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SCCO > SEC Filings for SCCO > Form 10-Q on 30-Apr-2013All Recent SEC Filings

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Form 10-Q for SOUTHERN COPPER CORP/


30-Apr-2013

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information that management believes is relevant to an assessment and understanding of the consolidated financial condition and results of operations of Southern Copper Corporation and its subsidiaries (collectively, "SCC", "the Company", "our", and "we"). This item should be read in conjunction with our interim unaudited Condensed Consolidated Financial Statements and the notes thereto included in this quarterly report. Additionally, the following discussion and analysis should be read in conjunction with the Management Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements included in Part II of our annual report on Form 10-K for the year ended December 31, 2012.

EXECUTIVE OVERVIEW

Business: 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, which we also produce and sell. Market forces outside of our control largely determine the sale prices for our products. Our management, therefore, focuses on value creation through copper production, cost control, production enhancement and maintaining a prudent capital structure to remain profitable. We endeavor to 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.

We are one of the world's largest copper mining companies in terms of production and sales with our principal operations in Peru and Mexico. We also have an active ongoing exploration program in Chile and in 2011 we started exploration activities in Argentina and Ecuador. In addition to copper we produce significant amounts of other metals, either as a by-product of the copper process or in a number of dedicated mining facilities in Mexico.

Outlook: Various key factors will affect our outcome. These include, but are not limited to, some of the following:

Changes in copper and molybdenum prices. The average copper price was $3.60 per pound in the first quarter of 2013 about 4.5% lower than in the first quarter of 2012. Average molybdenum and silver prices in the first quarter of 2013 decreased 20% and 8.1%, respectively, from average prices in the first quarter of 2012. During the first quarter of 2013 per pound LME spot copper prices ranged from $3.42 to $3.74 and averaged $3.60, as compared to an average of $3.59 in the last quarter of 2012. The LME spot price for copper closed at $3.44 per pound on March 28, 2013.

Sales structure. In the first quarter of 2013 approximately 77% of our revenue came from the sale of copper, 6% from molybdenum, 8% from silver and 9% from various other products, including zinc, gold and other materials.

Metals market. Regarding the copper market, even though we believe this metal's fundamentals are sound; its price has been affected by concerns about Chinese growth, LME stock increases and macroeconomic worries related to the U.S. fiscal deficit and Europe's debt crisis. Of these factors, the increments in the LME and other warehouses inventories are creating some concerns regarding the copper market balance. We believe this is part of the commodities cycle and a temporary event. We expect in the following quarters a recovery of demand, particularly from Asia, which currently represents approximately 60% of the world demand.

Regarding China, its gross domestic product ("GDP") is growing at almost 8% per year. Generally speaking, due to its urbanization process, China's GDP growth produces a growth in copper demand higher than its GDP growth rate. We expect this trend to restart in the next few quarters as China ends its destocking phase.

In the United States demand appears to be stronger as consumer confidence has increased and the economy is recovering. This has been reinforced by positive news related to new housing starts, the recovery of the car industry and decreases in the unemployment rate. This good news has somehow offset macroeconomic concerns related to the U.S. fiscal balance.

Even though the United States represents today only about 8% of the world demand for refined copper, the recovery of its economy is key to copper demand since the United States is the most important secondary copper consumer, effecting copper demand in other economies.


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On the supply side, we think that several structural factors, such as labor stoppages, technical problems and other issues are affecting and will continue to affect copper supply, reducing the impact of production coming from new projects and expansions. As a consequence of this, copper inventories should move to a more balanced market or even to one with some moderate undersupply.

We believe that, if the world's economies continue to improve, we are positioned to take advantage of the positive future outlook of the copper market, through our aggressive investment program of organic growth, aimed at increasing production from our current capacity of 650,000 tons to 1.2 million tons by 2017.

Molybdenum. we saw a 2.6% molybdenum demand growth in 2012, which helped to reduce the surplus of supply to demand from approximately 8% to 6%. We expect that in 2013 the balance between supply and demand will continue reducing the market surplus, thereby improving molybdenum prices in the near future.

