**SECURITIESAND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

** **

**2006**

**SecondQuarter**

 

**FORM10-Q**

 

**QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF**

**THESECURITIES EXCHANGE ACT OF 1934**

 

| **For Quarter Ended June 30, 2006** | ** ** | **Commission  file number 1-14066** |
|-------------------------------------|------------|-------------------------------------|

 

**SOUTHERNCOPPER CORPORATION**

(Exactname of registrant as specified in its charter)

 

| **Delaware**                                             | ** ** | **13-3849074**                       |
|----------------------------------------------------------|------------|--------------------------------------|
| (State or other jurisdiction of                          |       | (I.R.S. Employer Identification No.) |
| incorporation or organization)                           |       |                                 |
|                                                     |       |                                 |
| **11811 North Tatum Blvd. Suite 2500 Phoenix,  AZ**      | ** ** | **85028**                            |
| (Address  of principal executive offices)                |       | (Zip  Code)                          |
|                                                     |       |                                 |
| Registrant’s  telephone number, including area code |       | **(602) 977-6595**                   |

 

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

 

| Yes  x |   | No o |
|--------|--------|------|

 

Indicate by check mark whether the registrantis a large accelerated filer, an accelerated filer, or a non-accelerated filer.(See definition of “accelerated filer and large accelerated filer” in Rule12b-2 of the Exchange Act).

 

| Large accelerated filer x |   | Accelerated  filer o |   | Non-accelerated  filer o |
|---------------------------|--------|----------------------|--------|--------------------------|

 

Indicate by check mark whether the registrantis a shell company (as defined by Rule 12b-2 of the Act).

 

| Yes  o |   | No x |
|--------|--------|------|

 

As of June 30, 2006 there were outstanding147,230,425 shares of Southern Copper Corporation common stock, par value $0.01per share.

 

 

----

 

SouthernCopper Corporation

 

INDEXTO FORM 10-Q

 
| Part I. Financial Information:                           |                                                                                                        |
|----------------------------------------------------------|-------------------------------------------------------------------------------------------------------------|
|                                                     |                                                                                                        |   |
| Item. 1                                                  | Condensed Consolidated  Combined Financial Statements (unaudited)                                           |   |
|                                                     |                                                                                                        |   |
|                                                     | Condensed  Consolidated Combined Statement of Earnings three and six months ended June  30, 2006 and 2005   |   |
|                                                     |                                                                                                        |   |
|                                                     | Condensed  Consolidated Balance Sheet June 30, 2006 and December 31, 2005                                   |   |
|                                                     |                                                                                                        |   |
|                                                     | Condensed  Consolidated Combined Statement of Cash Flows three and six months ended June  30, 2006 and 2005 |   |
|                                                     |                                                                                                        |   |
|                                                     | Notes  to Condensed Consolidated Combined Financial Statements                                              |   |
|                                                     |                                                                                                        |   |
| Item 1a.                                                 | Risk factors                                                                                                |   |
|                                                     |                                                                                                        |   |
| Items 2 and 3.                                           | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                 |   |
|                                                     |                                                                                                        |   |
| Item 4.                                                  | Controls and  Procedures                                                                                    |   |
|                                                     |                                                                                                        |   |
| Report of  Independent Registered Public Accounting Firm |                                                                                                        |
|                                                     |                                                                                                        |   |
| Part II. Other  Information:                             |                                                                                                        |
|                                                     |                                                                                                        |   |
| Item 1.                                                  | Legal Procedures                                                                                            |   |
|                                                     |                                                                                                        |   |
| Item 4.                                                  | Submission  of Matters to a Vote of Security Holders                                                        |   |
|                                                     |                                                                                                        |   |
| Item 6.                                                  | Exhibits                                                                                                    |   |
|                                                     |                                                                                                        |   |
| Signatures                                               |                                                                                                        |   |
|                                                     |                                                                                                        |   |
| Exhibit 15                                               |     Awareness  letter of Independent Registered Public Accounting Firm                       |   |
|                                                     |                                                                                                        |   |
| 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                      |   |

 

2

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Part I – FINANCIAL INFORMATION

 

Item1.  Condensed Consolidated CombinedFinancial Statements

 

SouthernCopper Corporation

 

CONDENSED CONSOLIDATED COMBINED STATEMENT OFEARNINGS

(Unaudited)

 
| ** **                                                                                    | ** ** | **3 Months Ended** | ** ** | **6 Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|------------------------------|------------|------------------------------|------------|
| ** **                                                                                    | ** ** | **June, 30**            | ** ** | **June 30,**            | ** ** |
| ** **                                                                                    | ** ** | **2006**                     | ** ** | **2005**                     | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                    | ** ** | **(in thousands)**      | ** ** |
| Net sales:                                                                                    |       |                         |       |                         |       |   |   |   |   |
| Non affiliates                                                                                |       | $                            | 1,276,749  |                         | $          | 947,728 |   | $ | 2,398,040 |   | $ | 1,864,537 |   |
| Affiliates                                                                                    |       | —                       |       | 6,367                        |       | — |   | 28,357 |   |
| Total net sales                                                                               |       | 1,276,749                    |       | 954,095                      |       | 2,398,040 |   | 1,892,894 |   |
|                                                                                          |       |                         |       |                         |       |   |   |   |   |
| Operating costs and expenses:                                                                 |       |                         |       |                         |       |   |   |   |   |
| Cost of sales (exclusive of depreciation,  amortization and depletion shown separately below) |       | 521,788                      |       | 413,105                      |       | 928,732 |   | 802,675 |   |
| Selling, general and administrative                                                           |       | 23,313                       |       | 20,405                       |       | 47,329 |   | 39,003 |   |
| Depreciation, amortization and depletion                                                      |       | 77,982                       |       | 70,544                       |       | 131,085 |   | 131,511 |   |
| Exploration                                                                                   |       | 4,636                        |       | 5,497                        |       | 9,209 |   | 10,844 |   |
| Total operating costs and expenses                                                            |       | 627,719                      |       | 509,551                      |       | 1,116,355 |   | 984,033 |   |
|                                                                                          |       |                         |       |                         |       |   |   |   |   |
| Operating income                                                                              |       | 649,030                      |       | 444,544                      |       | 1,281,685 |   | 908,861 |   |
|                                                                                          |       |                         |       |                         |       |   |   |   |   |
| Interest expense                                                                              |       | (28,202                      | )          | (21,558                      | )          | (51,109 | ) | (48,556 | ) |
| Capitalized interest                                                                          |       | 6,511                        |       | 3,578                        |       | 11,606 |   | 7,569 |   |
| Loss on derivative instruments                                                                |       | —                       |       | (2,700                       | )          | — |   | (2,700 | ) |
| Loss on debt prepayments                                                                      |       | (860                         | )          | (5,974                       | )          | (860 | ) | (7,664 | ) |
| Other income (expense)                                                                        |       | 8,466                        |       | (651                         | )          | 7,488 |   | 184 |   |
| Interest income                                                                               |       | 14,303                       |       | 3,038                        |       | 23,608 |   | 8,490 |   |
| Earnings before taxes on income and minority  interest                                        |       | 649,248                      |       | 420,277                      |       | 1,272,418 |   | 866,184 |   |
|                                                                                          |       |                         |       |                         |       |   |   |   |   |
| Taxes on income                                                                               |       | 207,864                      |       | 106,749                      |       | 407,736 |   | 252,870 |   |
| Minority interest                                                                             |       | 2,104                        |       | 1,597                        |       | 3,827 |   | 3,022 |   |
|                                                                                          |       |                         |       |                         |       |   |   |   |   |
| Net earnings                                                                                  |       | $                            | 439,280    |                         | $          | 311,931 |   | $ | 860,855 |   | $ | 610,292 |   |
|                                                                                          |       |                         |       |                         |       |   |   |   |   |
| Per common share amounts:                                                                     |       |                         |       |                         |       |   |   |   |   |
| Net earnings basic and diluted                                                                |       | $                            | 2.98       |                         | $          | 2.12 |   | $ | 5.85 |   | $ | 4.15 |   |
| Dividends paid                                                                                |       | $                            | 2.75       |                         | $          | 2.38 |   | $ | 5.50 |   | $ | 3.06 |   |
| Weighted average common shares outstanding  (Basic)                                           |       | 147,230                      |       | 147,228                      |       | 147,230 |   | 147,228 |   |
| Weighted average common shares outstanding  (Diluted)                                         |       | 147,230                      |       | 147,228                      |       | 147,230 |   | 147,228 |   |

 

The accompanyingnotes are an integral part of these condensed consolidated combined financialstatements.

 

3

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SouthernCopper Corporation

 

CONDENSED CONSOLIDATED BALANCE SHEET

(Unaudited)

 
| ** **                                                          | ** ** | **June 30,**       | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                          | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **                                                          | ** ** | **(in thousands)** | ** ** |
| ASSETS                                                              |       |                    |       |                  |       |
| Current assets:                                                     |       |                    |       |                  |       |
| Cash and cash equivalents                                           |       | $                       | 800,950    |                  | $          | 876,003 |   |
| Accounts receivable Trade – Non affiliates                     |       | 471,869                 |       | 342,412               |       |
| Accounts receivable - Affiliates                                    |       | 6,493                   |       | 9,099                 |       |
| Accounts receivable – other                                    |       | 30,694                  |       | 34,949                |       |
| Inventories                                                         |       | 461,341                 |       | 395,845               |       |
| Deferred income tax – current portion                          |       | —                  |       | 5,248                 |       |
| Prepaid and other current assets                                    |       | 63,073                  |       | 50,798                |       |
| Total current assets                                                |       | 1,834,420               |       | 1,714,354             |       |
|                                                                |       |                    |       |                  |       |
| Property, net                                                       |       | 3,442,431               |       | 3,326,126             |       |
| Capitalized mine stripping, net                                     |       | —                  |       | 289,369               |       |
| Leachable material, net                                             |       | 187,046                 |       | 210,118               |       |
| Intangible assets, net                                              |       | 119,452                 |       | 120,861               |       |
| Other assets, net                                                   |       | 40,985                  |       | 26,746                |       |
| Total Assets                                                        |       | $                       | 5,624,334  |                  | $          | 5,687,574 |   |
|                                                                |       |                    |       |                  |       |
| LIABILITIES                                                         |       |                    |       |                  |       |
| Current liabilities:                                                |       |                    |       |                  |       |
| Current portion of long-term debt                                   |       | $                       | 10,000     |                  | $          | 10,000 |   |
| Accounts payable                                                    |       | 286,072                 |       | 284,977               |       |
| Accrued income taxes                                                |       | 94,116                  |       | 275,763               |       |
| Due to affiliated companies                                         |       | 5,956                   |       | 6,355                 |       |
| Deferred income taxes                                               |       | 5,275                   |       | —                |       |
| Accrued workers’ participation                                 |       | 157,725                 |       | 195,552               |       |
| Other accrued liabilities                                           |       | 60,816                  |       | 22,985                |       |
| Total current liabilities                                           |       | 619,960                 |       | 795,632               |       |
|                                                                |       |                    |       |                  |       |
| Long-term debt                                                      |       | 1,529,948               |       | 1,162,065             |       |
| Deferred income taxes                                               |       | 172,999                 |       | 259,089               |       |
| Other liabilities                                                   |       | 88,038                  |       | 120,795               |       |
| Asset retirement obligation                                         |       | 11,702                  |       | 11,221                |       |
| Total non-current liabilities                                       |       | 1,802,687               |       | 1,553,170             |       |
|                                                                |       |                    |       |                  |       |
| Commitments and Contingencies (Note J)                              |       |                    |       |                  |       |
|                                                                |       |                    |       |                  |       |
| MINORITY INTEREST                                                   |       | 11,103                  |       | 12,695                |       |
|                                                                |       |                    |       |                  |       |
| STOCKHOLDERS’ EQUITY                                           |       |                    |       |                  |       |
| Common stock                                                        |       | 1,474                   |       | 1,474                 |       |
| Additional paid-in capital                                          |       | 773,580                 |       | 774,168               |       |
| Retaining earnings                                                  |       | 2,518,719               |       | 2,648,359             |       |
| Other accumulative comprehensive loss                               |       | (11,382                 | )          | (13,090               | )          |
| Treasury stock                                                      |       | (91,807                 | )          | (84,834               | )          |
| Total Stockholders’ Equity                                     |       | 3,190,584               |       | 3,326,077             |       |
|                                                                |       |                    |       |                  |       |
| Total Liabilities, Minority Interest and  Stockholders’ Equity |       | $                       | 5,624,334  |                  | $          | 5,687,574 |   |

 

The accompanying notes are an integral partof these condensed consolidated combined financial statements.

