SOUTHERN PERU COPPER CORP/ - 10-Q Quarterly Report

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

2003
Second Quarter

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For Quarter Ended June 30, 2003

Commission file number 1-14066

SOUTHERN PERU COPPER CORPORATION
(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		13-3849074 (I.R.S. Employer Identification No.)
2575 East Camelback Rd. Phoenix, AZ (Address of principal executive offices)		85016 (Zip Code)
(602) 977-6500 Registrant's telephone number, including area code

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ý No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Act of 1934).

Yes ý No o

As of July 31, 2003, there were outstanding 14,111,187 shares of Southern Peru Copper Corporation common stock, par value $0.01 per share. There were also outstanding 65,900,833 shares of Southern Peru Copper Corporation Class A common stock, par value $0.01 per share.

Southern Peru Copper Corporation
and Subsidiaries

INDEX TO FORM 10-Q

		Page No.
Part I.	Financial Information:
Item 1.	Financial Statements (unaudited)
	Condensed Consolidated Statement of Earnings Three Months and Six Months ended June 30, 2003 and 2002	3
	Condensed Consolidated Balance Sheet June 30, 2003 and December 31, 2002	4
	Condensed Consolidated Statement of Cash Flows Three Months and Six Months ended June 30, 2003 and 2002	5
	Notes to Condensed Consolidated Financial Statements	6-12
Item 2 and 3.	Management's Discussion and Analysis of Financial Condition and Results of Operations and Quantitative and Qualitative Disclosure about Market Risk	13-20
Item 4.	Controls and procedures	21
Independent Accountants' Report		22
Part II.	Other Information:
Item 1.	Legal procedures	23
Item 4.	Submission of Matters to a Vote of Security Holders	23
Item 6.	Exhibits and Reports on Form 8-K	24
Signatures		25

Exhibit 15	—	Independent Accountants' Awareness letter
Exhibit 31.1	—	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 31.2	—	Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit 32.1	—	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
Exhibit 32.2	—	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Southern Peru Copper Corporation
and Subsidiaries

CONDENSED CONSOLIDATED STATEMENT OF EARNINGS
(Unaudited)

			3 Months Ended June 30,						6 Months Ended June 30,
			2003			2002			2003			2002
			(in thousands, except for per share amounts)
Net sales:
	Stockholders and affiliates		$	—		$	4,952		$	—		$	7,109
	Others			168,387			188,420			343,225			322,457

Total net sales				168,387			193,372			343,225			329,566

Operating costs and expenses:
	Cost of sales			102,653			124,652			217,337			214,914
	Administrative and other expenses			7,042			7,884			13,725			14,955
	Depreciation, amortization and depletion			18,497			16,288			36,369			32,509
	Exploration expense			2,280			2,109			3,155			3,408

		Total operating costs and expenses		130,472			150,933			270,586			265,786

		Operating income		37,915			42,439			72,639			63,780
Interest income				813			666			1,526			1,393
Other income (expense)				518			66			855			(10,151	)
Interest expense				(3,243	)		(3,245	)		(6,212	)		(8,256	)

Earnings before taxes on income, minority interest and cumulative effect of the change in accounting principle				36,003			39,926			68,808			46,766
Taxes on income				14,180			12,701			26,911			14,838
Minority interest of investment shares				177			413			390			523

Earnings before cumulative effect of the change in accounting principle				21,646			26,812			41,507			31,405
Cumulative effect of the change in accounting principle, net of income tax				—			—			1,541			—

Net earnings			$	21,646		$	26,812		$	39,966		$	31,405

Per common share amounts:
	Earnings before cumulative effect of the change in accounting principle		$	0.27		$	0.34		$	0.52		$	0.39
	Cumulative effect of the change in accounting principle, net of income tax			—			—			(0.02	)		—

	Net earnings—basic and diluted		$	0.27		$	0.34		$	0.50		$	0.39

	Dividends paid		$	0.11		$	0.04		$	0.21		$	0.11

	Weighted average common shares outstanding (Basic)			80,010			80,004			80,009			80,004

	Weighted average common shares outstanding (Diluted)			80,015			80,009			80,014			80,007

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

Southern Peru Copper Corporation
and Subsidiaries

CONDENSED CONSOLIDATED BALANCE SHEET
(unaudited)

				June 30, 2003		December 31, 2002
				(in thousands)
ASSETS
Current assets:
	Cash and cash equivalents			$	230,585	$	147,537
	Accounts receivable, net				59,441		60,345
	Inventories				88,905		91,880
	Other assets				18,037		11,110

