How much did the Grasberg slippage affect 2003 and 2004 results, and when will production normalize?

The October 9, 2003 slippage and December 12 debris flow cut 2003 copper sales by about 233 million lbs (-15%) and mill throughput by 14%. Management expects to return to its key high-grade ore areas in Q2 2004. 2004 sales are guided to about 1.0 billion lbs of copper and 1.5 million oz of gold, with a significant portion in the second half, and 2005 sales are projected to rebound to 1.5 billion lbs and 2.9 million oz. Long-term mine plans and reserves are not expected to change, although some higher-grade ore was deferred, mostly into 2005. Insurance coverage is uncertain and subject to a deductible of roughly $40 million.

What is the company's debt and liquidity position after 2003?

Total debt, including preferred stock classified as debt, was $2.23 billion at year-end 2003, down from $2.04 billion in 2002 after accounting for conversions. Major 2003 actions included issuing $500 million of 10 1/8% senior notes due 2010 and $575 million of 7% convertible notes due 2011, refinancing the bank facilities, and redeeming gold-denominated preferred stock. In January 2004, FCX issued $350 million of 6 7/8% senior notes due 2014 and completed about $226 million of early conversions of its 8 1/4% convertible notes, leaving about $67 million outstanding. A $165 million revolving credit facility, expandable to $350 million, was in place. Operating cash flow of $572 million in 2003 is expected to fall to about $230 million in 2004 due to deferred sales and the Atlantic Copper turnaround.

Why is the effective tax rate so high at 58%?

Indonesian Contract of Work income is taxed at 35%, plus a 10% withholding tax on dividends and interest paid to the U.S. parent, and a 2% U.S. alternative minimum tax. FCX receives little tax benefit from parent company costs (interest, G&A) because it has no U.S. taxable income, and it receives no benefit from losses at Atlantic Copper because those losses cannot offset Indonesian profits. Foreign tax credits of $381 million are carried forward against a valuation allowance, so the deferred tax asset is largely reserved. As Indonesian profits grow relative to parent and smelter costs, the consolidated rate tends to fall.

What are the main political and contractual risks to the Indonesian operations?

All significant mining operations are in Papua under a Contract of Work that runs to 2021, with two 10-year extensions subject to government approval that cannot be unreasonably withheld. Management says about 48% of aggregate reserves will be mined before 2021, so the extensions matter for the back end of the reserve base. Separatist activity, the August 2002 ambush, and terrorist bombings in Bali and Jakarta create security risk, although operations were not interrupted. Indonesian officials have questioned the validity of pre-1999 contracts and have periodically raised environmental compliance issues, including a suggestion of a tailings pipeline. Insurance does not cover expropriation. The government has publicly committed to honoring existing contracts, and the company cites U.S. law that restricts aid to countries that expropriate U.S.-owned property.

What is the outlook for copper and gold prices and their effect on earnings?

Each $0.10/lb change in copper prices moves annual consolidated net income by about $70 million, and each $25/oz change in gold moves it by about $28 million, based on projected volumes of 1.34 billion lbs of copper and 2.2 million oz of gold. Copper rose from a 2003 range of $0.70–$1.05/lb to about $1.35/lb by early 2004, and gold traded between $320 and $417/oz in 2003. The company has no price protection contracts on mine production and is largely unhedged. Preferred stock redemptions indexed to gold and silver are carried as debt, and their values move with metal prices. Royalties are expected to rise to roughly $38–45 million in 2004 at higher copper prices.

FCX 10-K FY2003 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 10, 2004. Cited figures are marked; the original filing is the authoritative source.

Freeport-McMoRan Copper & Gold (FCX) closed 2003 with record consolidated revenues of $2.21 billion^a (up 16% from $1.91 billion) and operating income of $823 million (up 29%), driven by higher copper and gold price realizations and higher gold volumes.

Net income applicable to common stock rose to $154.2 million^b ($0.97 diluted EPS) from $127.1 million, though the result was held back by a $24.7 million SFAS 150 charge, $34.6 million of debt extinguishment losses, and a consolidated effective tax rate of 58%. Operating cash flow was $572 million, and the company reinitiated a dividend ($0.36 annualized, raised to $0.80 starting February 2004). The central risk for investors is operational.

An October 9, 2003 slippage in the Grasberg open pit killed eight workers, and a December 12 debris flow followed. PT Freeport Indonesia declared force majeure on concentrate deliveries, copper sales volumes fell 15%^c to 1.3 billion pounds, and mill throughput dropped 14%. Management expects a return to key ore areas in Q2 2004 and guides to roughly 1.0 billion pounds of copper and 1.5 million ounces of gold in 2004, with a much stronger 2005 (1.5 billion pounds and 2.9 million ounces).

Insurance recovery is uncertain, subject to a deductible of about $40 million^d. The balance sheet improved meaningfully, with stockholders' equity rising to $776 million from $267 million, largely through conversions of convertible preferred and notes into common stock.

Total debt remained high at $2.23 billion, and the company issued $350 million of 6 7/8% senior notes in January 2004 to refinance near-term maturities. Indonesian political and security risk, the Contract of Work's 2021 initial expiration, and the former auditor Arthur Andersen's situation remain relevant considerations.