 

4

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SouthernCopper Corporation

 

CONDENSED CONSOLIDATED COMBINED STATEMENT OF CASHFLOWS

(Unaudited)

 
| ** **                                                                             | ** ** | **3 Months Ended  June 30,** | ** ** | **6 Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                             | ** ** | **2006**                                    | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                             | ** ** | **(in thousands)**                     | ** ** |
| OPERATING ACTIVITIES                                                                   |       |                                        |       |                                        |       |   |   |   |   |
|                                                                                   |       |                                        |       |                                        |       |   |   |   |   |
| Net earnings                                                                           |       | $                                           | 439,280    |                                        | $          | 311,931 |   | $ | 860,855 |   | $ | 610,292 |   |
| Adjustments to reconcile net earnings to net  cash provided from operating activities: |       |                                        |       |                                        |       |   |   |   |   |
| Depreciation, amortization and depletion                                               |       | 77,982                                      |       | 70,544                                      |       | 131,085 |   | 131,511 |   |
| Capitalized mine stripping and leachable  material                                     |       | —                                      |       | (27,922                                     | )          | — |   | (52,545 | ) |
| Remeasurement loss (gain)                                                              |       | (11,954                                     | )          | 11,709                                      |       | (11,382 | ) | 12,035 |   |
| Provision for deferred income taxes                                                    |       | (3,477                                      | )          | 28,349                                      |       | 16,235 |   | 33,436 |   |
| Unrealized loss on derivative instruments                                              |       | 1,818                                       |       | —                                      |       | 1,818 |   | — |   |
| Amortization of deferred financing cost                                                |       | —                                      |       | 105                                         |       | — |   | 2,435 |   |
| Minority interest                                                                      |       | 2,104                                       |       | 1,597                                       |       | 3,827 |   | 3,022 |   |
|                                                                                   |       |                                        |       |                                        |       |   |   |   |   |
| Cash provided from (used for) operating  assets and liabilities:                       |       |                                        |       |                                        |       |   |   |   |   |
| Accounts receivable                                                                    |       | (159,597                                    | )          | 72,133                                      |       | (135,233 | ) | 131,875 |   |
| Inventories                                                                            |       | (25,193                                     | )          | (14,992                                     | )          | (65,496 | ) | (16,158 | ) |
| Accounts payable and accrued liabilities                                               |       | (173,874                                    | )          | (225,270                                    | )          | (252,694 | ) | (288,101 | ) |
| Other operating assets and liabilities                                                 |       | (14,297                                     | )          | (46,412                                     | )          | 21,504 |   | (33,540 | ) |
| Net cash provided by operating activities                                              |       | 132,792                                     |       | 181,772                                     |       | 570,519 |   | 534,262 |   |
|                                                                                   |       |                                        |       |                                        |       |   |   |   |   |
| INVESTING ACTIVITIES                                                                   |       |                                        |       |                                        |       |   |   |   |   |
| Capital expenditures                                                                   |       | (87,603                                     | )          | (69,969                                     | )          | (230,720 | ) | (145,230 | ) |
| Purchase of marketable securities                                                      |       | —                                      |       | —                                      |       | — |   | (74,339 | ) |
| Sales of marketable securities                                                         |       | —                                      |       | 74,339                                      |       | — |   | 119,606 |   |
| Other                                                                                  |       | 3,814                                       |       | (12,410                                     | )          | 2,003 |   | (13,133 | ) |
| Net cash used for investing activities                                                 |       | (83,789                                     | )          | (8,040                                      | )          | (228,717 | ) | (113,096 | ) |
|                                                                                   |       |                                        |       |                                        |       |   |   |   |   |
| FINANCING ACTIVITIES                                                                   |       |                                        |       |                                        |       |   |   |   |   |
| Debt repaid                                                                            |       | (21,510                                     | )          | (129,562                                    | )          | (21,510 | ) | (418,605 | ) |
| Debt incurred                                                                          |       | 389,192                                     |       | 30,000                                      |       | 389,192 |   | 200,000 |   |
| Dividends paid to common stockholders                                                  |       | (404,877                                    | )          | (350,043                                    | )          | (809,754 | ) | (450,043 | ) |
| Distributions to minority interest                                                     |       | (1,886                                      | )          | (2,729                                      | )          | (4,871 | ) | (3,509 | ) |
| Other                                                                                  |       | (7,704                                      | )          | (188                                        | )          | (7,116 | ) | (188 | ) |
| Net cash used for financing activities                                                 |       | (46,785                                     | )          | (452,522                                    | )          | (454,059 | ) | (672,345 | ) |
|                                                                                   |       |                                        |       |                                        |       |   |   |   |   |
| Effect of exchange rate changes on cash and  cash equivalents                          |       | 23,105                                      |       | 14,961                                      |       | 37,204 |   | 11,638 |   |
|                                                                                   |       |                                        |       |                                        |       |   |   |   |   |
| Increase (decrease) in cash and cash equivalents                                       |       | 25,323                                      |       | (263,829                                    | )          | (75,053 | ) | (239,541 | ) |
| Cash and cash equivalents, at beginning of period                                      |       | 775,627                                     |       | 734,995                                     |       | 876,003 |   | 710,707 |   |
| Cash and cash equivalents, at end of period                                            |       | $                                           | 800,950    |                                        | $          | 471,166 |   | $ | 800,950 |   | $ | 471,166 |   |
| Supplemental disclosure of cash flow  information:                                     |       |                                        |       |                                        |       |   |   |   |   |
| Cash paid during the period for:                                                       |       |                                        |       |                                        |       |   |   |   |   |
| Interest                                                                               |       | $                                           | 2,533      |                                        | $          | 20,259 |   | $ | 21,948 |   | $ | 55,687 |   |
| Income taxes                                                                           |       | $                                           | 482,325    |                                        | $          | 305,350 |   | $ | 727,638 |   | $ | 446,685 |   |

 

The accompanying notes are an integral partof these condensed consolidated combined financial statements.

 

5

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SouthernCopper Corporation

 

NOTES TO CONDENSED CONSOLIDATED COMBINED FINANCIALSTATEMENTS

(Unaudited)

 

A.           In the opinion of Southern Copper Corporation, (the “Company”, “SouthernCopper” or “SCC”), the accompanying unaudited condensed consolidated combinedfinancial statements contain all adjustments (consisting only of normalrecurring adjustments) necessary to present fairly the Company’s financialposition as of June 30, 2006 and the results of operations and cash flows forthe three and six months ended June 30, 2006 and 2005.  The condensed consolidated combined financialstatements for the three and six month periods ended June 30, 2006 and 2005have been subjected to a review by PricewaterhouseCoopers, the Company’sindependent registered public accounting firm, whose report dated August 2,2006, is presented on page 45.  Theresults of operations for the three and six months ended June 30, 2006 and 2005are not necessarily indicative of the results to be expected for the fullyear.  The December 31, 2005 balancesheet data was derived from audited financial statements, but does not includeall disclosures required by accounting principles generally accepted in theUnited States of America.  Theaccompanying condensed consolidated combined financial statements should beread in conjunction with the consolidated combined financial statements atDecember 31, 2005 and notes included in the Company’s 2005 annual report onForm 10-K/A Amendment No. 1.

 

In the first quarter of2006, the Company reclassified from additional paid-in capital to treasurystock the carrying value of its investment in shares held by one of its Mexicansubsidiaries in its controlling shareholder, Grupo Mexico S.A.B. de C.V. (GrupoMexico).  At June 30, 2006 and December31, 2005, the carrying amount was $87.3 million and $80.0 million, respectively.Certain prior year amounts have been reclassified to conform to the currentpresentation.

 

B.             Changes in Accounting Principle – CapitalizedMine Stripping

 

At the March 17, 2005meeting of the Emerging Issues Task Force (EITF), the EITF reached a consensusthat stripping costs incurred during the production phase of a mine arevariable production costs that should be included in the costs of the inventoryproduced (extracted) during the period that the stripping costs areincurred.  The EITF noted that theconsensus does not address the accounting for stripping costs incurred duringthe pre-production phase of a mine.  Theconsensus with respect to this issue was ratified by the FASB on March 30,2005, and is effective for the first reporting period in fiscal years beginningafter December 15, 2005, with early adoption permitted.

 

On January 1, 2006 theCompany adopted this consensus by reversing $289.4 million of net cumulativecapitalized stripping cost as of December 31, 2005 and recording a net chargeof $181.3 million to retained earnings after recognition of workers’participation and tax benefit of $108.1 million.

 

C.             Inventories were as follows:

(in millions)

 
| ** **                                 | ** ** | **June 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                       |       |                    |       |                        |       |
| Metals at lower of average cost or market: |       |                    |       |                        |       |
| Finished goods                             |       | $                       | 67.8       |                        | $          | 106.9 |   |
| Work-in-process                            |       | 234.2                   |       | 135.4                       |       |
| Supplies at average cost                   |       | 159.3                   |       | 153.5                       |       |
| Total inventories                          |       | $                       | 461.3      |                        | $          | 395.8 |   |

 

6

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D.            Income taxes:

 

The Company’s income taxprovision for the six months ended June 30, 2006 and 2005 was $407.7 millionand $252.9 million, respectively.  Theseprovisions include income taxes for Peru, Mexico and the United States.  The effective tax rates for the 2006 and 2005periods are 32.0% and 29.2%, respectively. The increase in the 2006 effective tax rate is attributable to thefollowing factors: 1) a non-deductible expense in our Peruvian operation of$138.4 million for copper derivative losses in the 2006 period, 2) anon-deductible expense of $28.2 million for workers’ participation resultingfrom a change in Mexican law regarding the basis of calculation in the 2005period, 3) a tax refund of $43.4 million received by our Mexican subsidiary inthe 2005 period for asset-based taxes (minimum income tax) paid in prior years,and 4) a decrease of 1% in the 2006 statutory tax rate for our Mexicanoperations.

 

E.              Provisionally Priced Sales:

 

At June 30, 2006, theCompany has recorded provisionally priced sales of 95.4 million pounds ofcopper, at an average forward price of $3.37 per pound.  Also the Company has recorded provisionallypriced sales of 3.6 million pounds of molybdenum at June 30, 2006 market priceof $25.00 per pound.  These sales aresubject to final pricing based on the average monthly LME or COMEX copperprices and Dealer Oxide molybdenum prices in the future month of settlement.

 

Following are theprovisionally priced copper and molybdenum sales outstanding at June 30, 2006:

 
| **Copper  (million lbs.)** | ** ** | **Priced at** | ** ** | **Month of  Settlement** | ** ** |
|---------------------------------|------------|--------------------|------------|-------------------------------|------------|
| 56.4                            |       | 3.38522            |       | July 2006                     |       |
| 19.5                            |       | 3.39018            |       | August 2006                   |       |
| 5.5                             |       | 3.35500            |       | September  2006               |       |
| 11.8                            |       | 3.30715            |       | October 2006                  |       |
| 2.2                             |       | 3.23956            |       | November  2006                |       |
| 95.4                            |       | 3.37153            |       |                          |       |

 
| **Molybdenum  (million lbs.)** | ** ** | **Priced at** | ** ** | **Month of  Settlement** | ** ** |
|-------------------------------------|------------|--------------------|------------|-------------------------------|------------|
| 1.8                                 |       | 25.00000           |       | July 2006                     |       |
| 0.8                                 |       | 25.00000           |       | August 2006                   |       |
| 1.0                                 |       | 25.00000           |       | September  2006               |       |
| 3.6                                 |       | 25.00000           |       |                          |       |

 

Management believes that thefinal pricing of these sales will not have a material effect on the Company’sfinancial position or results of operations.

 

F.              Derivative Instruments:

 

The Company occasionallyuses derivative instruments to manage its exposure to market risk from changesin commodity prices and interest rate risk exposure.  The Company does not enter into derivativecontracts unless it anticipates a future activity that is likely to occur thatwill result in exposing the Company to market risk.

 

Copper swaps:

 

Transactions under thiscopper price protection program are not accounted for as hedges under SFAS No.133 and are adjusted to fair market value based on the 

 

7

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copper price as of the lastday of the respective reporting period with the gain or loss recorded in totalnet sales. The actual impact of this protection program on the Company’s thirdand fourth quarter copper production can not be fully determined until thematurity of each copper swap contract with final adjustments based on theaverage annual copper price. As a result of this copper price protectionprogram, the Company decided to change its accounting policy to recognize thechange in the fair market value of these financial instruments against netsales. The Company believes that this income statement classification reflectsbetter the intention of this copper price protection program. Before the secondquarter of 2006, the change in the fair market value of our derivativeinstruments was accounted for in a separate non-operating income statement lineitem.

 

In the second quarter of2006 and in the first half of 2005 the Company entered into copper swapscontracts to protect a portion of its 2006 and 2005 copper production forfuture sales at a fixed copper price. Related to the settlement of these copper swap contracts the Companyrecorded losses of $257.9 million and $3.9 million in the second quarter of2006 and 2005 respectively, and $11.2 million in the six month period of2005.  These losses were recorded in netsales on the condensed consolidated combined statement of earnings.

 

At June 30, 2006, theCompany has copper swap contracts to protect 296.8 million pounds of copperproduction for the July-November period of 2006 at prices ranging from $2.95per pound through $3.92 per pound.  Thesecontracts are as follows:

 
| **Pounds  (in millions)** | ** ** | **Period**      | ** ** | **Copper Swap  Price (1)** | ** ** |
|--------------------------------|------------|-----------------|------------|--------------------------------------|------------|
| 121.6                          |       | July 2006       |       | $                                    | 3.33       | (2) |
| 105.8                          |       | August 2006     |       | $                                    | 3.45       | (2) |
| 52.9                           |       | September  2006 |       | $                                    | 3.49       | (2) |
| 11.0                           |       | October 2006    |       | $                                    | 3.53       | (2) |
| 5.5                            |       | November  2006  |       | $                                    | 3.52       | (2) |

 

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(1)                  SCC will receive (pay) if the actual averageCOMEX copper price for period is under (over) swap price on quantity hedged.