Silver. we believe that silver prices will have strong support due to its industrial uses as well as being perceived as a value shelter in times of economic uncertainty.

Zinc. we also believe that zinc has very good long term fundamentals due to its significant industrial consumption; however, inventories are currently at a relatively high level, which tends to maintain a relatively weak zinc price.

Production. We maintain our 2013 production guidance of 650,000 tons of copper, which includes approximately 3% of copper purchased from third parties. We expect molybdenum production in 2013 to be about 19,800 tons. Additionally, in 2013 we expect to produce and sell 16.3 million ounces of silver and produce 99,100 tons of zinc.

Capital Expenditures. In the first quarter 2013, we spent $316.8 million on capital expenditures, 78.5% higher than in the first quarter 2012, which represents 63.9% of net income. Our current plans aim to increase copper production by approximately 84% by 2017.

KEY MATTERS:

We discuss below several matters that we believe are important to understand our results of operations and financial condition. These matters include, (i) our earnings, (ii) our production, (iii) our "operating cash costs" as a measure of our performance, (iv) metal prices, (v) business segments, (vi) the effect of inflation and other local currency issues, and (vi) our capital investment and exploration program.

Earnings: Net sales and net income in the first quarter 2013 were lower than the first quarter of 2012 by $182.9 million and $126.0 million, respectively. These decreases were mainly the result of lower prices for copper and our main by-products and lower sales volume of copper (-4.3%) and zinc (-4.9%), partially offset by higher molybdenum (+5.8%) and silver (+9.5%) sales volume in the 2013 period.

We strongly believe that our Company's best potential for growth and enhancement of shareholder value is in copper, which currently represents about 80% of our sales. With stable, low-cost and growing production from our existing mines and continued success in advancing our growth pipeline, we are optimistic that we will see a period of sustained high performance for our Company in 2013 and beyond, if the world's economies continue to improve. A good example of this is the expansion of our Buenavista unit, where our projects should increase its production capacity from 180,000 tons to 488,000 tons of copper by 2015.

The table below highlights key financial and operational data of our Company for the three months ended March 31, 2013 and 2012:

                                                    Three months ended March 31,
                                                  2013          2012        Variance
Net sales (in millions)                        $    1,623    $    1,806    $     (183 )
Net income attributable to SCC (in millions)   $      495    $      621    $     (126 )
Earnings per share                             $     0.59    $     0.73    $    (0.14 )
Dividends per share                            $     0.24    $     0.54    $    (0.30 )
Average LME copper price                       $     3.60    $     3.77    $    (0.17 )
Pounds of copper sold (in millions)                   345           360           (15 )


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Production: The table below highlights key mine production data for our Company for the three months ended March 31, 2013 and 2012:

                                    Three months ended March 31,
                                  2013       2012       Variance
                                                      Volume    %
Copper (in million pounds)         329.6      337.1     (7.5 ) (2.2 )%
Molybdenum (in million pounds)      10.6       10.2      0.4    4.1 %
Silver (in million ounces)           3.1        3.4     (0.3 ) (7.9 )%
Zinc (in million pounds)            51.7       49.8      1.9    3.8 %

The table below highlights mine copper production data for our mines for the three months ended March 31, 2013 and 2012:

                                Three Months Ended March 31,
                              2013      2012        Variance
                                                 Volume     %
COPPER (in million pounds)
Toquepala                      53.7      68.9     (15.2 ) (22.1 )%
Cuajone                        88.3      80.6       7.7     9.6 %
La Caridad                     53.6      51.3       2.3     4.5 %
Buenavista                     64.0      70.7      (6.7 )  (9.5 )%
IMMSA                           3.5       3.1       0.4    12.9 %
                              263.1     274.6     (11.5 )  (4.2 )%

SX-EW Toquepala                15.8      16.9      (1.1 )  (6.5 )%
SX-EW La Caridad               12.6      12.6         -       - %
SX-EW Buenavista               38.1      33.0       5.1    15.5 %
                               66.5      62.5       4.0     6.4 %
Total mined copper            329.6     337.1      (7.5 )  (2.2 )%

Copper mined production in the first quarter of 2013 decreased 2.2% to 329.6 million pounds compared to 337.1 million pounds in the first quarter of 2012. This decrease was mainly the result of lower production at the Toquepala and Buenavista mine partially offset by higher production at the Cuajone and La Caridad mines. All variances in mine production were mainly the result of changes in ore grades and recoveries.

