Why did SCCO's earnings increase in 2002 even though copper prices fell?

Net earnings rose 30% largely because molybdenum prices averaged $3.77 per pound in 2002 versus $2.36 in 2001, which added roughly $25 million to net sales. Silver prices also rose, and cost-cutting programs including a workforce reduction lowered administrative and production costs. Lower depreciation from a change in estimated asset useful lives and lower interest expense after debt prepayment also contributed. Copper's LME average fell to 71 cents from 72 cents, a modest decline that these gains more than offset.

What is the biggest financial risk facing SCCO in 2003?

The largest risk is the Ilo smelter modernization required under Peru's PAMA environmental program. MEM rejected the company's rescheduling request in February 2003 and issued a March 2003 notice demanding compliance within 90 days, with possible fines starting at about $20,000 and growing with each shortfall period. The project was previously estimated to cost over $600 million, has not been finalized, and will require financing beyond the Peruvian bond program, which has $149 million issued of a $750 million authorization. Management says it does not expect smelter closure and believes the fines will not be material, but the capital commitment is significant relative to the company's approximately $1.24 billion equity base.

How concentrated are SCCO's operations and what does that mean for investors?

Substantially all revenues come from the Toquepala and Cuajone mines, the SX/EW facility and the Ilo smelter and refinery, all located within a 48-kilometer radius in southern Peru. This concentration exposes the company to Peruvian economic and political conditions, currency fluctuations and inflation (the new sol), and changes in government regulation. Labor is also a factor: about 57% of the 3,575 employees are covered by labor agreements with nine unions, and a 14-day strike in the Toquepala area cost about 5 million pounds of copper output in the fourth quarter of 2002.

Does SCCO face material tax or legal exposure?

Management says pending matters will not materially affect financial position. Key items include a 2003 Peruvian tax court decision upholding SUNAT assessments for 1996 and 1997 on depreciation and offshore expense deductions, with possible further penalty assessments for 1996, 1998 and 1999. The U.S. IRS has also challenged the valuation method for leach dumps for 1994 to 1996, and the company has filed a protest. Labor litigation by former employees seeking investment shares, involving roughly 800 plaintiffs in the original case and about 3,000 more added in 2002, remains pending. Management acknowledges these could affect quarterly or annual results when resolved.

What changes in ownership and auditors were disclosed?

ASARCO's subsidiary Southern Peru Holdings Corporation held 54.2% of the company at year-end 2002, with Cerro Trading Company at 14.2% and Phelps Dodge Overseas Capital at 14.0%. ASARCO was contemplating a transaction to sell that stake to its parent, Americas Mining Corporation, which might close before the filing. Deloitte & Touche audited 2002, replacing Arthur Andersen in April 2002. On March 14, 2003, the Audit Committee dismissed Deloitte & Touche and appointed PricewaterhouseCoopers for 2003, subject to shareholder ratification at the May 8, 2003 annual meeting. Management reported no disagreements with either firm.

SCCO 10-K FY2002 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 31, 2003. Cited figures are marked; the original filing is the authoritative source.

Southern Peru Copper Corporation (SCCO, NYSE: PCU) reported 2002 net earnings of $60.6 million^a, or $0.76 per diluted share, up about 30% from $46.6 million ($0.58) in 2001, with net sales of $664.6 million versus $657.5 million.

The improvement was driven mainly by higher molybdenum and silver prices, which offset slightly lower copper prices and volumes, along with cost reductions. Operating break-even cost fell 3.7 cents per pound to 45.6 cents, and total copper output rose 1.2% to 764 million pounds. Interest expense dropped sharply after the company prepaid $121 million^b of debt in early 2002, though the prepayment triggered an $11.4 million penalty and an $8.5 million after-tax extraordinary loss.

Cash, marketable securities and total debt fell to $148 million^c and $299 million respectively, leaving the balance sheet less levered, with debt at 19.3% of total capitalization. The most material risk for investors is the Ilo smelter modernization. Peru's Ministry of Energy and Mines (MEM) rejected the company's request to reschedule the project in February 2003, and in March 2003 issued a 90-day notice requiring compliance with the PAMA environmental commitments, including $77.4 million of investment.

The project's cost was previously estimated above $600 million^d and has not been finalized, with only $63 million spent through 2002 and capital expenditures planned at about $194 million for 2003. Financing will rely partly on the Peruvian bond program and partly on international markets. Other exposures include Peruvian tax assessments from SUNAT, a pending IRS challenge on leach dump valuation, labor litigation involving former employees' investment shares, and heavy concentration of operations in southern Peru.