(2)                  The copper swap price is the per poundweighted average for the month or a portion of the month in the case of somecontracts.  Prices for July 2006 rangefrom $2.95 to $3.92, prices for August 2006 range from $3.03 to $3.90, pricesfor September 2006 range from $3.22 to $3.83, prices for October 2006 rangefrom $3.52 to $3.54, and the price for November 2006 is $3.52.

 

Additionally, during July2006, the Company entered into more copper swap contracts in order to protectan additional 88.8 million pounds of copper production for the third andfourth quarter of 2006 at prices ranging from $3.54 per pound through $3.81 perpound.  These contracts are as follows:

 
| **Pounds  (in millions)** | ** ** | **Period**      | ** ** | **Copper Swap  Price(1)** | ** ** |
|--------------------------------|------------|-----------------|------------|--------------------------------|------------|
| 10.7                           |       | July 2006       |       | $                              | 3.73       | (2) |
| 19.8                           |       | August 2006     |       | $                              | 3.70       | (2) |
| 17.6                           |       | September  2006 |       | $                              | 3.64       | (2) |
| 15.4                           |       | October 2006    |       | $                              | 3.62       | (2) |
| 16.5                           |       | November  2006  |       | $                              | 3.57       | (2) |
| 8.8                            |       | December  2006  |       | $                              | 3.59       | (2) |

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(1)                  SCC will receive (pay) if the actual averageCOMEX copper price for period is under (over) swap price on quantity hedged.

 

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(2)                  The copper swap price is the per poundweighted average for the month or a portion of the month in the case of somecontracts.  Prices for July 2006 rangefrom $3.69 to $3.81, prices for August 2006 range from $3.65 to $3.76, pricesfor September 2006 range from $3.60 to $3.70, prices for October 2006 rangefrom $3.56 to $3.68, prices for November 2006 range from $3.54 to $3.60 andprices for December range from $3.58 to $3.59.

 

Interest rate swaps:

 

In 2005, the Company enteredinto interest rate swap agreements to hedge its exposure to interest ratechanges on its variable rate debt.  Thesefacilities were terminated in July 2005 and the Company recorded a loss of $2.7million in the second quarter and first six months of 2005.

 

G.             Asset Retirement Obligation:

 

In 2005 the Company accruedan asset retirement obligation for its mining properties in Peru, as requiredby the Mine Closure Law, enacted in 2003 and adopted in 2005.  This law requires the Company to present amine closure plan to the Peruvian Ministry of Energy and Mines (“MEM”) byAugust 2006.  In April 2006, the Companyselected Walsh Peru S.A., a Peruvian subsidiary of Walsh EnvironmentalScientists and Engineers, Inc. (Boulder, Colorado), and the Mines Group, Inc.(Reno, Nevada) both independent consultants, to work in the development of themine closure plan which is currently under review.  The final plan will be subject to review andapproval by MEM and open to public discussion and comment in the area of theCompany’s operations.  In application ofSFAS No. 143 and according to the criteria established by FIN-47, the Companyhas made an estimate of this potential liability and recorded such liability,based on its review of the law. However, the Company cannot assure that theamount of this liability recorded will be adequate until our mine plan ispresented, reviewed and accepted by MEM.

 

The closure cost recognizedfor this liability includes the estimated cost required at the Peruvianoperations, based on the Company’s experience and includes costs at the Ilosmelter and refinery, tailings disposal and the dismantling of the Toquepalaand Cuajone concentrators, shops and auxiliary services.  In this regard, the Company recorded anadditional asset retirement liability in 2005 of $5.2 million for this new lawand increased net property by $4.6 million.

 

The following tablesummarizes the asset retirement obligation activity for the first six months of2006 and 2005 (in millions):

 
| ** **                      | ** ** | **2006** | ** ** | **2005** | ** ** |
|---------------------------------|------------|----------|------------|----------|------------|
| Balance as of January 1,        |       | $        | 11.2       |     | $          | 5.6 |   |
| Additions, changes in estimates |       | —   |       | —   |       |
| Accretion expense               |       | 0.5      |       | 0.2      |       |
| Balance as of June 30,          |       | $        | 11.7       |     | $          | 5.8 |   |

 

H.            Financing:

 

On May 9, 2006, the Companyissued an additional $400 million 7.5% notes due 2035.  These notes are in addition to the $600million of existing 7.5% notes due 2035 that were issued in July 2005.  The current transaction was issued at aspread of +240 basis points over the 30-year U.S. Treasury bond.  The original issue in July 2005 was issued ata spread of +315 basis points over the 30-year U.S. Treasury bond.  The notes are Investment Grade rated Baa2 byMoody’s, BBB- by Standard & Poor’s, and BBB- by Fitch. The notes wereissued at a discount of 

 

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$10.8 million. The Companycapitalized $3.2 million of cost associated with this facility and is includedin “Other assets – net” non-current on the consolidated balance sheet.Net proceeds from the May 2006 issuance ofnotes will be used to fund the Company’s $600 million expansion program, whichincludes an expansion of productive capacity at the Ilo, Peru smelter andrefinery, construction of a new SX/EW plant at Cananea, the initial cost todevelop the Los Chancas and Tia Maria projects and the remaining investment tocomplete the Ilo smelter modernization.

 

The notes issued in July2005 and the new notes issued in May 2006 are treated as a single series ofnotes under the indenture, including for purposes of covenants, waivers andamendments.  The Company has filed aregistration statement with the Securities and Exchange Commission, whichregistration statement has become effective, to exchange the new notes fornotes registered under the Securities Act of 1933, as amended.

 

In April 2006, the Companyrepurchased $16.5 million of Series A Yankee bonds issued by its subsidiaryMinera Mexico S.A.B. de C.V., in connection with this the Company paid apremium of $0.9 million, which is included in the consolidated combinedstatement of earnings on line “loss on debt prepayment”.

 

I.                 Related Party Transactions:

 

Receivable and payablebalances with affiliated companies and related parties are shown below (inmillions):

 
| ** **                                   | ** ** | **As of**    | ** ** |
|----------------------------------------------|------------|-------------------|------------|
| ** **                                   | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
| ** **                                   | ** ** | **2006**          | ** ** | **2005** | ** ** |
| Affiliate receivable:                        |       |              |       |   |   |
| Grupo Mexico  Servicios S.A de C.V.          |       | $                 | —     |   | $ | 2.6 |   |
| Grupo Mexico  S.A. de C.V.                   |       | —            |       | 0.4 |   |
| Mexico  Constructora Industrial S.A. de C.V. |       | 5.7               |       | 5.0 |   |
| Intermodal  Mexico S.A. de C.V.              |       | 0.5               |       | 0.4 |   |
| Ferrocarril  Mexicano S.A. de C.V.           |       | —            |       | 0.4 |   |
| Other                                        |       | 0.3               |       | 0.3 |   |
|                                         |       | $                 | 6.5        |   | $ | 9.1 |   |
|                                         |       |              |       |   |   |
| Affiliate payable:                           |       |              |       |   |   |
| Grupo Mexico  S.A. de C.V.                   |       | $                 | 2.5        |   | $ | 2.5 |   |
| Mexico  Constructora Industrial S.A. de C.V. |       | 0.4               |       | — |   |
| Ferrocarril  Mexicano S.A. de C.V.           |       | 2.6               |       | 3.0 |   |
| Higher Technology Solutions S.A.C.           |       | 0.5               |       | 0.2 |   |
| Other                                        |       | —            |       | 0.7 |   |
|                                         |       | $                 | 6.0        |   | $ | 6.4 |   |

 

The Company has entered intocertain transactions in the ordinary course of business with parties that arecontrolling shareholders or their affiliates. These transactions include the lease of office space, air transportationand construction services and products and services relating to mining andrefining.  The Company lends and borrowsfunds among affiliates for acquisitions and other corporate purposes.  These financial transactions bear interest.

 

The former holders of theCompany’s Class A common stock until June 2005 and their affiliates purchasedcopper and other products from the Company from time to time at pricesdetermined by reference to the LME and COMEX market price for copper andpublished prices for other products, if available.  Sales of copper and other products to theseformer holders of class A common stock amounted to 

 

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$4.2 million and $15.1million in the second quarter of 2005 and the first six months of 2005,respectively.

 

The Company sold to AsarcoLLC (Asarco), an affiliate of Grupo Mexico, $0.3 million and $13.2 million ofmetal products in the first six months of 2006 and 2005, respectively; and purchasedmetal products from Asarco for $1.1 million in the first six months of 2005. Inaddition the Company paid $0.9 million to Asarco in the first six months of2005 for tolling services. There were no purchases of metal products fromAsarco in the first six months of 2006.

 

Grupo Mexico, the Company’sultimate parent and the majority indirect stockholder of the Company, and itsaffiliates provide various services to the Company.  In 2005, these activities were principallyrelated to accounting, legal, tax, financial, treasury, human resources pricerisk assessment and hedging, purchasing, procurement and logistics, sales andadministrative and other support services. Grupo Mexico is reimbursed for these support services.  The total amount paid by the Company to GrupoMexico for such services in the first six months of 2006 and 2005 was $6.9million.  The Company expects to continueto pay for these services going forward in an amount of $13.8 million per year.

 

The Company’s Mexicanoperations paid fees of $8.9 million in both the first six months of 2006 and2005, primarily for freight services provided by Ferrocarril Mexicano, S.A. deC.V., a subsidiary of Grupo Mexico.

 

In addition, the Company’sMexican operations paid fees of $14.6 million and $8.6 million in the first sixmonths of 2006 and 2005, respectively, for construction services provided byMexico Constructora Industrial S.A. de C.V., an indirect subsidiary of GrupoMexico.

 

The Larrea family controls amajority of the capital stock of Grupo Mexico, and has extensive interests inother businesses, including oil drilling services, construction and realestate.  The Company engages in certaintransactions in the ordinary course of business with other entities controlledby the Larrea family relating to mining and refining services, the lease ofoffice space, and air transportation and construction services.  In connection with this, the Company paidfees of $0.9 million and $1.4 million in the first six months of 2006 and 2005,respectively, for maintenance services provided by Mexico Compañia de ProductosAutomotrices S.A. de C.V.

 

The Company purchased $2.2million and $1.3 million in the first six months of 2006 and 2005,respectively, of industrial materials from Higher Technology Solutions S.A.C. (“HigherTec”), a Peruvian corporation and a related company. Additionally, in the firstsix months of 2006 and 2005 the Company purchased $0.3 million and $0.4 millionof industrial material from Servicios y Fabricaciones Mecánicas S.A.C.,respectively. Mr. Carlos Gonzalez is the principal owner of thesecompanies. Mr. Carlos Gonzalez is son of SCC’s President and Chief ExecutiveOfficer.

 

It is anticipated that inthe future the Company will enter into similar transactions with such parties.

 

J.                Commitments and Contingencies:

 

Peruvian Operations

 

Royalty charge-

 

In June 2004, the PeruvianCongress enacted legislation imposing a royalty charge to be paid by miningcompanies in favor of the regional governments and 

 

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communities where miningresources are located.  Under the newlaw, the Company is subject to a 1% to 3% royalty, based on sales, applicableto the value of the concentrates produced in our Toquepala and Cuajone mines.  The Company made provisions of $28.2 millionand $15.6 million in the first six months of 2006 and 2005 respectively, forthis royalty.  These provisions areincluded in “Cost of sales (exclusive of depreciation, amortization anddepletion)” on the condensed consolidated combined statement of earnings.

 

In April 2005, aConstitutional Tribunal ruled the law constitutional and additionally statedthat the royalty charge applies to all concessions held in the mining industry,implying that those entities with tax stability contracts are subject to thischarge.  In 1996, the Company enteredinto a tax stability contract with the Peruvian government (a “Guarantee andPromotional Measures for Investment Contract”), relating to our solventextraction and electrowinning (“SX/EW”) production, which agreement  purports to, among other things, fix taxrates and other charges relating to such production.  The Company believes that the ConstitutionalTribunal’s interpretation relating to entities with tax stability contracts isincorrect and intends to protest the imposition of the royalty charge on SX/EWproduction, when and if assessed. Provisions made by the Company for the royalty charge do not includeapproximately $9.8 million of additional potential liability relating to itsSX/EW production from June 30, 2004 through June 30, 2006.

 

Power purchase agreement-

 

In 1997, SCC sold its Ilopower plant to an independent power company, Enersur S.A. (“Enersur”), for$33.6 million.  In connection with thesale, a power purchase agreement was also completed under which SCC agreed topurchase all of its power needs for its Peruvian operations from Enersur fortwenty years, commencing in 1997.

 

The Company agreed to amendits power purchase agreement in June 2003, resolving certain issues that arosebetween the parties and reducing power costs for the remaining life of theagreement.  The Company made a one-timecontractual payment of $4.0 million to Enersur under the terms of the newagreement.  The new agreement releasesEnersur from the obligation to construct additional capacity upon notice tomeet the Company’s increased electricity requirements from the plannedexpansion and modernization.  SCCbelieves it can satisfy the need for increased electricity requirements fromother sources, including local power providers.