Molybdenum production increased 4.1% in the first quarter of 2013 to 10.6 million pounds, compared to 10.2 million pounds in the first quarter of 2012 due to higher production at the La Caridad mine as a result of higher grade and recovery. This was partially offset by lower production at the Toquepala and Cuajone mines.

Silver mine production decreased 7.9% in the first quarter of 2013 as result of lower production at all our mines except at the Buenavista where increased by 3.7%.

Zinc production increased 3.8% in the first quarter of 2013, mainly due to higher grades and recoveries and higher production at the Santa Eulalia mine.

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 (exclusive of depreciation, amortization and depletion) as presented in the condensed consolidated statement of earnings is presented below under the subheading, "Non-GAAP Information Reconciliation."

We have defined operating cash cost per pound as cost of sales (exclusive of depreciation, amortization and depletion), less the cost of purchased concentrates, plus selling, general and administrative charges, treatment and refining charges, net revenue (loss) on sale of metal purchased from third parties and by-product revenues, and sales premiums; less workers' participation and other miscellaneous charges, including the Peruvian royalty charge, the special mining tax and the change in inventory levels; divided by total pounds of copper produced by our own mines. 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: molybdenum, zinc, silver, gold and other minor by-products and the premium over market price that we receive on copper sales. We account for the by-product revenues in this way because we consider our principal business to be the production and sale of copper. We believe that our


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Company is viewed by the investment community as a copper company, and is valued, in large part, by the investment community's view of the copper market and our ability to produce copper at a reasonable cost. The variation in recent years in the price of molybdenum, as well as variations in the prices of silver and zinc, have 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.

In conjunction with the review of our operating cash costs, please also see our annual report on Form 10-K for the year ended December 31, 2012, wherein Part II (Item 7, Key matters), we discuss our rationale for calculating operating cash costs.

Our operating cash costs per pound, as defined, are presented in the table below.

Operating Cash Cost per Pound of Copper produced

                           Without                   Including
                          by-product   By-product    by-product
(cents per pound)          revenue      revenue       revenue
1Q 2013                        198.9       (107.5 )        91.4

4Q 2012                        187.4        (97.1 )        90.3
3Q 2012                        178.2        (96.2 )        82.0
2Q 2012                        170.5       (111.1 )        59.4
1Q 2012                        183.9       (130.2 )        53.7

Year 2012                      179.6       (108.3 )        71.3

Variance: 1Q13 vs. 1Q12          8.2 %      (17.4 )%       70.2 %
Variance: 1Q13 vs. 4Q12          6.1 %       10.7 %         1.2 %

As seen in the table above, our cash cost, excluding by-product revenues, was higher by 15 cents per pound or 8.2% in the first quarter 2013 compared to the first quarter of 2012 due to higher production cost, mainly labor, fuel and operating material costs and lower copper production which increased the per pound cost.

In addition, our per pound cash cost for the three months ended March 31, 2013 when calculated with by-product revenues is 91.4 cents per pound compared with 53.7 cents per pound in the same period of 2012. The increase of 37.7 cents per pound or 70.2% was primarily result of the noted increases in production costs and lower prices for our major by-products.

Metal Prices. 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. Metal 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 economic concerns and financial investments.

