The Daily Magic Formula Stock for 03/12/2008 is Southern Copper Corp. According to the Magic Formula Investing Web Site, the ebit yield is 15% and the EBIT ROIC is 75-100 %.
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Southern Copper Corporation is one of the largest integrated copper producers in the world. We produce copper, molybdenum, zinc and silver. All of our mining, smelting and refining facilities are located in Peru and in Mexico and we conduct exploration activities in those countries and Chile. See â€śReview of Operationsâ€ť for maps of our principal mines, smelting facilities and refineries. Our operations make us one of the largest mining companies in Peru and also in Mexico. We believe, based on our review of the major mining companiesâ€™ 2006 annual reports, that we are the largest publicly traded copper mining company in the world based on copper reserves. We were incorporated in Delaware in 1952 and have conducted copper mining operations since 1960. Since 1996, our common stock has been listed on both the New York Stock Exchange and the Lima Stock Exchange.
Our Peruvian copper operations involve mining, milling and flotation of copper ore to produce copper concentrates and molybdenum concentrates; the smelting of copper concentrates to produce anode and blister copper; and the refining of blister/anode copper to produce copper cathodes. As part of this production process, we also produce significant amounts of molybdenum and silver. We also produce refined copper using SX/EW technology. We operate the Toquepala and Cuajone mines high in the Andes mountains, approximately 984 kilometers southeast of the city of Lima, Peru. We also operate a smelter and refinery west of the Toquepala and Cuajone mines in the coastal city of Ilo, Peru.
Our Mexican operations are conducted through our subsidiary, Minera Mexico S.A. de C.V. (â€śMinera Mexicoâ€ť), which we acquired on April 1, 2005. Minera Mexico engages principally in the mining and processing of copper, molybdenum, zinc, silver, gold and lead. Minera Mexico operates through subsidiaries that are grouped into three separate units. Mexicana de Cobre S.A. de C.V. (together with its subsidiaries, the â€śMexcobre Unitâ€ť) operates La Caridad, an open-pit copper mine, a copper ore concentrator, a SX/EW plant, a smelter, refinery and a rod plant. Mexicana de Cananea S.A. de C.V. (together with its subsidiaries, the â€śCananea Unitâ€ť) operates Cananea, an open-pit copper mine, which is located at the site of one of the worldâ€™s largest copper ore deposits, a copper concentrator and two SX/EW plants. Industrial Minera Mexico, S.A. de C.V. and Minerales Metalicos del Norte, S.A. (together with its subsidiaries, the â€śIMMSA Unitâ€ť) operate five underground mines that produce zinc, lead, copper, silver and gold, a coal mine and several industrial processing facilities for zinc and copper.
We utilize many up-to-date mining and processing methods, including global positioning systems and computerized mining operations. Our operations have a high level of vertical integration that allows us to manage the entire production process, from the mining of the ore to the production of refined copper and other products and most related transport and logistics functions, using our own facilities, employees and equipment.
The sales prices for our products are largely determined by market forces outside of our control. Our management, therefore, focuses on cost control and production enhancement to improve profitability. We achieve these goals through capital spending programs, exploration efforts and cost reduction programs. Our focus is on seeking to remain profitable during periods of low copper prices and maximizing results in periods of high copper prices. For additional information on the sale prices of the metals we produce, please see â€śMetal prices.â€ť
Unless stated otherwise, all our financial information is presented in US dollars and any reference herein to â€śU.S. dollarsâ€ť, â€śdollarsâ€ť, or â€ś$â€ť are to U.S. dollars; references to â€śS/.â€ť, â€śnuevo solâ€ť or â€śnuevos solesâ€ť, are to Peruvian nuevos soles; and references to â€śpesoâ€ť, â€śpesosâ€ť, or â€śPs.â€ť, are to Mexican pesos.
Unless otherwise noted, all tonnages are in metric tons. To convert to short tons, multiply by 1.102. All ounces are troy ounces. All distances are in kilometers. To convert to miles, multiply by 0.621. To convert hectares to acres, multiply by 2.47.
The following chart describes our organizational structure starting with our controlling stockholder. For clarity of presentation, the chart identifies only principal subsidiaries and eliminates intermediate holding companies.
We are a majority-owned, indirect subsidiary of Grupo Mexico S.A.B. de C.V. (â€śGrupo Mexicoâ€ť). Through its wholly-owned subsidiaries, Grupo Mexico currently owns approximately 75.1% of our capital stock. Grupo Mexicoâ€™s principal business is to act as a holding company for shares of other corporations engaged in the mining, processing, purchase and sale of minerals and other products and railway and other related services.
We conduct our operations in Peru through a registered branch (the â€śSPCC Peru Branchâ€ť or â€śPeruvian Branchâ€ť). The SPCC Peru Branch comprises substantially all of our assets and liabilities associated with our copper operations in Peru. The SPCC Peru Branch is not a corporation separate from us and, therefore, obligations of SPCC Peru Branch are direct obligations of SCC and vice-versa. It is, however, an establishment, registered pursuant to Peruvian law, through which we hold assets, incur liabilities and conduct operations in Peru. Although it has neither its own capital nor liability separate from us, it is deemed to have equity capital for purposes of determining the economic interests of holders of our investment shares, formerly known as labor shares (See Note 13 â€śMinority interestâ€ť of our consolidated combined financial statements).
On April 1, 2005, we acquired Minera Mexico, the largest mining company in Mexico on a stand-alone basis, from Americas Mining Corporation (â€śAMCâ€ť), a subsidiary of Grupo Mexico, our controlling stockholder. Minera Mexico is a holding company and all of its operations are conducted through subsidiaries that are grouped into three units: (i) the Mexcobre unit, (ii) the Cananea unit and (iii) the IMMSA unit. We now own 99.95% of Minera Mexico.
Forward-looking statements in this report and in other Company statements include statements regarding expected commencement dates of mining or metal production operations, projected quantities of future metal production, anticipated production rates, operating efficiencies, costs and expenditures as well as projected demand or supply for the Companyâ€™s products. Actual results could differ materially depending upon factors including the risks and uncertainties relating to general U.S. and international economic and political conditions, the cyclical and volatile prices of copper, other commodities and supplies, including fuel and electricity, availability of materials, insurance coverage, equipment, required permits or approvals and financing, the occurrence of unusual weather or operating conditions, lower than expected ore grades, water and geological problems, the failure of equipment or processes to operate in accordance with specifications, failure to obtain financial assurance to meet closure and remediation obligations, labor relations, litigation and environmental risks, as well as political and economic risk associated with foreign operations. Results of operations are directly affected by metals prices on commodity exchanges, which can be volatile.
Additional business information follows:
Copper is the worldâ€™s third most widely used metal and an important component in the worldâ€™s infrastructure. Copper has unique chemical and physical properties, including high electrical conductivity and resistance to corrosion, as well as excellent malleability and ductility that has made it a superior material for use in the electrical energy, telecommunications, building construction, transportation and industrial machinery businesses. Copper is also an important metal in non-electrical applications such as plumbing and roofing and, when alloyed with zinc to form brass, in many industrial and consumer applications.
Copper industry fundamentals, including copper demand, price levels and stocks, strengthened in late 2003 and copper prices have continued to improve through 2007 from the 15-year price lows set during 2002.
BUSINESS REPORTING SEGMENTS:
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 Companyâ€™s earnings. Nevertheless, the Company continues to manage its operations on the basis of the three copper segments.
The three segments identified are groups of individual 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 Companyâ€™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. Sales of its products are recorded as revenue of our Peruvian 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. Sales of its products are recorded as revenue of our Mexican 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 and sales of its products are recorded as revenue of the IMMSA unit.
Each of our segments reports independently to the Chief Operating Officer. 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.
Segment information is included under the captions â€śOverview-Metal productionâ€ť and â€śOre reserves.â€ť More information on business segment and segment financial information is included in Note 20 of our Consolidated Combined Financial Statements.
CAPITAL EXPANSION PROGRAM
For a description of our Capital Expansion Program see â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operations-Capital Expansion Program.â€ť
We are engaged in ongoing extensive exploration to locate additional ore bodies in Peru, Mexico and Chile. We invested $40.2 million on exploration programs in 2007, $22.7 million in 2006 and $24.4 million in 2005, and have budgeted $26.1 million for 2008.
Currently in Peru, we have direct control of 164,867 hectares of mineral rights. In Mexico, we hold 293,137 hectares of exploration concessions. We also hold 35,258 hectares of exploration concessions in Chile.
Tia Maria. The Tia Maria project, which includes the Tia Maria and the La Tapada deposits, is located in the department of Arequipa on the southern coast of Peru and is part of a copper porphyritic system.
We have completed feasibility studies in 2007 covering 36,232 meters of diamond drilling at Tia Maria and 73,085 meters at La Tapada. Estimated mineralized resources in Tia Maria show 193 million tons of mineralized material with 0.302% copper content. For La Tapada, the estimated mineralized resources show 445 million tons of mineralized material, with 0.434% copper content. The Company is conducting a bidding process for basic and detailed engineering as well as preparing to purchase major equipment and select construction management. The Company expects to invest $65 million in this project during 2008. When completed at the end of 2010, the new operating unit will produce 120,000 tons of copper cathodes per year.