 

Environmental matters-

 

The Company’s operations aresubject to applicable Peruvian environmental laws and regulations.  The Peruvian government, through its *Ministerio de Energía y Minas* (the Ministry of Energy andMines, or “MEM”) conducts certain annual audits of the Company’s Peruvianmining and metallurgical operations. Through these environmental audits, matters related to environmentalcommitments, compliance with legal requirements, atmospheric emissions andeffluent monitoring are reviewed.  TheCompany believes that it is in material compliance with applicable Peruvianenvironmental laws and regulations.

 

In accordance with Peruvianregulations, in 1996 SCC submitted its *Programa de Adecuación yManejo Ambiental* (the Environmental Compliance and ManagementProgram, known by its Spanish acronym, PAMA) to the MEM. A third-partyenvironmental audit was conducted in order to elaborate the PAMA.  The PAMA applied to all current operationsthat did not have an approved environmental impact study at the time.  SCC’s PAMA was approved in January 1997 andcontains 34 mitigation measures and projects necessary to (1) bring theexisting operations into compliance with the environmental standardsestablished by the 

 

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MEM and (2) identify areasimpacted by operations that are no longer active and need to be reclaimed orremedied.  By the end of 2005, 31 ofthese projects were completed, including all PAMA commitments related to theCompany’s operations in Cuajone and Toquepala. The three pending PAMA projects all relate to the Ilo smelteroperations.  The primary areas ofenvironmental concern are the smelter reverberatory slag eroded from slagdeposits up until 1994, and atmospheric emissions from the Ilo smelter.

 

The slag remediation programis progressing as scheduled and is expected to be completed by January2007.  With respect to the smelteremissions, the third phase of the Ilo modernization has started and isscheduled to be completed by January 2007. In July 2003, the Company awarded the contract to provide the technologyand basic engineering for the modernization of the Ilo smelter to Fluor ChileS.A. and Xtrata plc (formerly M.I.M. Holdings Limited).  The Company believes that the selectedproposal complies with the current environmental regulations.  This project is the Company’s largestshort-term capital investment project and is estimated at $500 million,including $474.9 million expended through June 2006 (which includes $47.3million of capitalized interest not included in the budget).  Beginning in 1995 and continuing while thisproject is under construction, the Company established an emissions curtailmentprogram that has allowed SCC to comply with the annual sulfur dioxide airquality standard (established by the MEM in 1996) in the populated areas of thecity of Ilo.

 

In 2003, the PeruvianCongress published a new law announcing future closure and remediationobligations for the mining industry.  Thelaw was amended in May 2004 and again in May 2005.  The current modification establishes thatmining companies submit their mine closure plans within one year of publicationof final regulations.  On August 16, 2005final regulations were published and the Company has initiated the preparationof the required mine closure plan. This plan will include the estimated costrequired for the Peruvian operations, including cost at the Ilo smelter andrefinery, tailings disposal and the dismantling of the Toquepala and Cuajone concentrators,shops and auxiliary services.  As part ofthe law and the qualifying regulations the Company is also required to engagean independent consulting entity to prepare the mine closure plan.  In April 2006, the Company selected WalshPeru S.A., a Peruvian subsidiary of Walsh Environmental Scientists andEngineers, Inc. (Boulder, Colorado), and the Mines Group Inc (Reno, Nevada),both independent consultants, to work in the development of the Mine ClosurePlan, which is currently under review. The plan, which must be submitted in August 2006, is subject to approvalby MEM and open to public discussion and comment in the area of Companyoperations.  Additionally, the lawrequires companies to provide financial guarantees to insure that remediationprograms are completed.  The Companybelieves the liability for these asset retirement obligations cannot currentlybe precisely measured, or estimated, until the Company has completed its mineclosure plan and is reasonably confident that it will be approved by MEM inmost material respects.  However, theCompany has made a preliminary estimate of this liability and has recorded suchamount in its financial statements.  Asof June 30, 2006, the Company has recorded $5.5 million for thisliability.  The Company believes thatthis estimate should be viewed with caution, pending final approval of its mineclosure plan, expected later in 2006.

 

For the Company’s Peruvianoperations, environmental capital expenditures were $86.4 million and $65.3million in the first six months of 2006 and 2005, respectively.  The Company expects to spend approximately$148.2 million for environmental capital expenditures in 2006, for the Ilosmelter modernization project.

 

13

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Mexican operations-

 

Environmental matters-

 

The Company’s operations aresubject to applicable Mexican federal, state and municipal environmental laws,to Mexican official standards, and to regulations for the protection of theenvironment, including regulations relating to water supply, water pollution,air pollution, noise pollution and hazardous and solid wastes.  Some of these laws and regulations arerelevant to legal proceedings pertaining to the Company’s San Luis Potosifacilities.

 

The principal legislationapplicable to the Company’s Mexican operations is the federal *Ley General del Equilibrio Ecológico y la Protección al Ambiente*(the General Law of Ecological Balance and Environmental Protection, or theEnvironmental Law), which is enforced by the *ProcuraduríaFederal de Protección al Ambiente* (Federal Bureau of EnvironmentalProtection or the PROFEPA).  The PROFEPAmonitors compliance with environmental legislation and enforces Mexicanenvironmental laws, regulations and official standards and, if warranted, thePROFEPA may initiate administrative proceedings against companies that violateenvironmental laws, which in the most egregious cases may result in thetemporary or permanent closing of non-complying facilities, the revocation ofoperating licenses and/or other sanctions or fines.  Also, according to the *Código PenalFederal* (Federal Criminal Code), the PROFEPA must informcorresponding authorities regarding environmental crimes.

 

Mexican environmentalregulations have become increasingly stringent over the last decade, and thistrend is likely to continue and has been influenced by the environmentalagreement entered into by Mexico, United States and Canada in connection withNAFTA in February 1999.  However, theCompany’s management does not believe that continued compliance with theEnvironmental Law or Mexican state environmental laws will have a materialadverse effect on the Company’s business, properties, result of operations,financial condition or prospects or will result in material capitalexpenditures.  Although the Companybelieves that all of its facilities are in material compliance with applicableenvironmental, mining and other laws and regulations, the Company cannot assureyou that stricter enforcement of existing laws and regulations or the adoptionof additional laws and regulations would not have a material adverse effect onthe Company’s business, properties, results of operations, financial conditionor prospects.

 

Due to the proximity ofcertain facilities of Minera Mexico to urban centers, the authorities mayimplement certain measures that may impact or restrain the operation of suchfacilities.  Any enforcement action toshut down any such facilities may have an adverse effect on the operatingresults of the relevant subsidiary.

 

The Company has institutedextensive environmental conservation programs at its mining facilities in Peruand Mexico.  The Company’s environmentalprograms include water recovery systems to conserve water and minimizecontamination of nearby streams, reforestation programs to stabilize thesurfaces of the tailings dams and the implementation of scrubbing technology inthe mines to reduce dust emissions.

 

For the Company’s Mexicanoperations, environmental capital expenditures were $2.5 million and $0.9million in the first six months of 2006 and 2005, respectively.  Approximately $25.7 million has been budgetedfor environmental capital expenditures in 2006, 77% of which belongs toprojects at La Caridad mine which have been delayed as a result of the mineclosure.

 

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Litigation matters-

 

Peruvian operations-

 

Garcia-Ataucuriand Others vs. SCC:  In April 1996, the Company was served with acomplaint filed in Peru by approximately 800 former employees seeking thedelivery of a substantial number of “labor shares” (*accioneslaborales*) of its Peruvian Branch plus dividends on such shares, tobe issued in a proportional way to each former employee in accordance withtheir time of work with SCC’s Branch in Peru.

 

The Company conducts itsoperations in Peru through a registered Branch. Although the Branch has neither capital nor liability separate from thatof the Company, under Peruvian law it is deemed to have an equity capital forpurposes of determining the economic interest of the holders of the laborshares.  The labor shares litigation isbased on claims of former employees for ownership of labor shares issued duringthe 1970s until 1989 under a former Peruvian mandated profit sharing system. In1971, the Peruvian Government enacted legislation providing that workers in themining industry would participate in the pre-tax profits of the enterprises forwhich they worked at a rate of 10%.  Thisparticipation was distributed 40% in cash and 60% as an equity interest in theenterprise. Under the law, the equity participation was originally delivered tothe “Mining Community”, an organization representing all workers.  The cash portion was distributed to theworkers after the close of the year.  Theaccrual for this participation was (and continues to be) a current liability ofthe Company, until paid.  In 1978, thelaw was amended and the equity distribution was calculated at 5.5% of pre-taxprofits and was made to individual workers of the enterprise in the form of “laborshares” to be issued in Peru by the Peruvian Branch of SCC.  These labor shares represented an equityinterest in the enterprise.  In addition,according to the 1978 law, the equity participations previously distributed tothe “Mining Community” were returned to the Company and redistributed in theform of labor shares to the individual employees or former employees.  The cash participation was adjusted to 4.0%of pre-tax earnings and continued to be distributed to employees following theclose of the year.  Effective in 1992,the law was amended to its present status, and the workers’ participation inpre-tax profits was set at 8%, with 100% payable in cash.  The equity participation component waseliminated from the law.

 

In 1995, the Company offeredto exchange new common shares of the Company for the labor shares issued underthe prior Peruvian law.  Approximately80.8% of the issued labor shares were exchanged for the Company’s commonshares, greatly reducing the minority interest on the Company’s balance sheet.What remains of the workers’ equity participation is now included in thecondensed consolidated balance sheet under the caption “Minority Interest”. AtJune 30, 2006, the labor share minority interest in the Company’s PeruvianBranch amounted to 0.71%.

 

Since 1995, the Company hasperiodically purchased labor shares on the open market.

 

In relation to the issuanceof “labor shares” by the Branch in Peru, the Corporation is a defendant in thefollowing lawsuits:

 

1)              As stated above, in April 1996, the Companywas served with a complaint filed in Peru by approximately 800 formeremployees, (García Ataucuri and others vs. SCC), seeking the delivery of38,763,806.80 “labor shares” (acciones laborales) (or S/. 3,876,380,679.56), asrequired by Law # 22333, to be issued in a proportional way to each formeremployee or worker in accordance with their time of work with SCC’s Branch inPeru, plus dividends on such shares. This amount corresponds to the totalnumber of labor shares for all of the Company’s Peruvian workers, and thecomplaint is seeking to have labor shares 

 

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issued to the plaintiffsproportionally to each in accordance with their time of work with the Company,plus dividends on such labor shares. In December 1999, a civil court of firstinstance of Lima decided against the Company, ordering the delivery of thelabor shares and dividends to the plaintiffs. The Company appealed this decision in January 2000.  On October 10, 2000, the Superior Court ofLima affirmed the lower court’s decision, which had been adverse to theCompany.  On appeal by the Company, thePeruvian Supreme Court annulled the proceeding noting that the civil courtslacked jurisdiction and that the matter had to be decided by a labor court. OnMarch 8, 2002, Mr. García Ataucuri restated the claim to comply with Peruvianlabor law and procedure requirements, and increased the number of plaintiffs toapproximately 958 ex-workers.  The lowerlabor judge dismissed the lawsuit in January 2005.  The plaintiffs have appealed to the LimaLabor superior court.

 

2)              Additionally, on May 10, 2006, the Companywas served with a new complaint filed in Peru, this time by 44 formeremployees, (Cornejo Flores and others vs. SCC), of the Company seeking deliveryof (1) labor shares (or shares of whatever other current legaldenomination)corresponding to years 1971 to December 31,1977 (we understand theplaintiffs are seeking the same 38,763,806.80 labor shares mentioned in the priorlawsuit), that should have been issued in accordance with Law # 22333, plusinterest” and (2) labor shares resulting from capital increases made by theBranch in 1980 “...for the amount of the workers’ participation of S/.17,246,009,907.20, equivalent to 172,460,099.72 labor shares”, plus dividends.On May 23, 2006, the Company answered this new complaint, denying the validityof the claim.

 

These two (2) complaints aresimilar to an April 1996 lawsuit filed by Mr. Garcia Ataucuri and othersseeking delivery of 38,763,806.80 labor shares plus dividends and S/.1,118,439,980.23 in labor shares resulting from capital increases made by theBranch. This case was dismissed on August 21, 1997 and the dismissal confirmedon appeal.

 

It should be noted thatthese two (2) lawsuits refer to the original Peruvian currency called “sol deoro,” which was later changed to the “new sol.”   One billion of soles de oro is equivalent totoday’s one new sol.  The labor sharesare currently called investment shares.

 

The Company asserts that theclaims are meritless and that the labor shares were distributed to the formeremployees in accordance with the law, then in effect Peruvian profit sharingsystem. We do not believe that an unfavorable outcome is reasonably possible.The Company has not made a provision for these lawsuits because it believesthat it has meritorious defenses to the claims asserted in the complaints.

 

Class actions

 

Three purported class actionderivative lawsuits have been filed in the Delaware Court of Chancery (NewCastle County) late in December 2004 and early January 2005 relating to theacquisition of Minera Mexico by SCC.  OnJanuary 31, 2005, the three actions Lemon Bay, LLP v. Americas MiningCorporation, et al., Civil Action No. 961-N, Therault Trust v. Luis PalominoBonilla, et al., and Southern Copper Corporation, et al., Civil Action No.969-N, and James Sousa v. Southern Copper Corporation, et al., Civil Action No.978-N were consolidated into one action titled, In re Southern CopperCorporation Shareholder Derivative Litigation, Consol.  C. A. No. 961-N and the complaint filed inLemon Bay was designated as the operative complaint in the consolidatedlawsuit.  The consolidated actionpurports to be brought on behalf of the Company’s common stockholders.