We are subject to market risks arising from the volatility of copper and other metal prices. Assuming that expected metal production and sales are achieved, that tax rates are unchanged, giving no effect to potential hedging programs, metal price sensitivity factors would indicate the following change in estimated 2013 net income attributable to SCC resulting from metal price changes:

                                         Copper     Molybdenum      Zinc        Silver
Change in metal prices (per pound,
except silver - per ounce)             $     0.01   $      1.00   $    0.01   $     1.00
Annual change in net income
attributable to SCC (in millions)      $      8.0   $      25.9   $     1.2   $      9.1

Business Segments: We view our Company as having three operating segments and manage on the basis of these segments. These segments are our (1) Peruvian operations, (2) our Mexican open-pit operations and (3) 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. The Peruvian operations produce copper, with significant by-product production of molybdenum, silver and other material. Our Mexican open-pit operations include La Caridad and Buenavista mine complexes, the smelting and refining plants and support facilities which service both mines. The Mexican open pit operations produce copper, with significant by-product production of molybdenum, silver and other material. Our IMMSA unit includes five underground mines that produce zinc, lead, copper, silver and gold, a coal mine which produces coal and coke, and several industrial processing facilities for zinc, copper and silver.


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Segment information is included in our review of "Results of Operations" and also in Note 11 - "Segment and Related Information" of our condensed consolidated financial statements.

Inflation and Exchange Rate Effect of the Peruvian Nuevo Sol and the Mexican Peso: Our functional currency is the U.S. dollar. Portions of our operating costs are denominated in Peruvian nuevos soles and Mexican pesos. Since our revenues are primarily denominated in U.S. dollars, when inflation/deflation in Peru or Mexico is not offset by a change in the exchange rate of the nuevo sol or the peso to the dollar, our financial position, results of operations and cash flows could be adversely affected to the extent that the inflation/devaluation effects are passed onto us by our suppliers or reflected in our wage adjustments. In addition, the dollar value of our net monetary assets denominated in nuevos soles or pesos can be affected by devaluation of the nuevo sol or the peso, resulting in a remeasurement loss in our financial statements. Recent inflation and devaluation rates are provided in the table below for the three months ended March 31, 2013 and 2012:

                                                      Three Months Ended
                                                          March 31,
                                                      2013          2012
Peru:
Peruvian inflation rate                                  0.9 %         1.0 %
Nuevo sol/dollar appreciation /(devaluation) rate       (1.5 )%        1.1 %

Mexico:
Mexican inflation rate                                   1.5 %         1.0 %
Peso/dollar appreciation /(devaluation) rate             5.0 %         8.1 %

Capital Investment and Exploration Program

We made capital expenditures of $316.8 million for the three months ended March 31, 2013, compared with $177.4 million in the same period of 2012. In general, the capital expenditures and projects described below are intended to increase production and/or decrease costs.

Set forth below are descriptions of some of our current expected capital expenditure programs. We expect to meet the cash requirements for these projects from cash on hand, internally generated funds and from additional external financing, if required. All capital spending plans will continue to be reviewed and adjusted to respond to changes in the economy or market conditions.

Mexican operations:

Buenavista Projects: We continue the development of our $2.8 billion investment program at this unit which will allow us to increase its production capacity by approximately 170% from 180,000 tons to 488,000 tons by 2015. The table below contains a summary of the program progress:

Project                                    Overall progress   Estimated start-up
New concentrator with molybdenum circuit               42.7 % First half 2015
SXEW III                                               48.5 % First half 2014
Quebalix III                                            100 % First quarter 2013
Molybdenum plant                                       98.4 % Second quarter 2013

The new concentrator with molybdenum circuit project includes a new concentrator with an estimated annual production capacity of 188,000 tons of copper, and a 1,850 tons capacity molybdenum plant. The project will also produce annually 2.3 million ounces of silver and 21,000 ounces of gold. The total capital budget of the project is $1,383.6 million with a total investment of $214.8 million through March 31, 2013.

Through March 31, 2013, we have received two of eight shovels, 40 of 56 trucks and seven of eight drills. These units are currently in operation. The total capital budget of the mine equipment project is $504.8 million with $387.6 million expended through March 31, 2013.

The SXEW III project is moving forward. Plant equipment from Tia Maria has been installed in Mexico and will allow us to increase the annual plant capacity from 88,000 tons to 120,000 tons. The total capital budget of the project is $444.0 million with $170.6 million expended through March 31, 2013.