		Total current assets			396,968		310,872
Net property					1,231,929		1,248,996
Capitalized mine stripping, net					197,740		181,558
Other assets					9,591		10,820

		Total Assets		$	1,836,228	$	1,752,246

LIABILITIES
Current liabilities:
	Current portion of long-term debt			$	55,000	$	—
	Accounts payable				39,461		39,377
	Accrued liabilities				64,003		61,417

		Total current liabilities			158,464		100,794

Long-term debt					294,043		299,043
Deferred income taxes					90,993		88,566
Other liabilities and reserves					15,150		14,792
Asset retirement obligation					5,080		—

		Total non-current liabilities			405,266		402,401

MINORITY INTEREST					7,628		7,676

STOCKHOLDERS' EQUITY
Common stock (a)					261,737		261,726
Retained earnings					1,003,133		979,649

			Total Stockholders' Equity		1,264,870		1,241,375

			Total Liabilities, Minority Interest and Stockholders' Equity	$	1,836,228	$	1,752,246

(a) Common shares: Authorized					34,099		34,099
Outstanding					14,109		14,108
	Class A common shares Authorized and outstanding				65,901		65,901

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

Southern Peru Copper Corporation
and Subsidiaries

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS
(unaudited)

			3 Months Ended June 30,						6 Months Ended June 30,
			2003			2002			2003			2002
			(in thousands)						(in thousands)
OPERATING ACTIVITIES
	Net earnings		$	21,646		$	26,812		$	39,966		$	31,405
	Cumulative effect of the change in accounting principle, net of income tax			—			—			1,541			—
	Adjustments to reconcile net earnings to net cash provided from operating activities:
		Depreciation, amortization and depletion		18,497			16,288			36,369			32,509
		Capitalized mine stripping		(10,338	)		(14,879	)		(19,242	)		(28,350	)
		Remeasurement (gain) loss		(29	)		(3,238	)		(2,074	)		(2,109	)
		Provision for deferred income taxes		3,995			486			7,439			1,201
		Minority interest of investment shares		177			413			390			523
	Cash provided from (used for) operating assets and liabilities:
		Accounts receivable		16,953			(29,487	)		919			(6,272	)
		Inventories		(4,231	)		12,159			2,975			603
		Accounts payable and accrued liabilities		7,409			4,900			2,482			3,723
		Other operating assets and liabilities		(6,900	)		17,270			(7,474	)		17,560

Net cash provided by operating activities				47,179			30,724			63,291			50,793

INVESTING ACTIVITIES
	Capital expenditures			(6,815	)		(22,840	)		(16,004	)		(50,353	)
	Sale (purchase) of marketable securities			—			16,632			—			—
	Sales of property			1			75			3			78

Net cash used in investing activities				(6,814	)		(6,133	)		(16,001	)		(50,275	)

FINANCING ACTIVITIES
	Debt repayment			—			—			—			(122,914	)
	Proceeds from borrowings			50,000			—			50,000			25,922
	Escrow (deposits) withdrawals on long-term loans			183			(55	)		183			6,936
	Dividends paid to common stockholders			(9,121	)		(1,466	)		(16,482	)		(4,172	)
	Distributions to minority interest			(72	)		(47	)		(183	)		(142	)
	Treasury stock transaction			—			—			11			3
	Investment shares purchased			(171	)		(201	)		(317	)		(330	)

Net cash provided from (used for) financing activities				40,819			(1,769	)		33,212			(94,697	)

Effect of exchange rate changes on cash				73			2,626			2,546			1,368

Increase (decrease) in cash and cash equivalents				81,257			25,448			83,048			(92,811	)
Cash and cash equivalents, at beginning of period				149,328			94,598			147,537			212,857

Cash and cash equivalents, at end of period			$	230,585		$	120,046		$	230,585		$	120,046

Supplemental disclosure of cash flow information:
Cash paid during the year for:
	Interest		$	5,145		$	5,187		$	8,555		$	9,459

	Income taxes		$	2,915		$	1,281		$	2,915		$	1,290

Supplemental schedule of noncash investing and financing activities:
	Accounts receivable from shareholders offset by dividends paid		$	—		$	1,734		$	—		$	4,933