02—Key points

Key Highlights

Record consolidated revenues of $2.21 billion in 2003, up 16% from $1.91 billion, on higher copper ($0.82/lb realized, vs. $0.71) and gold ($366.60/oz, vs. $311.97) prices.
Operating income rose 29% to $823.3 million; net income applicable to common stock was $154.2 million, or $0.97 per diluted share, versus $0.87 in 2002.
Grasberg open-pit slippage (Oct. 9, 2003, eight fatalities) and Dec. 12 debris flow cut copper sales 15% to 1.3 billion lbs and mill throughput 14% to 203,000 tons/day; force majeure was declared on concentrate deliveries.
Record-low net cash production cost of $(0.02)/lb of copper in 2003 (vs. $0.08 in 2002), aided by high gold credits; FCX is positioned as one of the lowest-cost copper producers globally.
Debt of $2.23 billion remains high, but the 2004 maturities of $154 million were pre-funded by the $350 million 6 7/8% senior notes issued in January 2004; equity rose to $776 million from $267 million through preferred and note conversions.
Dividend policy reinstated in 2003 at $0.09/quarter and increased to $0.20/quarter ($0.80 annualized) effective February 2004.
Reserves of 54.4 billion lbs copper and 60.4 million oz gold (aggregate); FCX equity share 36.0 billion lbs and 42.2 million oz, with no change in reserves at adjusted metal prices; Rio Tinto holds about 13% of common stock.

03—Questions

Frequently Asked Questions

How much did the Grasberg slippage affect 2003 and 2004 results, and when will production normalize?
The October 9, 2003 slippage and December 12 debris flow cut 2003 copper sales by about 233 million lbs (-15%) and mill throughput by 14%. Management expects to return to its key high-grade ore areas in Q2 2004. 2004 sales are guided to about 1.0 billion lbs of copper and 1.5 million oz of gold, with a significant portion in the second half, and 2005 sales are projected to rebound to 1.5 billion lbs and 2.9 million oz. Long-term mine plans and reserves are not expected to change, although some higher-grade ore was deferred, mostly into 2005. Insurance coverage is uncertain and subject to a deductible of roughly $40 million.
What is the company's debt and liquidity position after 2003?
Total debt, including preferred stock classified as debt, was $2.23 billion at year-end 2003, down from $2.04 billion in 2002 after accounting for conversions. Major 2003 actions included issuing $500 million of 10 1/8% senior notes due 2010 and $575 million of 7% convertible notes due 2011, refinancing the bank facilities, and redeeming gold-denominated preferred stock. In January 2004, FCX issued $350 million of 6 7/8% senior notes due 2014 and completed about $226 million of early conversions of its 8 1/4% convertible notes, leaving about $67 million outstanding. A $165 million revolving credit facility, expandable to $350 million, was in place. Operating cash flow of $572 million in 2003 is expected to fall to about $230 million in 2004 due to deferred sales and the Atlantic Copper turnaround.
Why is the effective tax rate so high at 58%?
Indonesian Contract of Work income is taxed at 35%, plus a 10% withholding tax on dividends and interest paid to the U.S. parent, and a 2% U.S. alternative minimum tax. FCX receives little tax benefit from parent company costs (interest, G&A) because it has no U.S. taxable income, and it receives no benefit from losses at Atlantic Copper because those losses cannot offset Indonesian profits. Foreign tax credits of $381 million are carried forward against a valuation allowance, so the deferred tax asset is largely reserved. As Indonesian profits grow relative to parent and smelter costs, the consolidated rate tends to fall.
What are the main political and contractual risks to the Indonesian operations?
All significant mining operations are in Papua under a Contract of Work that runs to 2021, with two 10-year extensions subject to government approval that cannot be unreasonably withheld. Management says about 48% of aggregate reserves will be mined before 2021, so the extensions matter for the back end of the reserve base. Separatist activity, the August 2002 ambush, and terrorist bombings in Bali and Jakarta create security risk, although operations were not interrupted. Indonesian officials have questioned the validity of pre-1999 contracts and have periodically raised environmental compliance issues, including a suggestion of a tailings pipeline. Insurance does not cover expropriation. The government has publicly committed to honoring existing contracts, and the company cites U.S. law that restricts aid to countries that expropriate U.S.-owned property.
What is the outlook for copper and gold prices and their effect on earnings?
Each $0.10/lb change in copper prices moves annual consolidated net income by about $70 million, and each $25/oz change in gold moves it by about $28 million, based on projected volumes of 1.34 billion lbs of copper and 2.2 million oz of gold. Copper rose from a 2003 range of $0.70–$1.05/lb to about $1.35/lb by early 2004, and gold traded between $320 and $417/oz in 2003. The company has no price protection contracts on mine production and is largely unhedged. Preferred stock redemptions indexed to gold and silver are carried as debt, and their values move with metal prices. Royalties are expected to rise to roughly $38–45 million in 2004 at higher copper prices.

04—Continue

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