Los Chancas. The Los Chancas project, located in the department of Apurimac in southern Peru, is a copper and molybdenum porphyry deposit. The exploration program and the final phase of the metallurgical testing were completed in early 2006. Pre-feasibility studies were completed in 2007. Estimated mineralized resources identified after the preliminary design of the pit are 355 million tons of mineralized material with a 0.62% copper content, 0.05% molybdenum and 0.039 grams of gold per ton. We expect to work on a feasibility study during 2008 which will include complementary studies and an additional drilling program in order to define the ore reserves of the deposit.
Tantahuatay. The Tantahuatay project is located in the department of Cajamarca in northern Peru. The exploration work is intended to evaluate the upper part of the deposit mainly for gold recovery. Work to date indicates 27.1 million tons of mineralized material, with an average silver content of 13.0 grams per ton and 0.89 grams of gold per ton. We have a 44.25% share in this project. We have started a feasibility study to evaluate the possibility of recovering gold mineral from the upper part of the deposit. We continue our efforts on dealing with social and environmental concerns of communities near the project.
Other Peruvian Prospects.
As part of the exploration program in 2007, we have drilled 14,352 meters in the southern region of Peru. Our 2008 program includes more intense copper exploration activities in the southern and northern parts of Peru, as well as gold exploration in Ayacucho, in the central part of Peru.
In addition to exploratory drilling programs at existing mines, we are currently conducting exploration to locate mineral deposits at various other sites in Mexico. The following are some of the more significant exploration projects:
El Arco. The El Arco site is located in the state of Baja California in Mexico. Preliminary investigations of the El Arco site indicate a mineral deposit of 846 million tons of mineralized material with average copper grades of 0.51% and 0.14 grams of gold per ton, and 170 million tons of leach mineralized materials with average copper grades of 0.56%. In 2007, we have continued in the process of identifying water sources for a leaching operation, and have finished four tests holes that indicate sufficient water potential for leaching operations.
Angangueo. The Angangueo site is located in the state of MichoacĂˇn in Mexico. A mineral deposit of 13 million tons of mineralized material has been identified with diamond drilling. Testing indicates that the mineral deposit contains mineralized material containing 0.16 grams of gold and 262 grams of silver per ton, and is comprised of 0.79% lead, 0.97% copper and 3.5% zinc. During 2005, we received the approval for our environmental impact study and we are in the process of obtaining land use approval. During 2007, we have continued negotiating with the state of Michoacan to purchase various properties essential to the operation.
Buenavista. The Buenavista project site is located in the state of Sonora in Mexico, adjacent to the Cananea ore body. Drilling and metallurgical studies have shown that the site contains 36 million tons of mineralized material containing 29 grams of silver, 0.69% of copper and 3.3% of zinc per ton. A new â€śscoping levelâ€ť study indicates that Buenavista may be an economical deposit. During 2007, 2,100 meters were drilled to upgrade the mineral resource and to acquire material for metallurgical testing. Results confirm the previous geologic interpretation of the mineralized areas.
Carbon Coahuila . In Coahuila, an intensive exploration program of diamond drilling has identified two additional areas, Esperanza with a potential for more than 30 million tons of â€śin placeâ€ť mineralized coal and Guayacan with a potential for 15 million tons of â€śin placeâ€ť mineralized coal, that could be used for a future coal-fired power plant. During 2007 along with 5,767 meters of drilling, 23 million tons of mineralized coal resources were identified at our Nueva Rosita No. 16 concession.
The Chalchihuites . The Chalchihuites project is located in the state of Zacatecas. It is a contact deposit with mixed oxides and sulfides of lead, copper, zinc and silver. A drilling program, in the late nineties, defined 16 million tons of mineralized material containing 95 grams of silver, 0.36% lead, 0.69% copper and 3.08% zinc per ton. Preliminary metallurgical testing indicates a leaching precipitating-flotation recovery process that can be applied to this ore. In 2007 we continued with the evaluation of the ore body and we expect to conclude the metallurgical testing of the project during 2008.
Sierra de Lobos . This project is located southwest of the city of Leon, Guanajuato. Our target is a copper and zinc deposit with grades between 0.5% and 1.0% copper and between 5% and 7% zinc including a small contribution of gold and silver. In 2007, 7,338 meters have been drilled. Results confirm the presence of copper and zinc mineralization, but an economic deposit has not yet been identified.
In Chile we have control of 35,258 hectares of mining rights, and are currently developing different exploration programs.
El Salado. The El Salado prospect, located in the Atacama Region, is being explored for copper-gold. Through 2007, 24,798 meters of diamond drilling were completed, 4,448 meters and 8,326 meters were drilled in 2007 and 2006, respectively. Likewise, in the Sierra Aspera, a copper-gold prospect, located in the north of Chile, 1,128 meters of diamond drilling was performed.
Other Chilean Prospects. There are other prospects such as Esperanza (copper-molybdenum), located in the Atacama region. During 2007, we completed 2,538 meters of diamond drilling. We are also continuing with the exploration of the Resguardo prospect (gold-copper) in the Tarapaca region and the Catanave prospect (gold-silver) in the Arica region.
PRINCIPAL PRODUCTS AND MARKETS
The principal uses of copper are in the building and construction industry, electrical and electronic products and, to a lesser extent, industrial machinery and equipment, consumer products and the automotive and transportation industries. Molybdenum is used to toughen alloy steels and soften tungsten alloy and is also used in fertilizers, dyes, enamels and reagents. Silver is used for photographic, electrical and electronic products and, to a lesser extent, brazing alloys and solder, jewelry, coinage, silverware and catalysts. Zinc is primarily used as a coating on iron and steel to protect against corrosion. It is also used to make die cast parts, in the manufacturing of batteries and in the form of sheets for architectural purposes.
Our marketing strategy and annual sales planning emphasize developing and maintaining long-term customer relationships, and thus acquiring annual or other long-term contracts for the sale of our products is a high priority. Approximately 90% of our metal production for the years 2007, 2006 and 2005, were sold under annual or longer-term contracts. Sales prices are determined based on prevailing commodity prices for the quotation period, generally being the month of, the month prior to or the months following the actual or contractual month of shipment or delivery, according to the terms of the contract.
We focus on the ultimate end-user customers as opposed to selling on the spot market or to trading companies. In addition, we devote significant marketing effort to diversifying our sales both by region and by customer base. We strive to provide superior customer service, including just-in-time deliveries of our products. Our ability to consistently fulfill customer demand is supported by our substantial production capacity.
For additional information on sales by segment, see â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operations â€” Segment Sales Information.â€ť
Prices for our products are principally a function of supply and demand and, except for molybdenum, are established on the Commodities Exchange, or COMEX, in New York and the London Metal Exchange or LME, the two most important metal exchanges in the world. Prices for our molybdenum products are established by reference to the publication Plattâ€™s Metals Week. Our contract prices also reflect any negotiated premiums and the costs of freight and other factors. From time to time, we have entered into hedging transactions to provide partial protection against future decreases in the market price of metals and we may do so under certain market conditions. We have entered into copper swaps and collar contracts in 2007, 2006 and 2005 and into zinc swap contracts in 2006. At December 31, 2007 we did not have any copper or zinc swap contracts outstanding. See â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operations.â€ť For a further discussion of prices for our products, please see â€śManagementâ€™s Discussion and Analysis of Financial Condition and Results of Operations â€”Metal Prices.â€ť
GermĂˇn Larrea Mota-Velasco, Director. Mr. Larrea has been Chairman of the Board since December 1999, Chief Executive Officer from December 1999 to October 2004, and a director of the Company since November 1999. He has been Chairman of the Board of Directors, President and Chief Executive Officer of Grupo MĂ©xico S.A.B. de C.V. (holding) since 1994. Mr. Larrea is also the Chairman and Chief Executive Officer of Americas Mining Corporation (â€śAMCâ€ť) (mining division) since 2003. Mr. Larrea has been Chairman of the Board of Directors and Chief Executive Officer of Grupo Ferroviario Mexicano (railroad division) since 1997. Mr. Larrea was previously Executive Vice Chairman of Grupo MĂ©xico S.A.B. de C.V., and has been member of the Board of Directors since 1981. He is also Chairman of the Board of Directors and Chief Executive Officer of Empresarios Industriales de MĂ©xico (holding), Perforadora MĂ©xico (drilling company), MĂ©xico CompaĂ±ia Constructora (construction company), Fondo Inmobiliario (real estate company), since 1992. He founded Grupo Impresa, a printing and publishing company in 1978, remaining as the Chairman and Chief Executive Officer until 1989 when the company was sold. He is also a director of Grupo Financiero Banamex, (Citigroup) S.A. de C.V., Banco Nacional de MĂ©xico, S.A., Consejo Mexicano de Hombres de Negocios, and Grupo Televisa, S.A. de C.V. He and Mr. Genaro Larrea Mota-Velasco are brothers.
