SCCO

Business Context and Reporting Period

Company: Southern Copper Corporation (SCC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2007
Business Overview: SCC operates in the mining industry, primarily producing copper, with significant byproduct sales of molybdenum, zinc, silver, and gold. Operations are managed across three segments: Peruvian operations, Mexican open-pit operations, and Mexican underground operations (IMMSA Unit).

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 21.1% ($237.0 million) driven by a 20.1% increase in copper prices, higher sales volumes (up 9.7%), and increased prices for byproducts (molybdenum, zinc, silver).
• Profitability: Net earnings rose 30.9% to $551.7 million. Operating income increased 24.5% to $787.4 million.
• Cost Structure: Operating costs increased to $570.9 million from $488.6 million. This was due to higher power costs, increased worker participation payments, and higher depreciation/amortization ($74.1 million vs. $53.1 million) linked to capitalized leachable material.
• Production Volumes: Mine copper production increased 6.9% (24.5 million pounds) to 378.4 million pounds. Molybdenum production rose 6.6%, while zinc production decreased 6.6% due to lower ore grades.
• Derivative Losses: A $21.2 million loss on derivative instruments was recorded in Q1 2007, primarily due to a $22.7 million unrealized loss on embedded derivatives in marketable securities (reverse barrier notes), partially offset by a $1.5 million gain on exchange rate derivatives.

Guidance, Outlook, and Risks

• Operational Outlook: The Ilo smelter modernization project was completed in January 2007. As of March 31, 2007, the smelter was operating at 80% capacity; full capacity is expected in Q2 2007. Until then, the company is selling some copper concentrates.
• Capital Projects: Ongoing projects include a new SX/EW plant at Cananea mine and a crushing/conveying system at Toquepala (99.8% complete). Exploration studies for Los Chancas and Tia Maria are in progress.
• Labor Risks: A brief strike occurred at the Ilo smelter and Peruvian mines in late April 2007 (post-period end) which was resolved after 5 days. The company notes that future labor disputes could materially affect operations.
• Legal & Tax Contingencies:
  • Peru: Ongoing litigation regarding "labor shares" from former employees. The company believes claims are without merit and has not accrued a liability.
  • Tax: Various tax audits are pending in the U.S. (IRS), Peru (SUNAT), and Mexico (SAT). The company adopted FIN 48 in Q1 2007, resulting in a $3.5 million reduction to retained earnings for unrecognized tax benefits.
  • Asarco Litigation: Parent company Grupo Mexico faces claims related to the Asarco bankruptcy and alleged fraudulent conveyance, which could indirectly impact SCC.
• Dividends: A quarterly dividend of $1.50 per share ($441.7 million total) was declared on April 26, 2007, payable June 1, 2007.

Investor Verification Checklist

• Smelter Ramp-up: Verify the timeline for the Ilo smelter reaching 100% capacity and the impact on concentrate sales vs. refined copper sales.
• Derivative Exposure: Review the valuation and risk of the $380 million in reverse barrier notes and embedded derivatives, which caused a significant non-cash loss in Q1.
• Labor Stability: Monitor the status of collective bargaining agreements in Peru (expiring 2007) and potential for future strikes in Mexico and Peru.
• Tax Resolution: Track the outcome of the IRS appeals process (targeted for completion by Dec 31, 2007) and Peruvian tax court rulings regarding interest deductions.
• Byproduct Pricing: Assess the sustainability of high molybdenum and zinc prices, which significantly reduced the company's reported operating cash cost per pound.