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

Southern Peru Copper Corporation
and Subsidiaries

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

A.		In the opinion of Southern Peru Copper Corporation (the "Company", "Southern Peru" or "SPCC"), the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting only of normal recurring adjustments) necessary to present fairly the Company's financial position as of June 30, 2003 and the results of operations and cash flows for the three and six months ended June 30, 2003 and 2002. Certain reclassifications have been made in the financial statements from amounts previously reported. The condensed financial statements for the three and six months ended June 30, 2003 have been subjected to a review by a member firm of PricewaterhouseCoopers, the Company's independent public accountants, whose report dated July 15, 2003, is presented on page 22. The results of operations for the three and six-month periods are not necessarily indicative of the results to be expected for the full year. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's 2002 annual report on Form 10-K.
B.		Inventories were as follows: (in millions)

		June 30, 2003		December 31, 2002
Metals at lower of average cost or market:
	Finished goods	$	1.6	$	1.7
	Work-in-process		46.0		45.0
Supplies at average cost, net of reserves			41.3		45.2

Total inventories		$	88.9	$	91.9

C.		At June 30, 2003, the Company has recorded sales of 3.2 million pounds of molybdenum at an average provisional price of $5.37 per pound. These sales are subject to final pricing based on the average monthly Dealer Oxide molybdenum prices in the month of settlement, which will occur in the third quarter of 2003. It is the opinion of management that the final pricing of these sales will not have a material effect on the Company's financial results.
D.		Ore Reserves: Effective January 1, 2003, the Company recalculated its ore reserve estimates using a 76 cents per pound copper price assumption, the three-year average copper price according to COMEX, and current cost assumptions. Ore reserve calculations for 2002 and recent prior years were calculated based on 90 cents per pound copper price assumption, which represented the Company's long-term outlook for copper price. The Company understands that the Securities and Exchange Commission (SEC) has recently stated that in calculating ore reserves companies should use no more than a three-year average copper price. The Company, therefore, has made this change to comply with the SEC directive.

		Southern Peru uses its ore reserve estimates in determining the amount of mine stripping capitalized, units of production amortization of capitalized mine stripping and depletion of mineral land. As a result of the change in ore reserves the amount of capitalized mine stripping on the balance sheet at June 30, 2003 was decreased by $1.3 million; and on the Company's statement of earnings, reported depreciation, amortization and depletion have increased by $0.1 million and $0.2 for the second quarter of 2003 and the first six months of 2003, respectively. Operating income decreased by $0.7 million and $1.5 million for the second quarter of 2003 and the first six months of 2003, respectively.
E.		Taxes on Income: As a large corporation, the Company is regularly audited by the Federal, state and foreign tax authorities. All of these audits can result in proposed assessments. Among current audits, the Internal Revenue Service (IRS) has completed the fieldwork phase of their audit of the Company for the years 1994 through 1996. In September 2002, the IRS issued a Preliminary Notice of Proposed Adjustment, which among other things challenged the Company's method of valuation of leach dumps. The Company filed a protest with the Appeals office of the IRS in December 2002 and has commenced negotiations with the IRS concerning the resolution of this matter.
		In prior years, the Company received assessments from SUNAT (the Peruvian tax department) for years 1996 to 1999, in which several deductions taken were disallowed. SUNAT has challenged the Company's depreciation method, the deduction of certain interest expense and other expenses related to charges incurred outside of Peru. The Company appealed these assessments. In February 2003, the Peruvian tax court affirmed SUNAT's assessments related to the 1996 and 1997 tax years in which the Company's method for deducting depreciation expense for tax purposes, and the deduction of certain expenses incurred outside Peru were challenged; thereby rejecting the Company's appeals in connection with such assessments. The Peruvian tax court indicated that it will not assess penalties related to the 1997 tax year. However, penalties related to the tax years 1996, 1998 and 1999 may be assessed depending on the outcome of the Company's appeal.
		In view of the decision of the Peruvian tax court regarding SUNAT'S assessment for 1996 and 1997, the Company has withdrawn its challenge of similar assessments made by SUNAT for the 1998 and 1999 tax years.
		Accordingly, in the first six months of 2003 the Company recorded a charge to worker's participation, (included in cost of sales on the statement of earnings) and income tax expense of $0.5 million and $4.7 million respectively, to recognize the cost of these assessments. The Company continues to appeal the portion of assessments related to the disallowance of interest deductions and the penalties associated with these assessments. Company management believes that it will prevail in this appeal.
		It is the opinion of management that the outcome of these matters will not materially adversely affect the financial position, results of operations or cash flows of the Company and its consolidated subsidiaries. However, it is possible that these matters could have a material effect on the Company's quarterly or annual financial position, operating results or cash flows when they are resolved in future periods.