Oscar GonzĂˇlez Rocha, Director. Mr. Oscar GonzĂˇlez Rocha has been our Chief Executive Officer since October 21, 2004 and its President since December 1999. He has been a director of the Company since November 1999. Previously, he was our General Director and Chief Operating Officer from December 1999 to October 20, 2004. Mr. GonzĂˇlez has been a director of Grupo MĂ©xico S.A.B. de C.V. from 2002 to present and Managing Director of Mexicana de Cobre, S.A. de C.V. from 1986 to 1999 and of Mexicana de Cananea, S.A. de C.V. from 1990 to 1999. He has been an alternate director of Grupo MĂ©xico S.A.B. de C.V. from 1988 to April 2002.
Emilio Carrillo Gamboa, Director. Mr. Emilio Carrillo Gamboa has been a director of the Company since May 30, 2003 and is our fifth independent director nominee. Mr. Carrillo Gamboa is a prominent lawyer in Mexico and has been a partner of the law firm Bufete Carrillo Gamboa, S. C., a law firm specializing in corporate, financial, commercial, and public utility issues, for the last five years. Mr. Carrillo Gamboa has extensive business experience and currently serves on the boards of many prestigious international and Mexican corporations as well as charitable organizations. Since March 9, 2005 he is Chairman of the Board of the Mexico Fund, Inc. (NYSEâ€”msxf), a nondiversified closed-end management investment company. He is also Chairman of the Board of Holcim-Apasco, S.A. de C.V. (cement company). Mr. Carrillo was Director General of TelĂ©fonos de Mexico S.A. de C.V. (â€śTELMEXâ€ť) and from July 1987 to February 1989, he was Mexicoâ€™s Ambassador to Canada. Mr. Carrillo is a director of the following companies: Grupo Modelo, S.A. de C.V. (beer brewing), Kimberly-Clark de MĂ©xico, S.A. de C.V. (consumer products), San Luis Corporacion, S.A. de C.V. (automotive parts), Empresas ICA Sociedad Controladora, S.A. de C.V. (construction), Holcim Apasco, S.A. de C.V., The Mexico Fund, Inc., Bank of Tokyoâ€”Mitsubishi (MĂ©xico), S.A., Gasoductos de Chihuahua, S. de R.L. de C.V. and subsidiaries, Grupo Posadas, S.A. de C.V., and Grupo MĂ©xico S.A.B. de C.V. and subsidiaries. He is a member of the Valuation, Contract Review and Nominating and Corporate Governance Committees of the Mexico Fund and a member of the Audit Committee of the following companies: Empresas ICA Sociedad Controladora, S.A. de C.V. since 2002, Holcim-Apasco S. A. de C. V. since 2002, Grupo Modelo, S.A. de C.V. since 2002, Kimberly-Clark de MĂ©xico, S.A. de C.V. since 2002, San Luis Corporacion, S.A. de C.V. since 2002, The Mexico Fund, Inc. since 2002, Grupo MĂ©xico S.A.B. de C.V. since 2003, and Grupo Posadas since 2006. Except for Bank of Tokyoâ€”Mitsubishi (MĂ©xico), S.A., and Gasoductos de Chihuahua, S. de R.L. de C.V., which are private companies, the rest are public companies listed on the Mexican Stock Exchange, and two are listed on the NYSE: The Mexico Fund, Inc., and Empresas ICA Sociedad Controladora, S.A. de C.V. Mr. Carrillo Gamboa has a law degree from the Autonomous National University of Mexico, attended a continuous legal education program at Georgetown University Law School, and practiced at the World Bank.
Alfredo Casar PĂ©rez, Director. Mr. Casar PĂ©rez has been a director since October 26, 2006. He has been a member of the Board of Directors of Grupo MĂ©xico S.A.B. de C.V. since 1997. He is also a member of the Board of Directors of Ferrocarril Mexicano, S.A. de C.V., an affiliated company of Grupo MĂ©xico S.A.B. de C.V., since 1998 and its Chief Executive Officer since 1999. From 1992 to 1999, Mr. Casar served as Chief Executive Officer and Member of the Board of Directors of Cia. Perforadora Mexico and Mexico CompaĂ±Ăa Constructora, two affiliated companies of Grupo MĂ©xico S.A.B. de C.V.
Mr. Casar served as Project Director of ISEFI, a subsidiary of Banco Internacional in 1991 and Executive Vice President of Grupo Costamex in 1985. Mr. Casar also worked for Bufete Inmobiliario, Secretaria de Agricultura and El Colegio de Mexico. Mr. Casar holds a degree in Economics from the Autonomous Technological Institute of Mexico, ITAM, and one in Industrial Engineering from the Anahuac University. He also holds a Masterâ€™s in Economics from the University of Chicago.
Jaime F. Collazo GonzĂˇlez, Director. Mr. Collazo GonzĂˇlez has been a director of the Company since April 28, 2004 and our Vice President, Finance and Chief Financial Officer from April 28, 2004 to March 10, 2005. He has been Director of Administration, Auditing and Information Technology of Grupo MĂ©xico S.A.B. de C.V. since March 2004. From 1998 to 2003, Mr. Collazo GonzĂˇlez held the position of Managing Partner of Administration and Business Consulting, SC (a business consulting firm). Previously, he held several positions with IBM de Mexico, S.A., the last one being Vice President and Chief Financial Officer, prior to his retirement in 1998. He holds a Bachelorâ€™s degree in Administration from Universidad TecnolĂłgica de MĂ©xico and a Masterâ€™s degree in Business Administration from Instituto TecnolĂłgico y de Estudios Superiores de Monterrey.
Xavier GarcĂa de Quevedo Topete, Director. Mr. GarcĂa de Quevedo has been a director of the Company since November 1999 and our Executive Vice President and Chief Operating Officer since April 12, 2005. He has been the President and Chief Executive Officer of Minera Mexico, S. A. de C. V. since September 2001 to date. He was President of Grupo Ferroviario Mexicano, S.A. de C.V. and of Ferrocarril Mexicano, S.A. de C.V. from December 1997 to December 1999, and Managing Director of Exploration and Development of Grupo MĂ©xico S.A.B. de C.V. from 1994 to 1997. He has been a Director of Grupo MĂ©xico S.A.B. de C.V. since April 2002. Mr. GarcĂa de Quevedo is the Chairman of the Mining Chamber of MĂ©xico.
J. Eduardo GonzĂˇlez FĂ©lix, Director. Mr. Eduardo GonzĂˇlez FĂ©lix has been a director of the Company and our Vice President, Finance and Chief Financial Officer since March 11, 2005. He has been the President and Chief Financial Officer of the Mining Division of Grupo MĂ©xico S.A.B. de C.V. (â€śAMCâ€ť) from January 2004 to March 2005 and its Chief Financial Officer from 1999 to March 2003. Mr. GonzĂˇlez has been the Chief Financial Officer of Minera Mexico from mid-2001 to December 2003. He had also headed Grupo MĂ©xico S.A.B. de C.V.â€™s Treasury and Investor Relations departments from 1999 to 2001. Prior to joining Grupo MĂ©xico S.A.B. de C.V., Mr. GonzĂˇlez was a Senior Associate at McKinsey & Company, Inc., heading work for clients in various countries and industry sectors. Mr. GonzĂˇlez holds two degrees from the University of Arizona in Economics and Political Science and a Master in Business Administration in Finance and International Business from the University of Chicago, Graduate School of Business. He has also concluded extensive graduate studies and research in Political Philosophy and European Union Economics at the Oxford University in England. Mr. GonzĂˇlez has also worked at the Kimberly-Clark Corporation and at the Chicago Board of Trade.
Harold S. Handelsman, Director. Mr. Handelsman has been a director of the Company since August 2002 and is a special independent director nominee. Mr. Handelsman has been Executive Vice President and General Counsel of The Pritzker Organization, LLC, a private investment firm, since 1998. Mr. Handelsman has also been a senior executive officer of the Hyatt Corporation since 1978 and currently serves as Executive Vice President of Global Hyatt Corporation, and is a director of a number of private corporations. He received a B.A. degree from Amherst College in 1968 and a J.D. degree from Columbia University in 1973.
Genaro Larrea Mota-Velasco, Director. Mr. Larrea was our Vice President, Commercial from December 1999 until April 25, 2002, and has been a director since November 1999. He was Managing Commercial Director of Grupo MĂ©xico S.A.B. de C.V. from 1994 to August 30, 2001, and has been a director of Grupo MĂ©xico S.A.B. de C.V. since 1994. He and Mr. GermĂˇn Larrea Mota-Velasco are brothers.
Armando Ortega GĂłmez, Director. Mr. Ortega has been our Vice President-Legal and Secretary since April 25, 2002 and a director since August 2002. He has been our General Counsel since October 23, 2003. Previously, he was our Assistant Secretary from July 25, 2001 to April 25, 2002. He was General Counsel of Grupo MĂ©xico S.A.B. de C.V. from May 2001 to February 2007. Previously, he headed the Unit on International Trade Practices of the Ministry of Economy of Mexico with the rank of Deputy Vice Minister from January 1998 to mid-May 2001, and was negotiator for international matters for said Ministry from 1988 to May 2001.