 

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The consolidated complaintalleges, among other things, that the acquisition of Minera Mexico is theresult of breaches of fiduciary duties by the Company’s directors and is notentirely fair to the Company and its minority stockholders.  The consolidated complaint seeks, among otherthings, a preliminary and permanent injunction to enjoin the acquisition, theaward of damages to the class, the award of damages to the Company and suchother relief that the court deems equitable, including interest, attorneys’ andexperts’ fees and costs.  The Companybelieves that this lawsuit is without merit and is vigorously defending itselfagainst this action.

 

The Company’s managementbelieves that the outcome of the aforementioned legal proceeding will not havea material adverse effect on the Company’s financial position or results ofoperations.

 

Mexican operations-

 

The Mexican GeologicalServices (MGS) Royalties:

 

When Mexcobre originallyreceived mining concessions related to its La Caridad unit in 1970, it wasrequired to pay royalties to MGS (formerly named the Council of MineralResources - COREMI).  When the Mining Lawcame into effect in 1992, it was believed that this obligation wasterminated.  However, MGS, the MexicanSuperintendent of Mining and the Mexican Secretary of Economy, did not concedethat the royalty obligation of MGS was terminated and in 1995, MGS initiated aseries of legal actions.  In August 2002,MGS filed with the Third Federal District Judge in Civil Matters, an actiondemanding from Mexcobre the payment of royalties since 1997.  Mexcobre answered and denied MGS’s claims inOctober 2002.  In December 2005, Mexcobresigned an agreement with MGS.  Under theterms of this agreement the parties established a new procedure to calculatethe royalty payments applicable for 2005 and the following years, and theCompany paid in January 2006, $6.9 million of royalties for 2005 and $8.5million as payment on account of royalties from the third quarter 1997 throughthe last quarter of 2004.  We estimatethat the payment made on January 11 will cover 100% of the royalty paymentsrequired for past periods.  On an ongoingbasis the Company will be required to pay a 1% royalty on La Caridad’s copperproduction value after deduction of treatment and refining charges and certainother carrying costs.

 

San Luis Potosi Facilities:

 

The municipality of San LuisPotosi has granted Desarrolladora Intersaba, S.A. de C.V., licenses for use ofland and construction for housing and/or commercial zones in the former EjidoCapulines, where the residential project “Villa Magna” is expected to bedeveloped in the near future.

 

The “Villa Magna”residential project will be developed within an area that IMMSA’s approved RiskAnalysis by SEMARNAT (the federal environmental authority) has secured as asafeguard and buffer zone due to the use by IMMSA of Anhydrous Ammonia Gas.

 

Based on the foregoing,IMMSA has initiated two different actions regarding this matter:

 

(1)                    First, against the municipality of San LuisPotosi, requesting the annulment of the authorization and licenses granted toDesarrolladora Intersaba S.A. de C.V. to develop “Villa Magna” within the zincplant’s safeguard and buffer zone; and

 

(2)                    second, filed before SEMARNAT a request for adeclaration of a safeguard and buffer zone surrounding IMMSA’s zinc plant.

 

17

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These actions are awaitingfinal resolutions.  IMMSA believes that,should the outcome of the above mentioned legal proceedings be adverse to IMMSA’sinterests, the construction of the “Villa Magna” housing and commercialdevelopment would not, in itself, affect the operations of IMMSA’s zinc plant.

 

In addition to theforegoing, IMMSA has initiated a series of legal and administrative proceduresagainst the Municipality of San Luis Potosi due to its refusal to issue IMMSA’suse of land permit in respect to its zinc plant.  The Municipality has refused to grant suchlicense based on the argument that IMMSA has failed to submit, as part of theapplication process, a “*manifestación de impactoambiental*” (environmental impact assessment).  IMMSA believes that the environmental impactassessment is not required because IMMSA will not undertake constructionactivities.  The trial judge has orderedthe Municipality to continue the analysis of IMMSA’s request to issue the “*licencia de uso de suelo*” (use of land permit).  The municipality has refused to issue theland use permit.  IMMSA has filed arequest for relief against such resolution to compel the court to issue theland use permit.

 

Additionally, on May 11,2006 the municipality of San Luis Potosi published regulations regardingcommercial, industrial and rendering services activities, which entered intoforce on May 12, 2006.  These regulationsestablish the obligation to obtain within 30 days of the publication, amunicipal license to operate said activities. After the publication it was known that it would also cover any localenvironmental and health activities.

 

IMMSA, due to itsactivities, has always been legally considered a federally regulatedcorporation, and the Company has initiated legal actions against theregulations mentioned above.

 

Tax contingency matters-

 

U.S. Internal Revenue Service(IRS)

 

The Company is regularlyaudited by the federal, state and foreign tax authorities both in the UnitedStates and internationally.  These auditscan result in proposed assessments.  In2002, IRS issued a preliminary Notice of Proposed Adjustment for the years 1994through 1996.  In 2003, the Companysettled these differences with the IRS and made a payment of $4.4 million,including interest.  Generally, the years1994 through 1996 are now closed to further adjustment.

 

The IRS completed field auditwork for all years preceding 2003 and currently is auditing 2003 and 2004.  During the audit of the tax years 1997through 1999, the IRS questioned the Company’s accounting policy fordetermination of useful lives for depreciable property, the calculation ofdeductible and creditable Peruvian taxes, the methodology of capitalizinginterest and the capitalizing of certain costs (drilling, blasting and hauling)into inventory value as items for possible adjustment.  In the fourth quarter of 2003, the Companyand the IRS had jointly requested technical advice from the IRS National Officeto help resolve the inventory value dispute. In August 2005 the National Office of the IRS responded to the IRS fieldaudit group’s request for technical advice. The issuance of this technical advice memorandum (TAM) allowed the IRSto close the field audit work for the audit cycles 1997 through 1999 and 2000through 2002.  The TAM accepts theposition of the IRS field office and concludes that the Company is required tocapitalize the drilling, blasting and hauling costs of material transported toits leach dumps based on the weight of material moved, without regard to metalcontent or recoverability.

 

18

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On October 5, 2005 theCompany filed a formal protest with the IRS to appeal the proposed changes withrespect to the TAM conclusion, as well as other items of adjustment proposed bythe IRS field audit group.  These otheradjustments include the methodology of capitalizing interest, the determinationof useful lives for depreciable property, the calculation of deductible andcreditable Peruvian taxes and the established service fee between the Companyand related parties.  The Company believesthat the positions that it is reporting to the IRS are correct andappropriate.  The Company believes thatit has substantial defenses to the proposed IRS adjustments and that adequateprovisions have been made so that resolution of any issues raised by the IRSwill not have a material adverse effect on its financial condition or resultsof operations.  A pre-conference with theIRS Appeals Office has been scheduled for late August 2006.  A review by the Appeals Office will commenceafter this meeting.  Significantmanagement judgment is required in determining the provision for taxcontingencies.  The estimate of theprobable cost for resolution of the tax contingencies has been developed inconsultation with legal and tax counsel. The Company does not believe that there is a reasonable likelihood thatthere is an exposure to loss in excess of the amounts accrued.

 

Peruvian operations:

 

In Peru the *Superintendencia Nacional de Administración Tributaria*(SUNAT), the Peruvian Tax Administration, regularly audits the Company.  These audits can result in proposedassessments.

 

1)                In 2002 the Company received assessments and penalties from SUNAT for fiscalyears 1996 through 1999, in which several deductions taken weredisallowed.  SUNAT has challenged theCompany’s depreciation method and deduction of other expenses related tocharges incurred outside of Peru from 1996 through 1999, and the deduction ofcertain exchange differences and interest expenses from 1997 through 1999.  The Company appealed these variousassessments and resolution is still pending.

 

In February 2003, thePeruvian tax court confirmed SUNAT’s assessments and penalties with regard todepreciation and deductions of other expenses incurred outside of Peru forfiscal years 1996 and 1997. Consequently, the Company recognized an additional tax and workers’participation liability for fiscal years 1998 and 1999 on the amounts assessedby SUNAT.  Therefore, in 2003 the Companyrecorded a charge to workers’ participation, included in cost of sales(exclusive of depreciation amortization and depletion) on the statement ofearnings and income tax expense of $0.5 million and $4.4 million,respectively.  The Company, however, hasnot recognized a liability for penalties and interest assessed by SUNAT inconnection with the depreciation and other expenses deduction as it considersthey are not applicable.  The status ofthe penalty appeals and other tax contingencies is as follows:

 

a) Year 1996:  With regard to the appeal of the penaltyrelated to fiscal year 1996, the Company was required to issue a letter ofcredit to SUNAT of $3.4 million, which was issued in July 2003.  This deposit is recorded in other assets onthe condensed consolidated balance sheet. The Peruvian tax court denied the Company’s appeal in February2004.  Consequently, in April 2004, theCompany filed a lawsuit against the Peruvian tax court and SUNAT in thesuperior court of Peru.  The Company wasnot required to issue a deposit for appeal of assessments and rulings withrespect to any other years.  In September2005, the Superior Court declared the Company’s claim valid.  SUNAT has appealed this decision to theSupreme Court in Lima.

 

b) Year 1997:  With regard to the penalty issued by SUNATrelated to fiscal year 1997, in November 2002 the Peruvian tax court indicatedthat the penalty needed to be modified and declared the previously issuedpenalty null.  Consequently, 

 

19

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SUNAT issued a new penaltyin December 2003.  This penalty andpenalties related to fiscal years 1998 and 1999 have been protested beforeSUNAT.  The Company’s appeal before thePeruvian tax court related to the assessments (pertaining to the deduction ofcertain interest expense) for fiscal year 1997 was denied.  In this regard, in May 2003, the Companyfiled a lawsuit before the superior court against SUNAT and the Peruvian taxcourt, seeking the reversal of the ruling of the tax court.  In July, 2005 the Superior Court remanded thecase to SUNAT for a new pronouncement. SUNAT has appealed the court’s decision to the Supreme Court in Lima.

 

c) SUNAT has not ruled onthe interest deductions for 1998 or 1999.

 

d) The Company has notrecorded any expense associated with the assessment challenging deductions ofinterest expense for the years 1997, 1998, nor has the Company recorded anyexpense associated with the assessments for the years 2000 and 2001.

 

e) Years 1998 and 1999:  The Company’s appeal is still pendingresolution by SUNAT.

 

In December 2004 and January2005, the Company received assessments and penalties from SUNAT for the fiscalyears 2000 and 2001, in which certain deductions taken by the Company weredisallowed.  SUNAT has objected to theCompany’s method of deducting vacation pay accruals in 2000, a deduction in2000 for a fixed asset write-off, as well as certain other deductions in bothyears.  The Company has appealed theseassessments and resolution is still pending. Additionally, the Company received penalties and assessments from SUNATrelating to treatment of foreign exchange differences for 2000 and 2001.  The Company has appealed these assessmentsand resolution is still pending.

 

In June 2006, a resolutionof the fiscal court was published which found in favor of the tax payer, thatprofits related to foreign exchange differences need not be included incalculations for monthly advance tax payments. This resolution is mandatory in future cases.  Therefore, the Company expects that theportion of the 2000/2001 tax assessment related to foreign exchange differencewill be removed from the assessment.

 

Mexican operations

 

Labor matters-

 

During the first half of2006, there were a number of work stoppages at some of the Company’s Mexicanoperations.  While some of these workstoppages were of a short-term nature with little or no production loss, othershave been more disruptive.  An illegalwork stoppage at the La Caridad copper mine in Sonora began in the firstquarter of 2006 and ended when the mine was returned to the Company on July 26,2006.  An illegal work stoppage at the SanMartin polymetallic complex in Zacatecas commenced in the first quarter of 2006and ended in May 2006.  Additionally,workers at the Cananea copper mine went on an illegal work stoppage on June 1,2006 returning to work six weeks later on July 17, 2006.  These work stoppages have been declaredillegal by the Mexican authorities.  OnJune 9, 2006, the Company announced the closing of the La Caridad mine aspicketing workers made it impossible to continue operations. As a result ofthese illegal work stoppages, the Company declared “force majeure” on certainof its June and July copper contracts. On July 14, 2006, with the approval of a Labor Court, the Company firedthe La Caridad workers. Individual work agreements, and the collective unioncontract, were terminated in compliance with the provisions of the rulingrendered by federal labor authorities. On July 26, 2006, the La Caridadinstallations were returned to the Company and the Company commenced to hireworkers to resume operations. The Company intends to 

 

20

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reopen this mining unit witha structure that would eliminate the obstacles hampering productivity andpermit the Company to continue to implement modern mechanisms similar to thosein other mines worldwide to improve productivity at La Caridad.

 

Additionally, in recentyears the Company has experienced a number of strikes or other labordisruptions that have had an adverse impact on its operations and operatingresults.  For example, in Peru on August31, 2004, unionized workers at the mining units in Toquepala and Cuajoneinitiated strike and sought additional wage increases based on high metalprices.  In Mexico, on July 12, 2004, theworkers of La Caridad went on strike asking for the review of certaincontractual clauses.  Such a review wasperformed and the workers returned to work 18 days later.  On October 15, 2004, the workers of Cananeawent on strike, followed by La Caridad workers. The strike lasted for six days at La Caridad and nine days atCananea.  In each case, the operations atthe particular mine ceased until the strike was resolved.  The Company cannot give assurances that theywill not experience strikes or other labor-related work stoppages in the futurethat could have a material adverse effect on its financial condition andresults of operations.