F.		Debt and Available Credit Facilities: On April 25, 2003, the Company sold, to investors in Peru, $25 million of bonds with maturities ranging from January 2005 to April 2010. These bonds have an interest rate of LIBOR plus 2.375 percent and are the fifth issuance under a $750 million bond program. Continuing with this program, on May 15, 2003, the Company sold an additional $25 million of bonds with maturities ranging from February 2005 to May 2010. These bonds have an interest rate of LIBOR plus 2.3125 percent and are the sixth issuance under the bond program. Total issuances under this program now total $199 million.
G.		Related Party Transaction: As of June 30, 2003, the Company had an overdue receivable of $5.0 million from Americas Sales Corp. (ASC), for sales of copper products made in 2002 at market prices and with customary terms. ASC is a subsidiary of Grupo Mexico, the majority (54.2%) indirect stockholder of the Company. Grupo Mexico has guaranteed payment of this receivable and the unpaid balance accrues interest.
H.		Commitments and Contingencies: In 1997, the Company sold its existing power plant to an independent power company, Enersur S.A., for $33.6 million. In connection with the sale, a power purchase agreement was also completed, under which the Company agreed to purchase its power needs for twenty years commencing in 1997.
		In March 2003, the Company agreed to amend the power purchase agreement, resolving certain issues that arose between the parties and reducing power costs for the remaining life of the agreement. A new contract, documenting this agreement, was executed in June 2003. The new agreement frees Enersur S.A. from the obligation to construct additional capacity upon notice to meet the Company's increased electricity requirements from the planned expansion and modernization. SPCC can satisfy the need for increased electricity requirements from other sources, including local power providers.
		Environmental: The Company's activities are subject to Peruvian laws and regulations. As part of these regulations, SPCC submitted in 1996 the Environmental Compliance and Management Program (known by its Spanish acronym, PAMA) to the Peruvian Government. The PAMA applied to all current operations that did not have an approved environmental impact study at the time. SPCC's PAMA was approved in January 1997 and it contains 34 mitigation measures and projects necessary to bring the existing operations to the environmental standards established by the government. By the end of 2002, thirty-one of such projects were already completed. Additionally, in November of 2002 the government approved final completion of all PAMA commitments related to the Company's operations in Cuajone and Toquepala. The three pending PAMA projects all belong to the Ilo smelter operations.
		The Company's biggest outstanding capital investment project is the Ilo smelter expansion and modernization. This project will modernize the smelter and is targeted to capture no less than 92 percent of sulfur dioxide emissions, in compliance with PAMA requirements.

		The Company's PAMA, approved by the Peruvian Ministry of Energy and Mines ("MEM") in 1997, provided that the smelter would be modernized in a two-phase project; the first phase to be completed by the end of 2003 and the second and final phase by January 2007. In January 2002 the MEM approved the modified one-phase project to be initiated by the fourth quarter of 2002 and completed by December 2004. Given current economic, political and market conditions, in November 2002, the Company submitted a new request to MEM to reschedule the smelter modernization timetable and to start the project by the end of 2003, with completion no later than 2007.
		On February 28, 2003, MEM communicated its rejection to the Company's request to reschedule the smelter modernization timetable, stating that once the Company has taken effective action to implement the project and can demonstrate the commencement of the same, SPCC would have the right to apply for the rescheduling of the smelter modernization timetable.
		In March 2003, in a separate regular biannual environmental review process of SPCC's mining activities, MEM issued a notice to the Company demanding compliance with the commitments established in the PAMA within the next 90 days. MEM's notice orders the Company to commence the modernization project and to satisfy the investment requirements of the PAMA of $77.4 million within such 90-day period. According to applicable law, the Company has been subject to a first fine of approximately $20,000. Subsequent fines (subject to 90-day periods) would be based on the shortfall of actual expenditures against expenditures committed under the PAMA, as modified. The Company does not believe the amount of fines paid will be material to its financial position, results of operations or cash flows in future periods. The Company is confident that it will be able to resolve these issues with MEM and has given MEM assurances that it intends to comply fully with its commitments under PAMA.
		In June 2003 the Company hired an independent consulting firm to review and evaluate the six proposals received for the smelter modernization. The firm has already presented their report and SPCC has awarded the contract for the project to Flour-Xstrata.
		The selected proposal meets with SPCC's requirements, which are the use of proven technology (the ISASMELT from Australia), that will not only provide good economic returns but also comply with the current environmental regulations. It is estimated that the construction of the project will take no more than 36 months and it will be completed before January 2007, the original deadline established in the PAMA.
		The cost of the project was previously estimated to exceed $600 million, but has not been finalized pending the completion of the basic engineering by Flour-Xstrata. The approximate value of this project is estimated to be $306 million.
		The Company has on hand sufficient funds to commence the project but significant additional funds will be necessary for its completion. The Company has an approved Peruvian bond program of $750 million, of which $199 million have been issued. There can be no assurance that the entire Ilo smelter project can be financed with Peruvian resources. The Company plans to finance the portion of the cost that is not financed in Peru with funds from operations or by placing additional financing in the international market.