Luis Miguel Palomino Bonilla, Director. Mr. Luis Miguel Palomino Bonilla has been a director of the Company since March 19, 2004 and is a special independent director nominee. Mr. Palomino has been the principal and senior consultant of Proconsulta International (a financial consulting firm) since 2003. Previously he was First Vice President and Chief Economist, Latin America for Merrill Lynch Pierce Fenner & Smith, New York (investment banking) from 2000 to 2002. He was Chief Executive Officer, Senior Country and Equity Analyst of Merrill Lynch, Peru (investment banking) from 1995 to 2000. Mr. Palomino has held various positions with banks and financial institutions as an economist, financial advisor and analyst. He has a PhD in finance from the Wharton School of the University of Pennsylvania, Philadelphia, and graduated from the Economics Program of the University of the Pacific, Lima, Peru.
Gilberto Perezalonso Cifuentes, Director. Mr. Gilberto Perezalonso Cifuentes has been a director of the Company since June 2002 and is a special independent director nominee. He is currently Treasurer of the AsociaciĂłn Vamos MĂ©xico A.C., consultant to the Presidency of Grupo Televisa, S.A. and a member of its Board and its Executive Committee. He was Chief Executive Officer of Corporacion Geo S.A. de C.V. from February 2006 to February 2007. Mr. Perezalonso was the Chief Executive Officer of AeromĂ©xico (AerovĂas de MĂ©xico, S.A. de C.V.) from 2004 until December 2005. From 1980 until February 1998, Mr. Perezalonso held various positions with Grupo Cifra S.A. de C.V., the most recent position being that of General Director of Administration and Finance. From 1998 until April 2001, he was Executive Vice President of Administration and Finance of Grupo Televisa, S.A. He is also a member of the investment committee of IBM de MĂ©xico. He is a member of the advisory council of Banco Nacional de MĂ©xico, S.A. de C.V., the board and of the investment committee of Afore Banamex, the board and of the investment committee of Siefore Banamex No. 1, and is a member of the Boards of Corporacion Geo S.A. de C.V., Gigante, S.A. de C.V., International Center for Human Development, Costa Rica, Masnegocio Co. S. de R.L. de C.V., and Financiera Compartamos, S.A. de C.V., SFOL. Mr. Perezalonso is a member of the Audit Committee of Televisa S.A. de C.V. and Cablevision, S.A. de C.V. Mr. Perezalonso has a law degree from the Iberoamerican University and a Masterâ€™s degree in Business Administration from the Business Administration Graduate School for Central America (INCAE). Mr. Perezalonso has also attended the Corporate Finance program at Harvard University.
Juan Rebolledo Gout, Director. Mr. Rebolledo has been a director of the Company since May 30, 2003. Mr. Rebolledo has been International Vice President of Grupo MĂ©xico S.A.B. de C.V. since 2001. He was Deputy Secretary of Foreign Affairs of Mexico from 1994 to 2000 and Deputy Chief of Staff to the President of Mexico from 1993 to 1994. Previously, he was Assistant to the President of Mexico (1989-1993), director of the â€śNational Institute for the Historical Studies of the Mexican Revolutionâ€ť of the Secretariat of Government (1985-1988), Dean of Graduate Studies at the National Autonomous University of Mexico, Political Science Department (1984-1985), and professor of said university (1981-1983). Mr. Rebolledo holds a law degree from the National Autonomous University of Mexico, an MA in philosophy from Tulane University, and an LLM from Harvard Law School.
Carlos Ruiz SacristĂˇn, Director . Mr. Carlos Ruiz SacristĂˇn has been a director of the Company since February 12, 2004 and is a special independent director nominee. Since November 2001, he has been the owner and managing partner of Proyectos Estrategicos Integrales, a Mexican investment banking firm specialized in agricultural, transport, tourism, and housing projects. Mr. Ruiz has held various distinguished positions in the Mexican government, the most recent being that of Secretary of Communication and Transportation of Mexico from 1995 to 2000. While holding that position, he was also Chairman of the Board of Directors of the Mexican-owned companies in the sector, and member of the Board of Directors of development banks. Mr. Ruiz holds a Bachelorâ€™s degree in Business Administration from the Anahuac University of Mexico City, and an MBA degree from Northwestern University of Chicago.
Background and Role of Executive Officers in Determining Compensation:
The compensation of our executive officers is determined by our Chairman and other key executive officers, including Mr. Oscar GonzĂˇlez Rocha. Mr. Oscar GonzĂˇlez Rocha does not participate in any decision relating to his own compensation. Similarly, Messrs. J. Eduardo GonzĂˇlez FĂ©lix, our Vice President, Finance and Chief Financial Officer, Xavier GarcĂa de Quevedo Topete, our Executive Vice President and Chief Operating Officer, and JosĂ© N. Chirinos, our Comptroller do not participate in any discussion relating to their respective compensations. Mr. Remigio Martinez Muller, our Vice President of Exploration, does not participate in any decision relating to his own compensation.
The executive officers compensated by us or one or more of our subsidiaries are Messrs. Oscar GonzĂˇlez Rocha, J. Eduardo GonzĂˇlez FĂ©lix, Xavier GarcĂa de Quevedo Topete, JosĂ© N. Chirinos and Remigio Martinez Muller. Mr. Oscar GonzĂˇlez Rocha joined us in 1999 after having an outstanding career at Grupo Mexico and has been receiving compensation from us since March 2000. Mr. Eduardo GonzĂˇlez FĂ©lix joined us in March 2005, also after serving as Chief Financial Officer of various subsidiaries of Grupo Mexico. Mr. Xavier GarcĂa de Quevedo Topete joined us in November 1999 after serving as President of Grupo Ferroviario Mexicano, S.A. de C.V. and of Ferrocarril Mexicano, S.A. de C.V. Mr. JosĂ© N. Chirinos has more than 40 years of service with us, having held various positions in accounting, administration, and finance. In 2002, Mr. Remigio Martinez Muller joined us after serving as a Director of Exploration of Mexicana de Cobre, S.A. de C.V. Mr. Martinez has held several managerial positions within Grupo Mexico.
All our other executive officers, including Mr. GermĂˇn Larrea Mota-Velasco, our Chairman and Mr. Armando Ortega GĂłmez, our Vice President, Legal, General Counsel, and Secretary, are officers of Grupo Mexico or of certain of its subsidiaries and are compensated by Grupo Mexico or certain of its subsidiaries. Messrs. Larrea and Ortega GĂłmez have only received fees and stock awards for their services as members of our Board of Directors.
Grupo Mexico, and our other affiliated companies, provide various services to us, including 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 received payment from us for these services. The total amount paid by us to Grupo Mexico for such services in 2006 was $13.8 million.
Our objectives in compensating our executive officers are to encourage the achievement of our business objectives and superior corporate performance by them. Our business objectives include increasing production and lowering costs in a safe environment, maintaining customer satisfaction, market leadership, and enhancing shareholder value. The principal objective of our compensation practices is to reward and retain executives with key core competency critical to our long-term management strategy. We reward for results rather than on the basis of seniority, tenure or other entitlement. We believe that our executive compensation practices align compensation with our business values and strategy.
Peruvian Compensation Practices:
Our Peruvian compensation practices take into account many factors, including individual performance and responsibilities, years of service, elements of compensation mandated by Peruvian law, future challenges and objectives, contributions to the future success of our Company, the executiveâ€™s total compensation, and our financial performance. We may also look at the compensation levels of comparable companies.
Our executive officers receive only cash-based compensation, which is currently paid. The cash-base compensation has two principal components: base salary and bonus, which are discretionary, and compensation mandated by Peruvian law. We also sponsor programs to recruit and retain qualified employees working in Peru.
The payment of bonuses is discretionary and we do not necessarily pay bonuses every year. The payment of bonuses and the amount of the same depend, among other things, on our financial performance, our intensive capital investment plan, our future cash flow generation from operations, and our liquidity in general.
We do not provide compensation tied to specific pre-determined individual or Company performance criteria or long-term incentive compensation. Since 2000 we have not used the Southern Copper Corporation Incentive Compensation Plan to grant incentive cash payments to our executive officers or to our other key employees. Also, since 2000 we have not used independent consulting organizations to assist us with our executive compensation policies.
The cash incentive payments granted to our executives are not based on pre-established performance targets or on targets that have been previously communicated to the executives. The granting of the award and the amount of each award are discretionary and substantially uncertain until we decide to award them, generally at the beginning of each year.
All our employee compensation is denominated in Peruvian Nuevos Soles. We convert the Peruvian Nuevos Soles into U.S. dollars using the exchange rate prevailing at the end of each pay period.
We have not granted stock base compensation to any of our executive officers since 2000. The Stock Incentive Plan, under which options and stock awards could have been granted, expired by its terms on January 1, 2006.