 

Mine accident-

 

On February 19, 2006 anexplosion occurred at the IMMSA unit’s Pasta de Conchos coal mine, located inSan Juan de Sabinas, Coahuila, Mexico. Immediately, IMMSA along withneighboring industry initiated a rescue effort. Federal and local governmental help and support was received.  As a result of the accident 8 miners wereinjured and 65 perished.

 

The Coahuila public districtattorney (*Procurador de Justicia*) initiated aninvestigation to establish (1) the causes of the accident and (2) theresponsible party.  The investigation isunderway; however, it will be necessary for the investigation team to haveaccess to the site where the explosion occurred, which at present isblocked.  Recovery efforts are alsocontinuing, however progress is very slow as access is blocked by debris androcks.  It may take a further 3 to 6months to complete this effort.  Theunderground coal mining operations at Pasta de Conchos have been suspended andit is uncertain when such operations will resume.

 

Other legal matters-

 

The Company is involved invarious other legal proceedings incidental to its operations, but the Companydoes not believe that decisions adverse to it in any such proceedingsindividually or in the aggregate would have a material adverse effect on itsfinancial position or results of operations.

 

Our direct and indirectparent corporations, including AMC and Grupo Mexico, have from time to timebeen named parties in various litigations involving Asarco.  In March 2003, AMC purchased its interest inSCC from Asarco.  In August 2002 the U.S.Department of Justice brought a claim alleging fraudulent conveyance inconnection with AMC’s then-proposed purchase of SCC from Asarco.  That action was settled pursuant to a ConsentDecree dated February 2, 2003.  Theconsent decree is binding solely on the U.S. government.  In October 2004, AMC, Grupo Mexico, Mexicanade Cobre and other parties, not including SCC, were named in a lawsuit filed inNew York State court in connection with alleged asbestos liabilities, whichlawsuit claims, among other matters, that AMC’s purchase of SCC from Asarcoshould be voided as a fraudulent conveyance. While Grupo Mexico and its affiliates believe that these claims arewithout merit, we cannot assure you that these or future claims, if successful,will not have an adverse effect on the Company’s parent corporation or theCompany.  Any increase in the financialobligations of the Company’s parent corporation, as a result of matters related

 

21

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to Asarco or otherwisecould, among other matters, result in the Company’s parent corporationattempting to obtain increased dividends or other funding from the Company.  In 2005, certain subsidiaries of Asarco filedbankruptcy petitions in connection with alleged asbestos liabilities.  In July 2005, the unionized workers of Asarcocommenced a work stoppage, which was settled in November 2005.  As a result of various factors, including theabove-mentioned work stoppage, on August 9, 2005 Asarco filed a voluntarypetition for relief under Chapter 11 of the U.S. Bankruptcy Code before theU.S. Bankruptcy Court in Corpus Christi, Texas. Asarco’s bankruptcy case is being joined with the bankruptcy cases ofits subsidiaries.  Asarco is operatingand managing its businesses as a debtor in possession.  Asarco LLC’s bankruptcy could result inadditional claims being filed against Grupo Mexico and its subsidiaries,including SCC, Minera Mexico or its subsidiaries.

 

Asarco has informed us thatit believes that by utilizing the Chapter 11 process it can achieve an orderlyrestructuring of its business and finally resolve, among other contingencies,its environmental and asbestos claims. However, it is impossible to predict how the bankruptcy court willultimately rule with respect to such petitions and the impact such rulings willhave on Asarco and its subsidiaries.

 

K.            Segment and Related Information:

 

The Company operates in asingle industry, namely mining copper. Prior to April 1, 2005 acquisition of Minera Mexico, the Companydetermined that its operations in Peru fell within one segment.  With the acquisition of Minera Mexico theCompany continues to operate principally in one industry, the mining ofcopper.  However, because of the demandsof managing operations in two countries, effective April 1, 2005 Companymanagement views the new Southern Copper as having three operating segments andmanages on the basis of these segments. Additionally, in mining copper, the Company produces a number ofby-products, most important of which are molybdenum, silver and zinc.  The significant increase in the price ofmolybdenum over the past two years has had an important impact on the Company’searnings.  Nevertheless, the Companycontinues to manage its operations on the basis of the three coppersegments.  Added to the segmentinformation is the information regarding the Company’s molybdenum sales.  The segments identified by the Company are:

 

1.               Peruvian operations, which includes theToquepala and Cuajone mine complexes and the smelting and refining plants,industrial railroad and port facilities which service both mines.

 

2.               Mexican open pit copper mines, which includesLa Caridad and Cananea mine complexes and the smelting and refining plants andsupport facilities which service both mines.

 

3.               Mexican underground mining operations, whichincludes five underground mines that produce zinc, copper, silver and gold, acoal and coke mine, and several industrial processing facilities for zinc andcopper.  This group is identified as theIMMSA unit.

 

The Chief Operating Officerof the Company focuses on operating income as a measure of performance toevaluate different segments, and to make decisions to allocate resources to thereported segments.

 

22

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Financial informationrelating to Southern Copper’s segments is as follows:

 
| ** **                                                             | ** ** | **Three Months Ended June 30, 2006** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                             | ** ** | **(in millions)**                                        | ** ** |
| ** **                                                             | ** ** | **Mexican  Open Pit**                                    | ** ** | **Mexican  IMMSA Unit** | ** ** | **Peruvian  Operations** | ** ** | **Corporate  and other  Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                                   |       |                                                          |       |   |   |   |   |   |   |   |   |
| Net sales outside of segments                                          |       | $                                                             | 336.5      |   | $ | 153.5 |   | $ | 786.7 |   | $ | — |   | $ | 1,276.7 |   |
| Intersegment sales                                                     |       | 63.7                                                          |       | 8.3 |   | — |   | (72.0 | ) |   |   |
| Cost of sales (exclusive of depreciation,  amortization and depletion) |       | 200.7                                                         |       | 86.8 |   | 286.7 |   | (52.4 | ) | 521.8 |   |
| Selling, general and administrative expense                            |       | 8.5                                                           |       | 5.2 |   | 9.7 |   | (0.1 | ) | 23.3 |   |
| Depreciation, amortization and depletion                               |       | 50.1                                                          |       | 7.2 |   | 20.3 |   | 0.4 |   | 78.0 |   |
| Exploration                                                            |       | 0.1                                                           |       | 1.3 |   | 3.2 |   | — |   | 4.6 |   |
| Operating income                                                       |       | 140.8                                                         |       | 61.3 |   | 466.8 |   | (19.9 | ) | 649.0 |   |
| Less:                                                                  |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest, net                                                          |       |                                                          |       |   |   |   |   |   |   | (7.3 | ) |
| Loss on debt prepayment                                                |       |                                                          |       |   |   |   |   |   |   | (0.9 | ) |
| Other income (expense)                                                 |       |                                                          |       |   |   |   |   |   |   | 8.5 |   |
| Taxes on income                                                        |       |                                                          |       |   |   |   |   |   |   | (207.9 | ) |
| Minority interest                                                      |       |                                                          |       |   |   |   |   |   |   | (2.1 | ) |
| Net earnings                                                           |       |                                                          |       |   |   |   |   |   |   | $ | 439.3 |   |
|                                                                   |       |                                                          |       |   |   |   |   |   |   |   |   |
| Capital expenditure                                                    |       | $                                                             | 37.2       |   | $ | 11.8 |   | $ | 38.6 |   | $ | — |   | $ | 87.6 |   |
| Property, net                                                          |       | $                                                             | 1,588.7    |   | $ | 272.5 |   | $ | 1,552.5 |   | $ | 28.8 |   | $ | 3,442.5 |   |
| Total assets                                                           |       | $                                                             | 2,531.6    |   | $ | 561.5 |   | $ | 3,101.0 |   | $ | (569.8 | ) | $ | 5,624.3 |   |

 
| ** **                                                             | ** ** | **Three Months Ended June 30, 2005** | ** ** |
|------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                             | ** ** | **(in millions)**                                        | ** ** |
| ** **                                                             | ** ** | **Mexican  Open Pit**                                    | ** ** | **Mexican  IMMSA Unit** | ** ** | **Peruvian  Operations** | ** ** | **Corporate  and other  Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                                             | ** ** | ** **                                                    | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net sales outside of segments                                          |       | $                                                             | 416.3      |   | $ | 59.9 |   | $ | 477.9 |   | $ | — |   | $ | 954.1 |   |
| Intersegment sales                                                     |       | 4.2                                                           |       | 26.5 |   |   |   | (30.7 | ) | — |   |
| Cost of sales (exclusive of depreciation,  amortization and depletion) |       | 239.1                                                         |       | 65.1 |   | 174.4 |   | (65.5 | ) | 413.1 |   |
| Selling, general and administrative expense                            |       | 6.9                                                           |       | 4.1 |   | 8.2 |   | 1.2 |   | 20.4 |   |
| Depreciation, amortization and depletion                               |       | 46.5                                                          |       | 5.9 |   | 18.5 |   | (0.4 | ) | 70.5 |   |
| Exploration                                                            |       | 1.6                                                           |       | 1.2 |   | 2.7 |   | — |   | 5.5 |   |
| Operating income                                                       |       | 126.4                                                         |       | 10.1 |   | 274.1 |   | 34.0 |   | 444.6 |   |
| Less:                                                                  |       |                                                          |       |   |   |   |   |   |   |   |   |
| Interest, net                                                          |       |                                                          |       |   |   |   |   |   |   | (15.0 | ) |
| Loss on derivative instruments                                         |       |                                                          |       |   |   |   |   |   |   | (2.6 | ) |
| Loss on debt prepayment                                                |       |                                                          |       |   |   |   |   |   |   | (6.0 | ) |
| Other income (expense)                                                 |       |                                                          |       |   |   |   |   |   |   | (0.7 | ) |
| Taxes on income                                                        |       |                                                          |       |   |   |   |   |   |   | (106.8 | ) |
| Minority interest                                                      |       |                                                          |       |   |   |   |   |   |   | (1.6 | ) |
| Net earnings                                                           |       |                                                          |       |   |   |   |   |   |   | $ | 311.9 |   |
|                                                                   |       |                                                          |       |   |   |   |   |   |   |   |   |
| Capital expenditures                                                   |       | $                                                             | 13.1       |   | $ | 5.7 |   | $ | 51.2 |   | $ | — |   | $ | 70.0 |   |
| Property, net                                                          |       | $                                                             | 1,542.6    |   | $ | 261.3 |   | $ | 1,282.4 |   | $ | 23.2 |   | $ | 3,109.5 |   |
| Total assets                                                           |       | $                                                             | 2,229.3    |   | $ | 629.4 |   | $ | 2,300.0 |   | $ | (132.0 | ) | $ | 5,026.7 |   |

 

23

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| ** **                                                             | ** ** | **Six Months Ended June 30, 2006** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                             | ** ** | **(in millions)**                                      | ** ** |
| ** **                                                             | ** ** | **Mexican  Open Pit**                                  | ** ** | **Mexican  IMMSA Unit** | ** ** | **Peruvian  Operations** | ** ** | **Corporate  and other  Eliminations** | ** ** | **Consolidated** | ** ** |
|                                                                   |       |                                                        |       |   |   |   |   |   |   |   |   |
| Net sales outside of segments                                          |       | $                                                           | 725.4      |   | $ | 270.1 |   | $ | 1,402.5 |   | $ | — |   | $ | 2,398.0 |   |
| Intersegment sales                                                     |       | 159.6                                                       |       | 25.4 |   | — |   | (185.0 | ) |   |   |
| Cost of sales (exclusive of depreciation,  amortization and depletion) |       | 384.6                                                       |       | 161.7 |   | 554.2 |   | (171.8 | ) | 928.7 |   |
| Selling, general and administrative expense                            |       | 16.3                                                        |       | 9.0 |   | 19.0 |   | 3.0 |   | 47.3 |   |
| Depreciation, amortization and depletion                               |       | 76.8                                                        |       | 14.1 |   | 40.1 |   | 0.1 |   | 131.1 |   |
| Exploration                                                            |       | 0.6                                                         |       | 3.0 |   | 5.6 |   | — |   | 9.2 |   |
| Operating income                                                       |       | 406.7                                                       |       | 107.7 |   | 783.6 |   | (16.3 | ) | 1,281.7 |   |
| Less:                                                                  |       |                                                        |       |   |   |   |   |   |   |   |   |
| Interest, net                                                          |       |                                                        |       |   |   |   |   |   |   | (15.9 | ) |
| Loss on debt prepayment                                                |       |                                                        |       |   |   |   |   |   |   | (0.9 | ) |
| Other income (expense)                                                 |       |                                                        |       |   |   |   |   |   |   | 7.5 |   |
| Taxes on income                                                        |       |                                                        |       |   |   |   |   |   |   | (407.7 | ) |
| Minority interest                                                      |       |                                                        |       |   |   |   |   |   |   | (3.8 | ) |
| Net earnings                                                           |       |                                                        |       |   |   |   |   |   |   | $ | 860.9 |   |
|                                                                   |       |                                                        |       |   |   |   |   |   |   |   |   |
| Capital expenditure                                                    |       | $                                                           | 88.0       |   | $ | 19.6 |   | $ | 123.1 |   | $ | — |   | $ | 230.7 |   |
| Property, net                                                          |       | $                                                           | 1,588.7    |   | $ | 272.5 |   | $ | 1,552.5 |   | $ | 28.8 |   | $ | 3,442.5 |   |
| Total assets                                                           |       | $                                                           | 2,531.6    |   | $ | 561.5 |   | $ | 3,101.0 |   | $ | (569.8 | ) | $ | 5,624.3 |   |