		Environmental capital expenditures for the period 1997-2002 exceeded $148 million. As soon as the smelter expansion and modernization project begins, the Company foresees significant environmental capital expenditures starting in 2003. Approximately $55 million have been budgeted for the smelter project in 2003.
		In addition, the Company expects that MEM will issue new regulations during 2003 that will set forth the legal guidelines for the mining sectors remediation obligations. The Company has no basis for determining the possible effect of these pending regulations. However, material capital expenditures may be required to achieve compliance with these new regulations.
		Litigation: In April 1996, the Company was served with a complaint filed in Peru by approximately 800 former employees seeking the delivery of a substantial number of investment shares (formerly called "labor shares") of its Peruvian Branch plus dividends. In December 1999, a civil court of the first instance of Lima decided against the Company, ordering the delivery of the investment shares and dividends to the plaintiffs. The Company appealed this decision in January 2000. On October 10, 2000, the Superior Court of Lima affirmed the lower court's decision, which had been adverse to the Company. On appeal by the Company, the Peruvian Supreme Court annulled the proceeding noting that the civil courts lacked jurisdiction and that the matter had to be decided by a labor court. The case is now pending before a labor court of first instance in Lima.
		In August 2002, the Company was notified that approximately 3,000 additional former employees had filed a lawsuit before a labor court in Lima, for unspecified amounts, seeking the delivery of a substantial number of investment shares. The labor court dismissed the complaint due to procedural defects. On appeal by the plaintiffs, the Superior Court of Lima allowed the claims to proceed and remanded the case to the lower court for further proceedings. In April 2003 the lower court dismissed the case due to procedural defects.
		On December 28, 2000, a lawsuit styled Flores vs. Southern Peru Copper Corporation was filed against the Company in federal court in New York City. The Flores lawsuit sought unspecified compensatory and punitive damages for alleged personal injuries to eight persons resident in Peru arising from alleged releases into the environment from the Company's operations in Peru. The lawsuit invoked the jurisdiction of the court under the federal Alien Tort Claims Act, claiming violations of customary international law. The Flores lawsuit is similar to a suit filed in 1995 in Texas, for unspecified amounts, which was dismissed in 1996 by a U. S. district judge. That ruling was affirmed unanimously by a three-judge federal appeals court. The court made it clear that the claims of Peruvian residents should be tried in the courts of Peru, not in the United States. On July 16, 2002, the United States District Court for the Southern District of New York dismissed the complaint in the Flores lawsuit. In its decision, the district court ruled that it lacked jurisdiction under the Alien Tort Claims Act because the Peruvian plaintiffs had failed to allege a cognizable claim that international law had been violated. In the alternative, the district court stated that, even if it had jurisdiction, it nonetheless would dismiss the Flores lawsuit on the basis of the doctrine of forum non convenient, because the dispute should be litigated in the courts of Peru, not in the United States. On August 28, 2002, the Flores plaintiffs filed a notice of appeal to seek review of the district court decision by the United States Court of Appeals for the Second Judicial Circuit. The appeal is still pending.

		It is the opinion of management that the outcome of the aforementioned legal proceedings, as well as other miscellaneous litigation and proceedings now pending, will not have a material adverse effect on the financial position of the Company and its consolidated subsidiaries. However, it is possible that litigation matters could have a material effect on the Company's quarterly or annual operating results, when they are resolved in future periods.
H.		Impact of New Accounting Standards: Effective January 1, 2003, the Company adopted Statement of Financial Accounting Standards No. 143, "Accounting for Asset Retirement Obligations", which established standards for accounting for a legal obligation associated with the retirement of long-lived tangible assets. The Company has determined that a retirement obligation exists for a portion of its long-lived assets. These assets include a dam on the Torata River, close to the Company's Cuajone mine and the SX/EW facility. The cumulative effect of this change in accounting principle, net of taxes, was a charge to income of $1.5 million and is shown separately on the Company's consolidated statement of earnings. In addition, as part of this cumulative adjustme