The Company has two noncontributory defined benefit pension plans covering former salaried employees in the United States and certain former employees in Peru. Mr. Oscar GonzĂˇlez Rocha and Mr. Chirinos are not covered by our non-contributory retirement plans. They are covered by the Peruvian private pension system (â€śAFPâ€ť), a mandatory pension system. As required by Peruvian law, we retain every month a percentage of their salary and deposit the amount into their individual AFP accounts. The percentage of the monthly salary retained and deposited varies each year and has ranged from 8% to 10% over the years. Employees, including Mr. Chirinos, hired prior to 1995, received in 1995 a 13.53% salary increase to compensate them for the new deduction established by Peruvian law to participate in the mandatory pension system. In 2006 we reported in the Summary Compensation Table that Mr. Chirinos had received payments of $17,395 in 2005 and $16,839 in 2004 pursuant to requirements of the AFP. For 2006 we have included this increase in the salary reported for Mr. Chirinos.
We do not have corporate plans providing severance benefits to our executives. Our executive officers only receive severance benefits provided by Peruvian law. If the employee is terminated by us and he or she has a fixed-term employment agreement, Peruvian law requires that we pay the employee salaries for the remaining of the term of his or her employment agreement. Peruvian law also provides that if the employee has been dismissed without cause, he or she is entitled to one and one-half monthly salary for each year of service up to a maximum of eight years or twelve monthly salaries. Peruvian law also provides that at the termination of employment an employee will be able to withdraw the full amount of the compensation for the years of service, known as CTS (â€śCompensaciĂłn por Tiempo de Serviciosâ€ť) in Peru, described below. Our executive officers do not have change of control employment agreements. Our Peruvian employees, including Mr. JosĂ© Chirinos, do not have employment agreements.
Pursuant to Peruvian laws concerning expatriate employees, Mr. Oscar GonzĂˇlez Rocha entered into an employment agreement with us. The employment agreement is in effect for a term of one year and may be extended for additional periods. In accordance with the terms of the employment agreement, we have agreed to provide Mr. Oscar GonzĂˇlez Rocha (and any other expatriate employees) with benefits as required by Peruvian law, including severance benefits upon termination of employment. Our contract employees and their dependents, including Mr. Oscar GonzĂˇlez Rocha, receive free travel from their home country at the commencement of each year of the contract and to their home country at its termination. Mr. Oscar GonzĂˇlez Rocha and his spouse received, respectively, $1,481 and $1,481 as free travel in 2006.
Discretionary Cash Compensation:
(a) Base Salary:
Mr. GonzĂˇlez Rocha and Mr. Chirinos received $405,764 and $178,754, respectively, as annual salary in 2006.
The base salary of Mr. Oscar GonzĂˇlez Rocha for 2006 increased 10%, which compares with prior increases of approximately 7% in 2005 and 2004. The base salary of Mr. JosĂ© Chirinos for 2006 increased around 4%, which is lower than the increase of approximately 9% received in 2005. Mr. Oscar GonzĂˇlez Rochaâ€™s base salary at the commencement of his services with us is reflected in an employment agreement mandated by Peruvian law. The base salaries of our executive officers follow the guidelines of salaries of other key employees of the Company.
Mr. Oscar GonzĂˇlez Rocha received a cash incentive payment of $353,137 for services rendered in 2006 in recognition of his performance and to reward him for his leadership, vision and focus. Mr. JosĂ© Chirinos also received a cash incentive payment of $38,668, also in recognition of his extraordinary performance in 2006.
Peruvian Mandated Cash Compensation:
(a) Profit Sharing in the Profits of Our Peruvian Branch
Peruvian law requires that we, as well as all other mining companies in Peru, share 8% of the annual pre-tax profits of our Branch with all our workers (salaried and non-salaried). This benefit is payable in cash to each employee in an amount not to exceed 18 times his or her monthly salary. The excess is paid to a Peruvian pro-employment fund and to the regional governments where we operate, that is to say, the governments of Moquegua and Tacna in Peru.
Mr. GonzĂˇlez Rocha and Mr. Chirinos received, respectively, $562,212 and $318,827, as a participation in the pre-tax earnings of our Peruvian Branch in 2006.
(b) Peruvian Legal Holiday Bonuses:
Peruvian law also requires payment each year of one monthâ€™s salary to each employee as a bonus for Peruvian Independence holidays and Christmas.
Mr. GonzĂˇlez Rocha and Mr. Chirinos received, respectively, $73,117 and $39,802, as Peruvian Independence holidays and Christmas bonuses in 2006.
(c) Termination of Employment Compensation:
Additionally, as compensation for years of service or CTS, Peruvian law requires a deposit of one twelfth of an employeeâ€™s annual salary, vacation, travel, Independence holidays, Christmas, dependents and service award bonus, each year, for each employee (whether Peruvian or expatriate) working in Peru, as applicable. This amount is deposited in a local bank of the employeeâ€™s choosing, in an individual account, which accrues interest paid by said bank. For all legal purposes, the chosen bank acts as trustee of the deposited amounts. The CTS funds can only be fully withdrawn when the employee terminates employment.
In 2006 we deposited $44,379 and $23,114, respectively, for Mr. GonzĂˇlez Rochaâ€™s and Mr. Chirinosâ€™ 2006 CTS compensation.
Peruvian Mandated Company Housing:
Peruvian law also requires that we provide residences at our operations in Toquepala, Cuajone, and Ilo for our salaried and non-salaried employees, including for Mr. Oscar GonzĂˇlez Rocha. We provide a corporate residence in Lima, which Mr. Oscar GonzĂˇlez Rocha uses when he conducts business activities at our Lima headquarters. We have calculated that the incremental cost to us for the personal use of the Lima residence by Mr. Oscar GonzĂˇlez Rocha amounted to $5,943 in 2006. Our methodology in calculating the incremental cost consists of annual depreciation of the house plus maintenance expenses, less the rental fee paid by Mr. GonzĂˇlez Rocha.
Cash Compensation under Company Sponsored Programs:
(a) Vacation Compensation:
We provide vacation bonuses for all our salaried employees and payment for vacation travel to all our key salaried employees.
Mr. GonzĂˇlez Rocha received $33,213 as vacation bonus in 2006, and Mr. Chirinos received $16,967, as vacation bonus and travel in 2006.
(b) Five Percent Benefit or â€śQuinquenioâ€ť:
We also provide voluntarily to all salaried employees and to non-salaried employees under agreement with our local labor unions, a benefit consisting of five percent of the monthly salary for each period of five years of service. We call this benefit, colloquially in Peru, the â€śquinquenio.â€ť
Mr. GonzĂˇlez Rocha and Mr. Chirinos received, respectively, $20,288 and $56,418, as quinquenio in 2006.
We paid $15,074 for air travel in 2006 to enable the spouse of Mr. Oscar GonzĂˇlez Rocha to accompany Mr. Oscar GonzĂˇlez Rocha on business travel, principally from Lima to our operations in Mexico, and then back to Lima.
Company Provided Car and Driver:
Mr. Oscar GonzĂˇlez Rocha and Mr. JosĂ© N. Chirinos and other key salaried employees are provided with a Company car and a driver. We consider that the use of Company cars by Mr. GonzĂˇlez Rocha and Mr. Chirinos and other key salaried employees is not a personal benefit but is integrally and directly related to the performance of their functions as key executives or salaried employees of one of the largest companies in Peru, is required for security reasons, and is consistent with local practice.
Mexican Compensation Practices:
Our Mexican compensation practices also take into account many factors, including individual performance and responsibilities, years of service, elements of compensation mandated by Mexican law, future challenges and objectives, contributions to the future success of our Company, the executive total compensation, and our financial performance. We may also look at the compensation levels of comparable companies.
Our executive officers receive only cash-based compensation, which is currently paid. The cash-base compensation has two principal components: base salary and bonus, which are discretionary, and compensation mandated by Mexican law. We also sponsor programs to recruit and retain qualified employees working in Mexico.
The payment of bonuses is discretionary and we do not necessarily pay bonuses every year. The payment of bonuses and the amount of the same depend, among other things, on our financial performance, our intensive capital investment plan, our future cash flow generation from operations, and our liquidity in general.
We do not provide compensation tied to specific pre-determined individual or Company performance criteria or long-term incentive compensation. Also, we do not use independent consulting organizations to assists us with our executive compensation policies in Mexico.
The cash incentive payments granted to our executives are not based on pre-established performance targets or on targets that have been previously communicated to the executives. The granting of the award and the amount of each award are discretionary and substantially uncertain until we decide to award them, generally at the beginning of each year.
All our Mexican employee compensation is denominated in Mexican Pesos. We convert the Mexican Pesos into U.S. dollars using the exchange rate prevailing at the end of each pay period.
We do not grant stock base compensation to any of our executive officers in Mexico. We offer to eligible employees in Mexico stock purchase plans (the â€śEmployee Stock Purchase Plansâ€ť) through trusts that acquire shares of Grupo Mexico for future sales to our employees, and employees of subsidiaries and certain affiliated companies. Our officers and directors, who are also officers of Grupo Mexico, are eligible to participate in the Employee Stock Purchase Plans. Sales are at the approximate fair market value of the shares at the date of sale, and the employees pay for such shares over periods extending to a maximum of eight years on an interest-free basis. The number of shares allotted to each eligible employee is determined by the employeeâ€™s position. Certain key employees like Messrs. Oscar GonzĂˇlez Rocha, J. Eduardo GonzĂˇlez FĂ©lix, and Xavier GarcĂa de Quevedo Topete receive incentive cash bonuses which are used to purchase shares under the Employee Stock Purchase Plans. These amounts are reflected in the Summary Compensation Table under the Bonus column.
