SCCO

Business Context and Reporting Period

Company: Southern Copper Corporation (SCC)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2005
Business Overview: SCC is a leading integrated producer of copper, molybdenum, zinc, and silver. Operations are located in Peru and Mexico. Following the April 1, 2005, acquisition of Minera México (accounted for as a pooling of interests), the company operates three segments: Peruvian operations, Mexican open-pit operations, and the Mexican underground IMMSA unit. SCC is the largest mining company in Peru and Mexico and the largest publicly traded copper mining company globally based on reserves.

Key Financial Metrics (2005)

Production Highlights (2005): Total copper production was 1,521 million pounds (down 3.9% from 2004). Molybdenum production increased 2.8% to 32.6 million pounds. Zinc production increased 7.3% to 316.6 million pounds.

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 32.8% to $4.11 billion, driven primarily by a 29% increase in copper prices and a 95% increase in molybdenum prices. Copper sales volume declined slightly (1.6%) due to lower ore grades in Peru.
• Profitability: Net earnings rose 42.5% to $1.4 billion. Operating income margin improved to 50.9% from 47.9% in 2004.
• Cost Increases: Cost of sales increased 22.6%, attributed to higher fuel and power costs, increased worker participation payments (including a $36.3 million adjustment due to a Mexican Supreme Court ruling), and new Peruvian royalty charges ($40.3 million provision).
• Capital Structure: The company issued $800 million in new notes (6.375% due 2015 and 7.5% due 2035) in July 2005 to refinance existing debt, reducing total debt by approximately $158 million compared to 2004.

Guidance, Outlook, Risks, and Unusual Items

• Tragic Mine Accident: On February 19, 2006 (post-period), a gas explosion occurred at the Pasta de Conchos coal mine in Mexico, resulting in the deaths of 65 miners. This event is a significant operational and reputational risk.
• Accounting Change (EITF 04-06): Effective January 1, 2006, the company adopted new guidance requiring stripping costs during production to be expensed rather than capitalized. This resulted in a $322.9 million net charge to retained earnings and is expected to increase operating costs in future periods.
• Regulatory Risks:
  • Peru: A new 1-3% royalty tax on concentrate sales is in effect. The company is contesting the application of this tax to its SX/EW production under a tax stability contract.
  • Mexico: A Supreme Court ruling changed the calculation of statutory worker profit sharing, prohibiting the use of net operating loss carryforwards, leading to higher future liabilities.
• Capital Projects: Major ongoing projects include the Ilo smelter modernization (budgeted at $500 million, expected completion end of 2006) and a planned 450 MW power generation plant in Mexico (expected completion 2008).
• Market Risk: Financial performance remains highly sensitive to copper and molybdenum prices. A $0.01/lb change in copper price impacts net earnings by approximately $8.7 million.

Investor Verification Checklist

• Post-Period Accident Impact: Verify the financial and operational impact of the February 2006 Pasta de Conchos mine explosion, including potential litigation and production delays.
• Accounting Transition: Review the impact of the EITF 04-06 adoption on 2006 operating margins and cash flow, as previously capitalized stripping costs will now be expensed.
• Regulatory Liabilities: Monitor the status of the Peruvian royalty tax dispute regarding SX/EW production and the ongoing Mexican worker profit-sharing litigation.
• Debt Covenants: Confirm continued compliance with debt covenants, particularly the EBITDA/Interest ratio for Minera México Yankee bonds and the debt-to-equity ratio for the Mitsui facility.
• Capital Expenditure Execution: Track the progress and cost overruns of the Ilo smelter modernization and the new Mexican power plant projects.