 
| ** **                                                             | ** ** | **Six Months Ended June 30, 2005** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------------------------------------------|------------|
| ** **                                                             | ** ** | **(in millions)**                                      | ** ** |
| ** **                                                             | ** ** | **Mexican  Open Pit**                                  | ** ** | **Mexican  IMMSA Unit** | ** ** | **Peruvian  Operations** | ** ** | **Corporate  and other  Eliminations** | ** ** | **Combined** | ** ** |
|                                                                   |       |                                                        |       |   |   |   |   |   |   |   |   |
| Net sales outside of segments                                          |       | $                                                           | 820.6      |   | $ | 113.1 |   | $ | 959.2 |   | $ | — |   | $ | 1,892.9 |   |
| Intersegment sales                                                     |       | 74.5                                                        |       | 129.9 |   | — |   | (204.4 | ) | — |   |
| Cost of sales (exclusive of depreciation,  amortization and depletion) |       | 493.3                                                       |       | 188.5 |   | 346.7 |   | (225.8 | ) | 802.7 |   |
| Selling, general and administrative expense                            |       | 13.0                                                        |       | 7.8 |   | 16.7 |   | 1.5 |   | 39.0 |   |
| Depreciation, amortization and depletion                               |       | 83.2                                                        |       | 11.3 |   | 37.1 |   | (0.1 | ) | 131.5 |   |
| Exploration                                                            |       | 2.4                                                         |       | 2.7 |   | 5.7 |   | — |   | 10.8 |   |
| Operating income                                                       |       | 303.2                                                       |       | 32.7 |   | 553.0 |   | 20.0 |   | 908.9 |   |
| Less:                                                                  |       |                                                        |       |   |   |   |   |   |   |   |   |
| Interest, net                                                          |       |                                                        |       |   |   |   |   |   |   | (32.5 | ) |
| Loss on derivative instruments                                         |       |                                                        |       |   |   |   |   |   |   | (2.7 | ) |
| Loss on debt prepayment                                                |       |                                                        |       |   |   |   |   |   |   | (7.7 | ) |
| Other income (expense)                                                 |       |                                                        |       |   |   |   |   |   |   | 0.2 |   |
| Taxes on income                                                        |       |                                                        |       |   |   |   |   |   |   | (252.9 | ) |
| Minority interest                                                      |       |                                                        |       |   |   |   |   |   |   | (3.0 | ) |
| Net earnings                                                           |       |                                                        |       |   |   |   |   |   |   | $ | 610.3 |   |
|                                                                   |       |                                                        |       |   |   |   |   |   |   |   |   |
| Capital expenditures                                                   |       | $                                                           | 27.8       |   | $ | 15.9 |   | $ | 101.6 |   | — |   | $ | 145.3 |   |
| Property, net                                                          |       | $                                                           | 1,542.6    |   | $ | 261.3 |   | $ | 1,282.4 |   | $ | 23.2 |   | $ | 3,109.5 |   |
| Total assets                                                           |       | $                                                           | 2,229.3    |   | $ | 629.4 |   | $ | 2,300.0 |   | $ | (132.0 | ) | $ | 5,026.7 |   |

 

24

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Sales value per segment:

 
| ** ** | ** ** | **Three Months Ended June 30, 2006** | ** ** |
|------------|------------|---------------------------------------------------------------|------------|
| ** ** | ** ** | **(in millions)**                                        | ** ** |
| ** ** | ** ** | **Mexican  Open Pit**                                    | ** ** | **Mexican  IMMSA Unit** | ** ** | **Peruvian  Operations** | ** ** | **Intersegment  Elimination** | ** ** | **Consolidated** | ** ** |
|       |       |                                                          |       |   |   |   |   |   |   |   |   |
| Copper     |       | $                                                             | 375.3      |   | $ | 32.8 |   | $ | 640.0 |   | $ | (63.2 | ) | $ | 984.9 |   |
| Molybdenum |       | 1.7                                                           |       | — |   | 125.5 |   | — |   | 127.2 |   |
| Other      |       | 23.2                                                          |       | 129.0 |   | 21.2 |   | (8.8 | ) | 164.6 |   |
| Total      |       | $                                                             | 400.2      |   | $ | 161.8 |   | $ | 786.7 |   | (72.0 | ) | $ | 1,276.7 |   |
|            |            |                                                               |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 
| ** ** | ** ** | **Three Months Ended June 30, 2005** | ** ** |
|------------|------------|---------------------------------------------------------------|------------|
| ** ** | ** ** | **(in millions)**                                        | ** ** |
| ** ** | ** ** | **Mexican  Open Pit**                                    | ** ** | **Mexican  IMMSA Unit** | ** ** | **Peruvian  Operations** | ** ** | **Intersegment  Elimination** | ** ** | **Consolidated** | ** ** |
|       |       |                                                          |       |   |   |   |   |   |   |   |   |
| Copper     |       | $                                                             | 299.7      |   | $ | 15.4 |   | $ | 290.7 |   | $ | (12.9 | ) | $ | 592.9 |   |
| Molybdenum |       | 77.9                                                          |       | — |   | 178.5 |   | — |   | 256.4 |   |
| Other      |       | 42.9                                                          |       | 71.0 |   | 8.7 |   | (17.8 | ) | 104.8 |   |
| Total      |       | $                                                             | 420.5      |   | $ | 86.4 |   | $ | 477.9 |   | $ | (30.7 | ) | $ | 954.1 |   |

 
| ** ** | ** ** | **Six Months Ended June 30, 2006** | ** ** |
|------------|------------|-------------------------------------------------------------|------------|
| ** ** | ** ** | **(in millions)**                                      | ** ** |
| ** ** | ** ** | **Mexican  Open Pit**                                  | ** ** | **Mexican  IMMSA Unit** | ** ** | **Peruvian  Operations** | ** ** | **Intersegment  Elimination** | ** ** | **Consolidated** | ** ** |
|       |       |                                                        |       |   |   |   |   |   |   |   |   |
| Copper     |       | $                                                           | 792.7      |   | $ | 57.6 |   | $ | 1,123.1 |   | $ | (148.3 | ) | $ | 1,825.1 |   |
| Molybdenum |       | 35.7                                                        |       | — |   | 225.8 |   | — |   | 261.5 |   |
| Other      |       | 56.6                                                        |       | 237.9 |   | 53.6 |   | (36.7 | ) | 311.4 |   |
| Total      |       | $                                                           | 885.0      |   | $ | 295.5 |   | $ | 1,402.5 |   | $ | (185.0 | ) | $ | 2,398.0 |   |

 
| ** ** | ** ** | **Six Months Ended June 30, 2005** | ** ** |
|------------|------------|-------------------------------------------------------------|------------|
| ** ** | ** ** | **(in millions)**                                      | ** ** |
| ** ** | ** ** | **Mexican  Open Pit**                                  | ** ** | **Mexican  IMMSA Unit** | ** ** | **Peruvian  Operations** | ** ** | **Intersegment  Elimination** | ** ** | **Combined** | ** ** |
|       |       |                                                        |       |   |   |   |   |   |   |   |   |
| Copper     |       | $                                                           | 646.6      |   | $ | 99.1 |   | $ | 562.4 |   | $ | (161.7 | ) | $ | 1,146.4 |   |
| Molybdenum |       | 153.3                                                       |       | — |   | 379.8 |   | — |   | 533.1 |   |
| Other      |       | 95.2                                                        |       | 143.9 |   | 17.0 |   | (42.7 | ) | 213.4 |   |
| Total      |       | $                                                           | 895.1      |   | $ | 243.0 |   | $ | 959.2 |   | $ | (204.4 | ) | $ | 1,892.9 |   |

 

Geographic breakdown of Southern Copper’ssales is as follows:

 
| ** **                                | ** ** | **Three Months  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|-------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                | ** ** | **(in millions)**                          | ** ** |
| ** **                                | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| United States                             |       | $                                               | 533.8      |                                          | $          | 409.2 |   | $ | 1,023.4 |   | $ | 626.7 |   |
| Europe                                    |       | 493.3                                           |       | 180.1                                         |       | 757.7 |   | 367.6 |   |
| Mexico                                    |       | 213.1                                           |       | 115.8                                         |       | 369.6 |   | 411.4 |   |
| Peru                                      |       | 30.2                                            |       | 17.3                                          |       | 55.4 |   | 31.9 |   |
| Latin America (excluding Mexico and Peru) |       | 171.3                                           |       | 184.3                                         |       | 289.6 |   | 373.2 |   |
| Asia                                      |       | 92.9                                            |       | 51.3                                          |       | 160.2 |   | 93.3 |   |
| Derivative instruments                    |       | (257.9                                          | )          | (3.9                                          | )          | (257.9 | ) | (11.2 | ) |
| Total                                     |       | $                                               | 1,276.7    |                                          | $          | 954.1 |   | $ | 2,398.0 |   | $ | 1,892.9 |   |

 

25

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Major Customer SegmentInformation:

 

For the six months endedJune 30, 2006, the Company had revenues from a copper customer of the Mexicanand Peruvian operations, which amounted to 11.9% of total revenue.

 

L.              Impact of New Accounting standards:

 

In February 2006 the FASBpublished SFAS No. 155 “Accounting for Certain Hybrid Financial Instruments” anamendment of SFAS No. 133 and 140.  Thisstatement improves financial reporting by eliminating the exemption fromapplying statement 133 to interests in securitized financial assets so thatsimilar instruments are accounted for similarly regardless of the form of theinstruments.  This statement alsoimproves financial reporting by allowing a preparer to elect fair valuemeasurement at acquisition, at issuance or when a previously recognizedfinancial instrument is subject to a remeasurement (new basis) event, on aninstrument-by-instrument basis, in cases in which a derivative would otherwisehave to be bifurcated.  Providing a fairvalue measurement election also results in more financial instruments beingmeasured at what the Board regards as the most relevant attribute for financialinstruments, fair value.  SFAS 155 willbe effective for all instruments acquired or issued after the beginning of anentity’s first fiscal year that begins after September 15, 2006.  The Company is evaluating the impact thatthis statement may have on its financial position or results of operations.

 

In March 2006 the FASBpublished SFAS No. 156 “Accounting for Servicing of Financial Assets anamendment of FASB Statement No. 140”. This statement requires that all separately recognized servicing assetsand servicing liabilities be initially measured at fair value, ifpracticable.  The Board concluded thatfair value is the most relevant measurement attribute for the initialrecognition of all servicing assets and SFAS No. 156 permits, but does not require,the subsequent measurement of servicing assets and servicing liabilities atfair value.  An entity that usesderivative instruments to mitigate the risks inherent in servicing assets andservicing liabilities is required to account for those derivative instrumentsat fair value.  Under this Statement, anentity can elect subsequent fair value measurement of its servicing assets andservicing liabilities by class, thus simplifying its accounting and providingfor income statement recognition of the potential offsetting changes in fairvalue of the servicing assets, servicing liabilities, and related derivativeinstruments.  An entity that elects tosubsequently measure servicing assets and servicing liabilities at fair valueis expected to recognize declines in fair value of the servicing assets andservicing liabilities more consistently than by reporting other-than-temporaryimpairments. The Company is evaluating the impact that this statement may haveon its financial position or results of operations.

 

The Board decided to requireadditional disclosures and separate presentation in the statement of financialposition of the carrying amounts of servicing assets and servicing liabilitiesthat an entity elects to subsequently measure at fair value to address concernsabout comparability that may result from the use of elective measurementmethods.

 

SFAS No. 156 will be adoptedby the Company as of the beginning of the fiscal year that begins afterSeptember 15, 2006. The Company is evaluating the impact that this statementmay have on its financial position or results of operations.

 

In June 2006, the FASBpublished FIN 48 “Accounting for Uncertainty in Income Taxes” —aninterpretation of FASB Statement No. 109. This interpretation clarifies theaccounting for uncertainty in income taxes recognized in an enterprise’sfinancial statements in accordance with FASB Statement No. 109, Accounting forIncome Taxes. It prescribes a recognition threshold and measurement attributefor the financial statement recognition and measurement of a tax position takenor expected to be taken 

 

26

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in a tax return. Alsoprovides guidance on derecognition, classification, interest and penalties,accounting in interim periods, disclosure, and transition.

 

An enterprise that presentsa classified statement of financial position should classify a liability forunrecognized tax benefits as current to the extent that the enterpriseanticipates making a payment within one year or the operating cycle, if longer.An income tax liability should not be classified as a deferred tax liabilityunless it results from a taxable temporary difference (that is, a differencebetween the tax basis of an asset or a liability as calculated using this Interpretationand its reported amount in the statement of financial position). ThisInterpretation does not change the classification requirements for deferredtaxes.