MANAGEMENT DISCUSSION FROM LATEST 10K
This Managementâ€™s Discussion and Analysis of Financial Condition and Results of Operations relates to and should be read together with our Audited Consolidated Combined Financial Statements as of and for each of the years in the three-year period ended December 31, 2007. Effective April 1, 2005, Southern Copper Corporation acquired substantially all of the outstanding common stock of Minera Mexico. The acquisition was accounted for in a manner similar to a pooling of interests as it involved the reorganization of entities under common control. Under such accounting, the financial statements of SCC and Minera Mexico are combined on a historical cost basis for all the periods presented since they were under the indirect common control of Grupo Mexico during such periods. Therefore, unless otherwise noted, the discussion below of our financial condition and results of operations is for us, including our Minera Mexico subsidiary, on a consolidated or combined basis for all periods. Our combined financial results may not be indicative of the results of operations that actually would have been achieved had the acquisition of Minera Mexico taken place at the beginning of the periods presented and do not purport to be indicative of our future results.
This discussion contains forward-looking statements that are based on managementâ€™s current expectations, estimates and projections about our business and operations. Our actual results may differ materially from those currently anticipated and expressed in the forward-looking statements as a result of a number of factors. See â€śCautionary Statements.â€ť
Our business is primarily the production and sale of copper. In the process of producing copper, a number of valuable metallurgical by-products are recovered, such as molybdenum, zinc, silver, lead and gold, which we also produce and sell. Market forces outside of our control largely determine the sales prices for our products. Our management, therefore, focuses on copper production, cost control, production enhancement and maintaining a prudent capital structure to improve profitability. We believe we achieve these goals through capital spending programs, exploration efforts and cost reduction programs. Our aim is to remain profitable during periods of low copper prices and to maximize financial performance in periods of high copper prices.
A number of events and results highlight our Companyâ€™s 2007 year. Net sales were $6,085.7 million an 11.5% increase over 2006, additionally, net earnings were $2,216.4 million, an increase of 8.8% over 2006, both sales and net earnings are the highest in the Company history. These increases were achieved while three of our Mexican properties, Cananea, San Martin and Taxco, were on strike from July 30 through the end of the year. We estimate that these strikes cost the Company 178.4 million pounds of copper and 25.6 million pounds of zinc, and reduced 2007 operating income by $487.5 million. Since January 11, 2008 the Cananea mine is open and is preparing to gradually resume normal operations in the near future. The mine was reopened based on a ruling by the labor authorities who declared the strike illegal. Subsequently, the Cananea union obtained an injunction from a federal judge preventing the Company from firing workers who do not return to work immediately, the same judge did explicitly safeguard the rights of any worker who wished to return to work at the mine and the right of the Company to conduct operations in the ordinary course of business. The ruling declaring the illegality of the Cananea strike was challenged before a federal judge who upheld the unionâ€™s case on February 14, 2008. The Company will appeal this unfavorable ruling. The Company expects that it will take about three months to return to full production at Cananea.
Earnings and sales in 2007 increased because of higher average metal prices for most of our products, copper was 4.2% to 5.9% higher in 2007, depending on whether it was priced on the COMEX or LME market, the molybdenum price was 22.7% higher and silver was 16% higher. Of our other significant by-products only zinc prices were lower in 2007 and, in that case, by 1.3%. The Cananea strike resulted in a decrease in copper, zinc and silver sales volumes. However, during this year there was an increase in the volume of molybdenum sales. Molybdenum production and sales volume increased in 2007 due to higher grades at our Peruvian mines and from an increase in production from the La Caridad mine, which suffered strike losses in 2006. Another factor effecting the improvement in 2007 sales and net income was the impact of the derivative metal contracts which reduced net sales and operating income in 2006 by $276.1 million and increased net sales and operating income by $10.9 million in 2007.
During 2007 we announced a modification to our capital investment program to prioritize major investments in Peru. These investments include the Tia Maria SX/EW copper project in Arequipa, Peru, expansions of the Toquepala and Cuajone concentrators and the expansion of the smelter and refinery in Ilo, Peru. We estimate that these investments will have a capital cost of $2,108 million and increase our annual copper production by 270,000 tons in 2011. Feasibility studies indicate a resource of 638 million tons of mineralized material at Tia Maria with an average copper grade of 0.39%.
We discuss below several matters that our management believes are important to understand our results of operations and financial condition. These matters include (i) our â€śoperating cash costsâ€ť as a measure of our performance, (ii) metals prices, (iii) our acquisition of Minera Mexico, (iv) our business segments and (v) the effects of inflation and other local currency issues.
Since our inception, we have principally maintained operations in Peru. However, in recent years, we have refocused our strategies to internationalize our business and broaden our market exposure. In 2003, we acquired exploration properties in Chile, which are being evaluated for potential exploitation and in 2005 we acquired Minera Mexico, with substantial mining operation in Mexico. Please see â€śMinera Mexico Acquisition.â€ť
Operating Cash Costs
An overall benchmark used by us and a common industry metric to measure performance is operating cash costs per pound of copper produced. Operating cash cost is a non-GAAP measure that does not have a standardized meaning and may not be comparable to similarly titled measures provided by other companies. A reconciliation of our operating cash cost per pound to the cost of sales (including depreciation, amortization and depletion) as presented in the consolidated combined statement of earnings is presented under the subheading, â€śNon-GAAP Information Reconciliation,â€ť below. We have defined operating cash cost per pound as cost of sales (including depreciation, amortization and depletion); plus selling, general and administrative charges, treatment and refining charges; less by-products revenue and sales premiums, depreciation, amortization and depletion, workersâ€™ participation and other miscellaneous charges, including the Peruvian royalty charge and the change in inventory levels; divided by total pounds of copper produced and purchased by us. In our calculation of operating cash cost per pound of copper produced, we credit against our costs the revenues from the sale of by-products, principally molybdenum, zinc and silver and the premium over market price that we receive on copper sales. We account for the by-product revenue in this way because we consider our principal business to be the production and sale of copper. We believe that our Company is viewed by the investment community as a copper company, and is valued, in large part, by the investment communityâ€™s view of the copper market and our ability to produce copper at a reasonable cost. We also include copper sales premiums as a credit, as these amounts are in excess of published copper prices. The increase in recent years in the price of molybdenum, as well as increases in silver and zinc, has had a significant effect on our traditional calculation of cash cost and its comparability between periods. Accordingly, we present cash costs with and without crediting the by-product revenues against our costs.
We exclude from our calculation of operating cash cost depreciation, amortization and depletion, which are considered non-cash expenses. Exploration is considered a discretionary expenditure and is also excluded. Workersâ€™ participation provisions are determined on the basis of pre-tax earnings and are also excluded. Additionally excluded from operating cash costs are items of a non-recurring nature, the royalty charge and in periods prior to 2006 the portion of our mine stripping costs that we capitalized.
Our operating cash costs per pound, as defined, are presented in the table below for the three years ended December 31, 2007. We present cash costs with and without the inclusion of by-product revenues.
The decrease in the cash costs per pound of copper produced and purchased (including by-product revenue) in 2007 is mainly attributable to higher market price and volume of molybdenum in 2007. The credit for molybdenum sales amounted to $0.849 per pound, $0.420 per pound and $0.617 per pound, in 2007, 2006 and 2005, respectively. The credit to the cost for zinc sales amounted to $0.337 per pound, $0.374 per pound and $0.126 per pound in 2007, 2006 and 2005, respectively. The credit to operating cash cost for the by-product revenue in 2007 reduced cash cost by $1.568 per pound, an increase in benefit of $0.444 per pound over 2006. The improved benefit is almost entirely due to molybdenum revenue, which accounted for $0.429 per pound of the improvement. The reason for the added benefit from molybdenum revenues in 2007 is attributable to both higher sales volume and higher sales price. Volumes improved because of better grades at our Peruvian mines and higher production, an increase of 8.1 million pounds from La Caridad in Mexico, which had significant strike activity in 2006. Molybdenum prices were 22.7% higher in 2007. The credit to operating cash cost in 2006 improved over 2005 by $0.145 per pound and was principally caused by improvements in the sales price of zinc and silver, reduced somewhat by a decrease in the sales price of molybdenum.
