.

 

Other:

 

Regional development contribution

 

In December 2006, the Company’s Peruvian Branch signed a contract with the Peruvian government committing the Company to annual contributions for five years to support the regional development of Peru.  This was in response to an appeal by the president of Peru to the mining industry.  The contributions are being used for social benefit programs.  In 2008 and 2007, the Company made a contribution of $17.9 million and $16.1 million, calculated based on 2007 and 2006 Peruvian earnings after income tax, respectively.  These contributions were deposited with a separate entity, Copper Assistance Civil Association (Asociacion Civil Ayuda del Cobre) which will make disbursements for approved investments in accordance with the agreement.  The following years’ contributions could increase or decrease depending on copper prices.  The commitment of the Branch is for a total of 1.25% of its annual earnings, after Peruvian income tax.  If the copper price drops below $1.79 per pound the contribution will cease.  In the first six months of 2008 the Company made a provision of $7.7 million 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.  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 $33.3 million, and $27.2 million in the first six months of 2008 and 2007, 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.

 

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.

 

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Tax contingency matters:

 

Tax contingencies are provided for under FIN No 48 (see Note F “Income Taxes.”)

 

N.            Segment and Related Information:

 

Company management views Southern Copper as having three operating segments and manages on the basis of these segments.  The significant increase in the price of molybdenum in 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.  Each of its segments report independently to the Chief Operating Officer and he focuses on operating income as a measure of performance to evaluate different segments, and to make decisions to allocate resources to the reported segments.

 

The three segments identified are groups of mines with similar economic characteristics, type of products, processes and support facilities, similar regulatory environments, similar employee bargaining contracts and similar currency risks.  In addition, each mine within the individual group earns revenues from similar type of customers for their products and services and each group incurs expenses independently, including commercial transactions between groups.

 

Intersegment sales are based on arms-length prices at the time of sale.  These may not be reflective of actual prices realized by the Company due to various factors, including additional processing, timing of sales to outside customers and transportation cost.  Added to the segment information is information regarding the Company’s molybdenum sales.  The segments identified by the Company are:

 

1.               Peruvian operations, which includes 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 operations, which includes 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 includes five underground mines that produce zinc, copper, silver and gold, a coal mine  which produces coal and coke, and several industrial processing facilities for zinc and copper.  This group is identified as the IMMSA unit.

 

The Peruvian operations include two open pit copper mines whose mineral output is transported by rail to Ilo, Peru where it is processed at the Company’s Ilo smelter and refinery, without distinguishing between the products of the two mines.  The resulting product, anodes and refined copper, are then shipped to customers throughout the world.  These shipments are recorded as revenue of the Company’s Peruvian mines.

 

The Mexican open pit segment includes two copper mines whose mineral output is processed in the same smelter and refinery without distinguishing between the products of the two mines.  The resultant product, anodes and refined copper, are then shipped to customers throughout the world.  These shipments are recorded as revenues of the Company’s Mexican open pit mines.

 

The Company has determined that it is necessary to classify the Peruvian Open Pit operations as a separate operating segment from the Mexican Open Pit operations due to the very distinct regulatory and political environments in which they operate.  The Company’s Chief Operating Officer must consider the operations in each country separately when analyzing results of the Company and making key decisions.  The open

 

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pit mines in Peru must comply with stricter environmental rules and must continually deal with a political climate that has a very distinct vision of the mining industry as compared to Mexico.  In addition, the collective bargaining agreement contracts are negotiated very distinctly in each of the two countries.  These key differences result in the Company taking varying decisions with regards to the two countries.

 

The IMMSA segment includes five mines whose minerals are processed in the same smelter and refinery.  This segment also includes a coal underground mine.  Sales of product from this segment are recorded as revenues of the Company’s IMMSA unit.  While the Mexican underground mines are subject to a very similar regulatory environment of the Mexican open pit mines, the nature of the products and processes of the two Mexican operations vary distinctly.  These differences cause the Company’s Chief Operating Officer to take a very different approach when analyzing results and making decisions regarding the two Mexican operations.

 

Financial information is regularly prepared for each of the three segments and the results of the Company’s operations are regularly reported to the Chief Operating Officer on the segment basis.  The Chief Operating Officer of the Company focuses on operating income and on total assets as measures of performance to evaluate different segments and to make decisions to allocate resources to the reported segments.  These are common measures in the mining industry.

 

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

 

		Three Months Ended June 30, 2008
		(in millions)
		Mexican Open Pit			Mexican IMMSA Unit			Peruvian Operations			Corporate and other Eliminations			Consolidated
Net sales outside of segments		$	433.8		$	125.4		$	902.6		$	—		$	1,461.8
Intersegment sales		33.9			37.7			—			(71.6		)	—
Cost of sales (exclusive of depreciation, amortization and depletion)		200.6			109.0			312.2			(71.3		)	550.5
Selling, general and administrative		9.6			4.8			11.1			1.2			26.7
Depreciation, amortization and depletion		47.4			8.0			28.1			(0.3		)	83.2
Exploration		1.0			2.2			5.8			—			9.0
Operating income		$	209.1		$	39.1		$	545.4		$	(1.2	)	792.4
Less:
Interest, net														(13.8		)
Loss on derivative instruments														(1.5		)
Other income (expense)														3.1
Income taxes														(228.9		)
Minority interest														(2.8		)
Net earnings														$	548.5
Capital expenditure		$	54.7		$	12.4		$	63.1		$	0.7		$	130.9
Property, net		$	1,622.5		$	254.0		$	1,678.9		$	63.5		$	3,618.9
Total assets		$	3,026.2		$	695.7		$	2,970.0		$	(286.8	)	$	6,405.1

 

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