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The final testing of the Quebalix III concluded in February and it started operations in March 2013. The total capital budget of the project was $75.6 million. This project will allow crushing of up to 15 million tons of mineral per year, improving SXEW copper production by increasing recovery and reducing hauling cost and the required time to extract copper from mineral.

The final testing of the molybdenum plant for the current concentrator started in April and it is expected to conclude in May 2013. The plant had a total cost of $38 million and it is expected to have an average annual production of 2,000 tons of molybdenum.

Angangueo: The project is moving forward as scheduled to develop this underground polymetallic deposit in Michoacan, Mexico, which includes a concentrator with a milling capacity of 2,000 tons per day. The production plan indicates that Angangueo will have an estimated average annual metal content production of 10,400 tons of copper and 7,000 tons of zinc in the first seven years. The project is scheduled to begin production in the first half of 2015. Through March 31, 2013, we have spent $10.8 million.

Pilares project: In 2008, we acquired 100% ownership of Pilares, with the intention of operating it as an open-pit facility. In 2011, the Board of Directors approved the development of the Pilares mine, with a budget of $136.3 million. Current mineralized material is estimated at 43.4 million tons with 0.789% of copper sulfide content and 0.077% copper oxide. We expect to increase copper production by 40,000 tons per year by sending mineral from the Pilares site to our La Caridad concentrator. Pilares continues on hold while we solve a "right of way" issue with the local community.

El Arco: El Arco is a world class copper deposit in the central part of the Baja California peninsula, with ore reserves over 1.5 billion tons with an ore grade of 0.416% and 0.14 grams of gold per ton. In 2010, we concluded the feasibility study and an investment of $56.4 million was approved for land acquisition required for the project. This project, when developed, is expected to produce 190,000 tons of copper and 105,000 ounces of gold annually. In 2013, we will continue to invest in land acquisition required for the project.

Peruvian Operations:

Toquepala projects: Through March 31, 2013, we have spent $234.8 million on Toquepala projects. We have continued with the construction of the new in-pit crusher and conveyor belt system to replace current rail haulage. This will reduce operating cost, allowing for future savings.

Our expansion project includes an increase in milling capacity of the Toquepala concentrator from 60,000 tons per day to 120,000 tons, which should increase annual production by 100,000 tons of copper and 3,100 tons of molybdenum.

As a result of protests from some community groups, the approval process for the EIA of this project has been delayed. These groups raised concerns related to water usage and pollution. As a result of these issues the Peruvian government has started discussions with the local communities and the regional authorities to resolve this impasse. On February 8, 2013, we reached a final agreement with the province of Candarave, one of the three provinces neighboring our Toquepala unit, which commits us to funding S/.255 million (approximately $100 million) for development projects in the province. This agreement is contingent upon receiving approval for the project. We expect to continue working with the Candarave province and the other two provinces neighboring Toquepala to resolve all open issues during 2013. Assuming we receive approval of the EIA on a timely basis, project plant construction and other expansion related activities could start and its completion is scheduled for the first half of 2015.

Cuajone projects: Through March 31, 2013, we have spent $138.9 million on two projects to increase productivity through technological improvements in this unit: the Variable Cut-off Ore Grade project and the HPGR project. We expect that both projects will be at full capacity by the second half of 2013.

Tailings disposal at Quebrada Honda: This project increases the height of the existing Quebrada Honda dam to impound future tailings from the Toquepala and Cuajone mills and will extend the expected life of this tailings facility by 25 years. The first stage and construction of the drainage system for the lateral dam are finished. We are preparing bidding documents for the second stage that includes engineering and procurement to improve and increase the dam's embankment. The project has a total budgeted cost of $66.0 million with $49.0 million expended through March 31, 2013.

Tia Maria project: We continue to work on a new EIA study that will address recent government guidance on these studies, in order to reach an agreement that is mutually satisfactory to all parties. We are also working with our . . .

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