The cash cost without by-product revenue increased in 2007 principally as a result of the following factors, higher production cost (mainly power, water, labor and repair costs) which increased our cash cost by $0.158, higher freight and treatment charges due to the sale of concentrates which increased cost by $0.065 and also an increase of $0.031 in unit cost due to strikes at some of our Mexican operations. These increases were partially offset by a decrease in the purchase of outside metal, which reduced cost by $0.118. The cash cost without by-product revenue increased in 2006 as a result of cost increases. The increasingly higher copper prices in 2006 increased our computation of cash cost, as we include in our calculation the cost of purchased metal. The higher value and thus the higher cost of copper in 2006 increased our cash cost by $0.240 in 2006. Significant strike activity at some of our Mexican properties required us to purchase larger quantities of third party copper in 2006. Also the cost of fuel products, electricity and other supplies increased in 2006. Additionally, our operating cash costs increased in 2006 as a result of the EITF consensus, which we adopted on January 1, 2006 and is described below under â€śCritical Accounting Policies and Estimates-Capitalized Mine Stripping Costs.â€ť If we had applied this consensus in 2005 our per pound operating cash cost would have increased by $0.023.
The profitability of our operations is dependent on, and our financial performance is significantly affected by, the international market prices for the products we produce, especially for copper, molybdenum, zinc and silver. Metals prices historically have been subject to wide fluctuations and are affected by numerous factors beyond our control. These factors, which affect each commodity to varying degrees, include international economic and political conditions, levels of supply and demand, the availability and cost of substitutes, inventory levels maintained by producers and others and, to a lesser degree, inventory carrying costs and currency exchange rates. In addition, the market prices of certain metals have on occasion been subject to rapid short-term changes due to speculative activities.
We are subject to market risks arising from the volatility of copper and other metals prices. Assuming that expected metal production and sales are achieved, that tax rates are unchanged and giving no effects to potential hedging programs, metal price sensitivity factors would indicate the estimated change in net earnings resulting from metal price changes in 2008
Minera Mexico Acquisition
In April, 2005, we acquired Minera Mexico from a subsidiary of Grupo Mexico, our controlling stockholder. At the time of the acquisition Minera Mexico was the largest mining company in Mexico and the eleventh largest copper producer in the world on a stand-alone basis. We exchanged 67.2 million newly-issued shares of our common stock for the outstanding shares of Minera Mexicoâ€™s direct majority stockholder, and Minera Mexico became our 99.1% owned subsidiary. As a part of this transaction, on March 1, 2005, we paid a special transaction dividend of $100 million to all of our stockholders. Upon completion of the merger, Grupo Mexico increased its indirect beneficial ownership of our capital stock from approximately 54.2% to approximately 75.1%. In October 2005, in another transaction we acquired 6.4 million shares of Minera Mexico from Grupo Mexico for $30.3 million. This increased our holdings in Minera Mexico to 99.95%. With this acquisition, based on the then current data, we increased our total copper reserves by over 100% and increased our annual copper production by approximately 80%.
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 over the past three years has had an important impact on the Companyâ€™s earnings. Nevertheless, the Company continues to manage its operations on the basis of three copper segments. These segments are our Peruvian operations, our Mexican open-pit operations and our Mexican underground operations, known as our IMMSA unit. Our Peruvian operations include the Toquepala and Cuajone mine complexes and the smelting and refining plants, industrial railroad and port facilities which service both mines. Our Mexican open-pit operations include La Caridad and Cananea mine complexes, the smelting and refining plants and support facilities which service both mines. Our IMMSA unit includes five underground mines that produce zinc, lead, copper, silver and gold, a coal mine, and several industrial processing facilities for zinc, copper and silver.
Segment information is included in our review of â€śResults of Operationsâ€ť and also in Note 20 of our Consolidated Combined Financial Statements.
Results of Operations for the Year Ended December 31, 2007 Compared to Year Ended December 31, 2006.
Our sales in 2007 were $6,085.7 million, compared with $5,460.2 million in 2006, an increase of $625.5 million or 11.5%. The increase was attributable to higher market prices for most of our products. Copper was 4.2% to 5.9% higher in 2007, depending on whether it was COMEX or LME market, the molybdenum price was 22.7% higher and silver was 16% higher. Zinc prices decreased by 1.3% in 2007. In addition, molybdenum sales volume increased 40.2% in 2007 due to higher grades at our Peruvian mines and increased production from the La Caridad mine which had strike losses in 2006. 2007 net sales also include a $10.9 million gain on copper derivatives compared with a loss of $276.1 million in 2006. There was, however, a decrease in copper sales volume in 2007 due to a strike at the Cananea mine.
Sales volume for copper decreased by 55.7 million pounds in 2007 a decrease of 4% compared with 2006. The impact of this decrease in copper sales volume, as well as a volume decrease in the sale of zinc and silver was a result of the strikes at some of our Mexican operations. However, during this year there was an increase in the volume of molybdenum sales.
Mine copper production was 1,305.5 million pounds in 2007, a decrease of 2.2% from 2006. This decrease of 29.7 million pounds included a reduction of 24.6 million pounds at our Mexican operations due to strike related reductions at our Cananea and San Martin mines where strikes began on July 30, 2007 and ran through the end of the year. Additionally, production at our Peruvian mines decreased by 5.1 million pounds mainly due to lower ore grade at the Toquepala mine. The make up of our 2007 copper sales changed significantly from 2006, as we sold about 200 million additional pounds of copper in concentrate form and about 250 million pounds less of refined copper. This change was caused principally by some delays in reaching full capacity at our modernized Ilo smelter.
Molybdenum production and sales increased 36.8% and 40.2%, respectively in 2007 when compared to 2006. The increases are principally due to higher grades at our Peruvian mines and from La Caridad mine which lost production in 2006 due to strikes.
Mine zinc production amounted to 266.8 million pounds in 2007, a 11.4% decrease from 2006. The decrease of 34.3 million pounds in zinc production is mainly due to the strike losses at our Taxco and San Martin mines.
Copper made up 69.5% of net sales in 2007 compared with 76.0% in 2006. Sales of by-products in 2007 totaled $1,856.9 million compared with $1,313.1 million in 2006, an increase of 41.4%. The increase is principally attributable to the increase in the volume and sales prices for molybdenum. This increase was partially reduced by lower volume and sales prices for zinc. The table below provides the sales of our by-products as a percentage of our total net sales.
Cost of sales (exclusive of depreciation, amortization and depletion)
Our cost of sales (exclusive of depreciation, amortization and depletion) in 2007 was $2,122.2 million, compared with $2,019.8 million in 2006, an increase of $102.4 million, or 5.1%. The increase in cost of sales was principally due to $132.0 million of higher production cost, including, $21.7 million due to higher fuel and power cost, $15.5 million of higher water cost at our Mexican operations due to an increase in the water rate applicable to the mining industry, $14.8 million of higher labor costs, $24.9 million of higher repair costs, and $55.1 million of other operating costs offset by $146.8 million of lower metal purchased from third parties. The increase in cost of sales also includes $32.3 million of higher freight and selling cost mainly due to higher sale of concentrates, $27.1 million of inventory consumption and $39.4 million of higher workers participation.
Selling, general and administrative
Our selling, general and administrative expense in 2007 was $98.0 million, compared with $88.3 million in 2006, an increase of $9.7 million. The increase was principally due to higher labor costs of $6.4 million and $2.5 million of higher rental equipment and office maintenance cost at our Mexican corporate office.
Depreciation, amortization and depletion
Depreciation, amortization and depletion was $327.9 in 2007 compared with $275.1 million in 2006, an increase of $52.8 million over 2006. The increase includes additional charges of $24.4 million at our Peruvian operations, of which $21.7 million was for our newly activated Ilo smelter modernization project. Increases in depreciation, amortization and depletion in 2007 at our Mexican operations amounted to $28.5 million. This increase includes $11.4 million of higher amortization of capitalized leach material due to increased amounts capitalized in 2006, $8.9 million of accelerated depreciation of the processing plant equipment at Pasta de Conchos over the remaining mineral located in the open pit after the mine accident and $8.2 million due to the activation of maintenance and replacement equipment.
Exploration expense in 2007 was $40.2 million compared with $22.7 million in 2006, an increase of $17.5 million over 2006. This increase includes $11.8 million at our Peruvian operations, and was principally for the Tia Maria project in the department of Arequipa, where spending increased by $9.2 million. A feasibility study for the project was completed in 2007 and we are planning to begin the project in 2008. Exploration expense at our Mexican operation increased by $5.7 million in 2007 and was principally for the surface drilling activity at Santa Barbara, San Martin and Santa Eulalia.
Interest expense in 2007 was $123.2 million compared with $113.4 million in 2006, an increase of $9.8 million. Interest expense increased in 2007 principally as a result of an increase in our average debt outstanding. Please see â€śLiquidity and Capital Resourcesâ€ť for a further discussion of our financing program.
Capitalized interest in 2007 was $14.7 million, compared with $27.9 million in 2006, a decrease of $13.2 million. This decrease is largely due to the startup of the Ilo smelter modernization project in early 2007, for which we capitalized $14.0 million less interest in 2007.
Interest income in 2007 was $82.5 million, compared with $50.2 million in 2006, an increase of $32.3 million. Our interest income increased principally as a result of higher interest rates on short term securities and higher invested balances.
Loss on debt prepayments
Loss on debt prepayments in 2007 was $16.6 million, compared with $1.1 million in 2005, an increase of $15.4 million. Losses in both periods are related to the repurchase of our Mexican Yankee bonds.