The company also disclosed a change in auditors to PricewaterhouseCoopers and a move by the controlling holder to transfer SPCC's stock to a subsidiary of Americas Mining Corporation. For investors, the story combines improved near-term profitability and a stronger balance sheet with a sizable, uncertain capital commitment and regulatory pressure on the smelter. Copper prices, which averaged 71 cents per pound on the LME in 2002, remain the dominant driver of earnings, and management estimates that each one-cent change in copper price moves annual earnings by about $0.06 per share.

02—Key points

Key Highlights

Net earnings rose 30% to $60.6 million ($0.76 per diluted share) in 2002 from $46.6 million ($0.58) in 2001, driven by higher molybdenum and silver prices and cost reductions.
Copper production increased 1.2% to 764 million pounds, with record Ilo refinery cathode output of 621 million pounds, despite a 5 million pound loss from a fourth-quarter strike at Toquepala.
Operating break-even cost fell to 45.6 cents per pound from 49.3 cents, a 7.5% improvement.
Toquepala concentrator expansion was completed in September 2002 at $66.3 million versus a $69.5 million budget, lifting milling capacity from 45,000 to 60,000 tons per day.
Debt was reduced to $299 million from $396 million after a $121 million early prepayment, lowering debt to 19.3% of total capitalization from 24.5%; cash fell to $147.5 million.
Major regulatory risk: MEM rejected the request to reschedule the Ilo smelter modernization and in March 2003 demanded compliance within 90 days, with a PAMA investment requirement of $77.4 million and a previous project cost estimate above $600 million.
Earnings are highly sensitive to commodity prices: a $0.01 change in copper price moves annual EPS by about $0.06, while a $1.00 change in molybdenum moves it by $0.14.

03—Questions

Frequently Asked Questions

Why did SCCO's earnings increase in 2002 even though copper prices fell?
Net earnings rose 30% largely because molybdenum prices averaged $3.77 per pound in 2002 versus $2.36 in 2001, which added roughly $25 million to net sales. Silver prices also rose, and cost-cutting programs including a workforce reduction lowered administrative and production costs. Lower depreciation from a change in estimated asset useful lives and lower interest expense after debt prepayment also contributed. Copper's LME average fell to 71 cents from 72 cents, a modest decline that these gains more than offset.
What is the biggest financial risk facing SCCO in 2003?
The largest risk is the Ilo smelter modernization required under Peru's PAMA environmental program. MEM rejected the company's rescheduling request in February 2003 and issued a March 2003 notice demanding compliance within 90 days, with possible fines starting at about $20,000 and growing with each shortfall period. The project was previously estimated to cost over $600 million, has not been finalized, and will require financing beyond the Peruvian bond program, which has $149 million issued of a $750 million authorization. Management says it does not expect smelter closure and believes the fines will not be material, but the capital commitment is significant relative to the company's approximately $1.24 billion equity base.
How concentrated are SCCO's operations and what does that mean for investors?
Substantially all revenues come from the Toquepala and Cuajone mines, the SX/EW facility and the Ilo smelter and refinery, all located within a 48-kilometer radius in southern Peru. This concentration exposes the company to Peruvian economic and political conditions, currency fluctuations and inflation (the new sol), and changes in government regulation. Labor is also a factor: about 57% of the 3,575 employees are covered by labor agreements with nine unions, and a 14-day strike in the Toquepala area cost about 5 million pounds of copper output in the fourth quarter of 2002.
Does SCCO face material tax or legal exposure?
Management says pending matters will not materially affect financial position. Key items include a 2003 Peruvian tax court decision upholding SUNAT assessments for 1996 and 1997 on depreciation and offshore expense deductions, with possible further penalty assessments for 1996, 1998 and 1999. The U.S. IRS has also challenged the valuation method for leach dumps for 1994 to 1996, and the company has filed a protest. Labor litigation by former employees seeking investment shares, involving roughly 800 plaintiffs in the original case and about 3,000 more added in 2002, remains pending. Management acknowledges these could affect quarterly or annual results when resolved.
What changes in ownership and auditors were disclosed?
ASARCO's subsidiary Southern Peru Holdings Corporation held 54.2% of the company at year-end 2002, with Cerro Trading Company at 14.2% and Phelps Dodge Overseas Capital at 14.0%. ASARCO was contemplating a transaction to sell that stake to its parent, Americas Mining Corporation, which might close before the filing. Deloitte & Touche audited 2002, replacing Arthur Andersen in April 2002. On March 14, 2003, the Audit Committee dismissed Deloitte & Touche and appointed PricewaterhouseCoopers for 2003, subject to shareholder ratification at the May 8, 2003 annual meeting. Management reported no disagreements with either firm.

04—Continue

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