(Loss) Gain on derivative instruments
Loss on derivative instruments in 2007 was $73.7 million, compared with a loss of $11.6 million in 2006. Gain or losses on copper and other metal derivatives are included in the net sales line and gain or losses on gas derivatives are included in the cost of sales line of the consolidated combined statement of earnings. The (loss) gain on derivative instruments in 2007 and 2006 includes $81.0 million and $11.6 million of loss on the embedded derivatives on short-term investment, respectively. Also the 2007 (loss) gain on derivative instruments includes $1.3 million of loss on dual currency notes and gain of $8.6 million in exchange rate derivatives US dollar/Mexican peso. For a further discussion please see Note 3 Short-term Investments and Note 16 Derivative Instruments to our Consolidated Combined Financial Statements.
Other income (expense)
Other income in 2007 was $30.8 million, compared with an expense of $0.3 million in 2006. The increase in income is primarily attributable to $12.4 million of gain on the sale of an inactive Mexican subsidiary, $3.0 million of lower cost of disposal of assets, and $10.5 million of lower miscellaneous expenses.
Income taxes in 2007 were $1,185.3 million and include $1.153.8 million of Peruvian and Mexican income taxes and $31.5 for U.S. Federal and state income taxes. Income taxes in 2006 were $959.1 million and included $940.3 million of Peruvian and Mexican income taxes and $18.8 million for U.S. Federal and state income taxes. US income taxes are primarily attributable to investment income and limitations placed on the use of available tax credits (both foreign tax credits and the minimum tax credit).
The increase of $226.2 million or 23.6% was primarily due to $405.8 million of higher pretax income. The effective tax rate for 2007 was 34.7%, compared with 31.9% in 2006. The increase in the effective tax rate is largely due to the incremental U.S. tax on dividend income. The dividend income eliminates in financial consolidation (book income) but it is 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.
Minority interest in 2007 was $10.2 million compared with $9.3 million in 2006, an increase of $0.9 million or 10.0%. This increase is the result of higher earnings.
Our net earnings in 2007 were $2,216.4 million, compared with $2,037.6 million in 2006, an increase of $178.8 million or 8.8%. Net earnings increased as a result of the factors described above.
Segment Operating Income Information â€” 2007 vs.2006:
Net sales at our Peruvian operations in 2007 were $3,512.9 million, compared with $3,215.4 million in 2006, an increase of $297.5 million. This increase was principally due to increases in the sales price of copper and molybdenum. The LME copper price was 5.9% higher in 2007 (the majority of sales of our Peruvian operationsâ€™ copper is priced on LME) and the molybdenum price was 22.7% higher. Additionally in 2007 copper and molybdenum sales volume increased by 2.5 million pounds and 1.3 million pounds, respectively. Net sales in 2007 include a gain on copper derivatives of $5.5 million compared with a loss of $162.3 million in 2006.
Operating costs and expenses at our Peruvian operations in 2007 were $1,541.2 million, compared with $1,383.4 in 2006, an increase of $157.8 million principally due to higher cost of sales and higher depreciation, amortization and depletion. The increase in cost of sales (exclusive of depreciation, amortization and depletion) of $117.8 million was principally the result of higher labor cost of $26.6 million due to increase in salaries and exchange rate effect, $9.6 million of higher fuel and power cost, $37.4 million of higher freight and selling cost mainly due to the sale of concentrates and $16.8 million of inventory consumption. The increase in depreciation, amortization of depletion of $24.4 million is mainly due to the newly activated Ilo smelter modernization project which represents an additional charge of $21.7 million.
Operating income in 2007 was $1,971.7 million, compared with $1,832.0 million in 2006, an increase of $139.7 million. The operating income increased as a result of the factors described above.
Net sales from our Mexican open-pit operations in 2007 were $2,225.1 million, compared with $1,987.1 million in 2006, an increase of $238.0 million or 12.0%. This improvement is the result of the higher molybdenum volume, produced and sold in 2007 and the higher sales price for the molybdenum. Sales of molybdenum, produced by our La Caridad mine increased from 5.5 million pounds in 2006 to 13.6 million pounds in 2007. Significant production and sales of molybdenum were lost in 2006 as La Caridad had a lengthy strike in the first half of the year. This increase, from molybdenum sales, was reduced by the decrease in volume of copper sales, due principally to a strike at the Cananea mine. In addition, n et sales in 2007 included a gain on copper derivatives of $5.5 million compared with a loss of $113.9 million in 2006.
Operating cost and expenses at our Mexican open-pit operations in 2007 were $954.4 million compared with $1,067.3 million in 2006, a decrease of $112.9 million or 10.6%. This decrease was principally the result of lower cost of sales net of higher depreciation, amortization and depletion. The decrease in cost of sales (exclusive of depreciation, amortization and depletion) of $131.9 million was principally the effect of the Cananea strike, which began on July 30, 2007 and continued through the end of 2007. An increase in depreciation, amortization and depletion of $16.6 million in 2006 was principally due to higher amortization of capitalized leach material due to increased amounts capitalized in 2006.
Operating income in 2007 was $1,270.7 million, compared with $919.8 million in 2006, an increase of $350.9 million or 38.1%. The operating income increased as a result of the factors described above.
Net sales at our IMMSA unit in 2007 were $680.7 million, compared with $702.5 million in 2006, a decrease of $21.8 million or 3.1%. The decrease was principally due to lower sales volume caused by strikes at the Taxco and San Martin mines and lower zinc prices partially offset by higher sales prices in 2007 for copper and silver. Net sales in 2006 include a loss on zinc derivatives of $0.2 million.
Operating costs and expenses at our IMMSA unit were $434.3 million in 2007, compared with $405.2 million in 2006, an increase of $29.1 million or 7.2%. This increase was principally the result of higher cost of sales (exclusive of depreciation, amortization and depletion) and higher depreciation, amortization and depletion. The increase in cost of sales (exclusive of depreciation, amortization and depletion) of $15.8 million, was principally the result of $12.0 million of higher fuel and power cost, $1.7 million of higher water cost due to increase in water rates and $3.2 million of other operating cost. These increases were partially offset by $0.9 million of lower metal purchased from third parties. The increase in depreciation,
amortization and depletion of $9.1 million is mainly due to the accelerated depreciation of the processing plant equipment at Pasta de Conchos over the remaining mineral located in the open pit after the mine accident .
Operating income in 2007 was $246.4 million, compared with $297.3 million in 2006, a decrease of $50.9 million or 17.1%. The operating income decreased as a result of the factors described above.
Intersegment Eliminations and Adjustments
The net sales, operating costs and expenses and operating income discussed above will not be directly equal to amounts in our consolidated combined statement of earnings because the adjustments of intersegment operating revenues and expenses must be taken into account. Please see Note 20 to our consolidated combined financial statements.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
RESULTS OF OPERATIONS
Net cash provided by operating activities was $728.3 million in the third quarter of 2007, compared with $522.6 million in the 2006 period. The increase of $205.7 million was due to an increase in net earnings of $106.3 million mainly due to higher molybdenum and silver prices and higher molybdenum sales volume; $ 37.5 million of lower capitalized leachable material due to the work stoppage at the Cananea mine; $13.8 million higher depreciation, amortization and depletion due to the capitalization of the Ilo smelter modernization project and the amortization of capitalized leachable material and $42.8 million of decrease in working capital mainly due to the increase in workersâ€™ participation and income tax provision due to higher earnings.
Net cash used in investing activities was $65.7 million in the third quarter of 2007 compared with $101.9 million in the third quarter of 2006 and included $72.1 million for capital expenditures and $6.2 million received on the redemption of bonds with a face value of $20.0 million. The capital expenditures included investments at our Peruvian operations of $24.5 million which included $12.7 million for four Komatzu trucks, $2.7 million for a new ball mill at the Cuajone concentrator, $4.4 million for the tailing disposal project, $1.9 million for the new PLS dams at Huanaquera project and $2.8 million for various other replacement expenditures. In addition, we spent $47.6 million for replacement assets at our Mexican operations, including, $9.6 million for the leachable ore crushing, transportation and stacking system project at Cananea, $3.4 million for the gas handling system in the smelter at La Caridad, $1.8 million for the PLS dams and leaching system at Cananea, $25.0 million for various other replacement expenditures at our Mexican open pit operations, $7.3 million for our IMMSA unit and $0.5 million for our Mexican corporate office. In the third quarter of 2006, cash used for investment activities was $101.9 million; this amount includes capital spending of $102.3 million, $30.9 million of which was spent in the Ilo smelter modernization project, $24.6 million for other replacement expenditures in Peru and $46.8 million for replacement expenditures at our Mexican operations, $34.1 million of which was for replacement equipment at our Mexican open pit operations and $12.7 million for our IMMSA unit.
Net cash used in financing activities in the third quarter of 2007 was $473.4 million, compared with $290.9 million in the third quarter of 2006. The third quarter of 2007 includes a dividend distribution of $471.1 million. The third quarter of 2006 includes a dividend distribution of $294.5 million and the repurchase by our Mexican operation of $2.0 million of Yankee bonds.