 

This interpretation iseffective for fiscal years beginning after December 15, 2006. Earlierapplication of the provisions of this Interpretation is encouraged if theenterprise has not yet issued financial statements, including interim financialstatements, in the period this Interpretation is adopted. The Company isevaluating the impact that this statement may have on its financial position orresults of operations.

 

27

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PartI Item 1a.  Risk Factors

 

Set forth below are certain changes from therisk factors previously disclosed in SCC’s Amendment No. 1 on Form 10-K/A forthe year ended December 31, 2005 filed on March 28, 2006 with the Securitiesand Exchange Commission.

 

***We may be adversely affected bylabor disputes.***

 

During the first half of 2006, there were anumber of work stoppages at some of our Mexican operations.  While some of these work stoppages were of ashort-term nature with little or no production loss, others have been moredisruptive. An illegal work stoppage at the La Caridad copper mine in Sonorabegan in the first quarter of 2006 and ended when the mine was returned to theCompany on July 26, 2006.  An illegalwork stoppage at the San Martin polymetallic complex in Zacatecas commenced inthe first quarter of 2006 and ended in May 2006.  Additionally, workers at the Cananea coppermine went on an illegal work stoppage on June 1, 2006, returning to work sixweeks later on July 17, 2006.  These workstoppages have been declared illegal by the Mexican authorities.  On June 9, 2006, we announced the closing ofthe La Caridad mine as picketing workers made it impossible to continueoperations.  As a result of these illegalwork stoppages, we declared “force majeure” on certain of our June and Julycopper contracts.  On July 14, 2006, withthe approval of a Labor Court, the Company fired the La Caridad workers.Individual work agreements, and the collective union contract, were terminatedin compliance with the provisions of the ruling rendered by federal laborauthorities. On July 26, 2006, the installations were returned to the Companyand the Company commenced to hire workers are being hired to resumeoperations.  The Company intends toreopen this mining unit with a structure that would eliminate the obstacleshampering productivity and permit the Company to continue to implement modernmechanisms similar to those in other mines worldwide, to improve productivityat La Caridad.  We cannot assure thatthese events or further labor disputed will not have an adverse effect on ourbusiness, results of operation or financial condition.

 

***Peruvian economic and politicalconditions may have an adverse impact on our business.***

 

On April 9, 2006, Peruvian citizensparticipated in the election for president, congress and representatives to theAndean Parliament, to be appointed for the five-year period commencing July 28,2006.  24 political parties participatedin this election process.

 

As none of the presidential candidatesreceived more than 50 percent of the valid votes; on June 4, 2006 a run-offelection between the top two vote getters was held. On June 16, 2006 theNational Office of Electoral Processes proclaimed Mr. Alan Garciapresident-elect, thereby bringing the electoral process to an end. Mr. Garciaassumed office on July 28, 2006. Mr. Garcia, a member of the APRA party, waspresident of Peru from 1985 to 1990.

 

Because we have significant operations inPeru, we cannot provide any assurance that political developments in Peru,including the 2006 presidential and congressional elections, will not have amaterial adverse effect on market conditions, prices of our securities, ourability to obtain financing, and our results of operations and financialcondition.

 

***Mexican economic and politicalconditions may have an adverse impact on our business.***

 

A general election was held in Mexico on Sunday,July 2, 2006.  Voters went to the pollsto elect, on the federal level: a new President of the Republic for six years,500 members to the Chamber of Deputies and 128 members to the Senate.  On July 6, 2006 Preliminary results declaredMr. Felipe Calderon winner of the presidential election, by a very slim margin.Mr. Calderon is a member of Partido Accion Nacional (the 

 

28

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National Action Party). Mr. Andres LopezObrador, the candidate of the Partido de la Revolucion Democratica, therunner-up to Mr. Calderon has filed challenges in many electoral districts,alleging irregularities and called for street protests. He is requesting manualballot-by-ballot recount in these districts. The Federal Electoral Tribunal,Mexico ́s highest court in electoral matters, must certify a winner by September6, 2006.

 

Because we have significant operations inMexico, we cannot provide any assurance that political developments in Mexico,including the 2006 presidential and congressional elections, will not have amaterial adverse effect on market conditions, prices of our securities, ourability to obtain financing, and our results of operations and financialcondition.

 

29

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PartI Item 2.

 

MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION

ANDRESULTS OF OPERATIONS

 

EXECUTIVE OVERVIEW

 

Our business is primarily the production andsale of copper.  In the process ofproducing copper, a number of valuable metallurgical by-products are recovered,such as molybdenum, zinc, silver, lead and gold, which we also produce andsell.  Market forces outside of ourcontrol largely determine the sales prices for our products.  Our management, therefore, focuses on copperproduction cost control, production enhancement and maintaining a prudent andconservative capital structure to improve profitability.  We believe we achieve these goals throughcapital spending programs, exploration efforts and cost reductionprograms.  Our aim is to remainprofitable during periods of low copper prices and to maximize financialperformance in periods of high copper prices.

 

We discuss below several matters that webelieve are important to understand our results of operations and financialcondition.  These matters include, (i)our “operating cash costs” as a measure of our performance, (ii) metal prices(iii) the effects of inflation and other local currency issues and (iv) ourexpansion and modernization program.

 

Operating Cash Costs.  Anoverall benchmark used by us and a common industry metric to measureperformance is operating cash costs per pound of copper produced.  Operating cash cost is a non-GAAP measurethat does not have a standardized meaning and may not be comparable tosimilarly titled measures provided by other companies.  A reconciliation of our cash cost per poundto the cost of sales (including depreciation, amortization and depletion), ispresented under the subheading “Non-GAAP Information Reconciliation”,below.  We have defined operating cashcost per pound as cost of sales (including depreciation, amortization anddepletion); plus selling, general and administrative charges, treatment andrefining charges; less by-products revenue and sales premiums, depreciationamortization and depletion, workers’ participation and other miscellaneouscharges, 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 perpound of copper produced we credit against our costs the revenues from the saleof by-products, principally molybdenum, zinc and silver and the premiums overmarket price that we receive on copper sales. We account for the by-product revenue in this way because we considerour principal business to be the production and sale of copper.  We believe that our Company is viewed by theinvestment community as a copper company, and is valued, in large part, by theinvestment community’s view of the copper market and our ability to producecopper at a reasonable cost.  We alsoinclude copper sales premiums as a credit, as these amounts are in excess ofpublished copper prices.  The recentsurge in the price of molybdenum has had a significant effect on ourtraditional calculation of cash cost and its comparability betweenperiods.  Accordingly, we present cashcosts with and without crediting the by-products revenues against our costs.

 

We exclude from our calculation of operatingcash cost depreciation, amortization and depletion, which are considerednon-cash expenses.  Exploration isconsidered a discretionary expenditure and is also excluded.  Workers’ participation provisions aredetermined on the basis of pre-tax earnings and are also excluded.  Additionally excluded from operating cashcost are items of a non-recurring nature, and the new Peruvian royalty and inperiods prior to 2006 the portion of mine stripping costs that we capitalized.

 

30

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Our operating cash costs per pound, asdefined, are presented in the table below, for the three and six months endedJune 30, 2006 and 2005.  We present cashcosts with and without the inclusion of by-product revenues.

 
| ** **                                                                        | ** ** | **Three Months  Ended June 30,** | ** ** | **Six Months  Ended June 30,** | ** ** |
|-----------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                        | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                        | ** ** | **(in cents per pound)**         | ** ** |
| Cash cost per pound of copper produced and  purchased                             |       | 36.5                                            |       | (2.9                                          | )          | 28.8 |   | (9.4 | ) |
| Cash cost per pound of copper produced and  purchased without by-products revenue |       | 129.1                                           |       | 100.6                                         |       | 122.8 |   | 98.1 |   |

 

A reconciliation of the Company’s operatingcash costs per pound to GAAP cost of sales is presented below.

 

As seen on the chart above, our per poundcash cost for the second quarter and six months of 2006 when calculated withby-products revenue is 36.5 cents and 28.8 cents respectively, compared withcredits of 2.9 cents and 9.4 cents in the second quarter and six months of2005, respectively.  The reduction inby-products credit was due to lower molybdenum prices and volume partiallyoffset by increases in silver and zinc prices. The price of molybdenum in the second quarter and six months of 2006averaged $24.22 per pound and $23.23 per pound, respectively, as compared to$34.64 per pound and $32.54 per pound in the comparable 2005 periods.    The price of zinc averaged $1.49 and $1.26per pound in the second quarter and first six months of 2006, respectiveincreases of 157% and 114% over the comparable 2005 periods.  The silver price averaged $12.22 and $10.96per ounce in the second quarter and first six months of 2006, respectiveincreases of 71% and 55% over the comparable 2005 periods.

 

Our cash costs, excluding by-productrevenues, were higher by 28.5 cents and 24.7 cents per pound in the secondquarter and six months of 2006, respectively, than the comparable 2005periods.  In 2006, a new accountingpolicy was adopted, which requires that we charge to production cost all minestripping cost.  Under our previouspolicy, in 2005, a portion of our mine stripping cost was capitalized.  In the second quarter and first six months of2005, our per pound cash costs were reduced by 7.1 cents and 6.7 cents,respectively, for capitalized mine stripping cost.  In addition, because of illegal workstoppages related production decreases in our Mexican operations we needed to purchaseadditional copper concentrates to meet our smelting requirements.  As we include the cost of purchased materialin our operating cash cost, the impact of this material increased our per poundoperating cash cost by 28.6 and 15.3 cents in the second quarter and first sixmonths of 2006, respectively, over the comparable 2005 periods.

 

Metal Prices.  Theprofitability of our operations is dependent on, and our financial performanceis significantly affected by, the international market prices for the productswe produce, especially for copper, molybdenum, zinc and silver.  Metals prices historically have been subjectto wide fluctuations and are affected by numerous factors beyond our control.  These factors, which affect each commodity tovarying 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 certainmetals have on occasion been subject to rapid short-term changes due tospeculative activities.

 

We are subject to market risks arising fromthe volatility of copper and other metal prices.  Assuming that expected metal production andsales are achieved, that tax rates are unchanged, giving no effect to potentialhedging programs, metal price sensitivity 

 

31

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factors would indicate the following changein estimated 2006 earnings 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 earnings (in millions)                         |       | $          | 8.7        |           | $          | 15.3     |       | $          | 1.7        |   | $ | 11.2 |   |

 

Inflation and Devaluation ofthe Peruvian Nuevo Sol and the Mexican Peso.  Ourfunctional currency is the U.S. dollar. Portions of our operating costs are denominated in Peruvian Nuevos solesand Mexican pesos.  Since our revenuesare primarily denominated in U.S. dollars, when inflation/deflation in Peru orMexico is not offset by a change in the exchange rate of the Nuevo sol or thepeso, respectively, to the dollar, our financial position, results ofoperations and cash flows could be adversely affected in our wageadjustments.  In addition, the dollarvalue of our net monetary assets denominated in Nuevos soles or pesos can beaffected by devaluation of the Nuevo sol or the peso, resulting in aremeasurement loss in our condensed consolidated combined financial statements.

 

For the three and six months ended June 30,2006 and 2005, inflation and devaluation rates were as follows:

 
| ** **                                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------------|------------|--------------------------------------------|------------|------------------------------------------|------------|
| ** **                                | ** ** | **2006**                                   | ** ** | **2005**                                 | ** ** | **2006** | ** ** | **2005** | ** ** |
| Peru:                                     |       |                                       |       |                                     |       |   |   |   |   |
| Inflation  rate                           |       | (0.2                                       | )%         | 0.5                                      | %          | 1.4 | % | 1.0 | % |
| New  Sol/Dollar (change in exchange rate) |       | (2.9                                       | )%         | (0.3                                     | )%         | (5.0 | )% | (0.9 | )% |
|                                      |       |                                       |       |                                     |       |   |   |   |   |
| Mexico:                                   |       |                                       |       |                                     |       |   |   |   |   |
| Inflation  rate                           |       | (0.2                                       | )%         | —                                   |       | 0.7 | % | 0.8 | % |
| Peso/dollar  (change in exchange rate)    |       | 4.1                                        | %          | (4.0                                     | )%         | 6.4 | % | (3.7 | )% |

 

Expansion and ModernizationProgram.

 

The Ilo smelter modernization project in Peruis moving ahead on schedule with construction work in process and is expectedto finish by January 2007.  At July 31,2006, the smelter project reached 91.5% completion. Two new 70MVA transformerswere energized and are operating. The oxygen plant, the water intake anddesalinization plants are finished and ready for operation. Investments in thesmelter project exceed $400 million and have generated more than 3,500 new jobsduring the construction; 50% of them from the city of Ilo. With the completionof the Ilo smelter modernization project, we will have fulfilled ourobligations under the PAMA.  Totalinvestment for all steps of the PAMA will be approximately $600 million.

 

Additionally, the Company’s crushing andconveying project at the Toquepala mine are in production.  The primary crusher and overland conveyingsystem are fully operational; construction of the ramp for this project willcontinue until expected completion in the fourth quarter of 2006.  The project is 96.8% complete.  We will construct a new SX/EW plant at theCananea mine with a 33,000 mtpy capacity. A letter of intent was issued toBechtel International, Inc. to develop the plant’s basic engineering.

 

The Company is currently in the evaluationprocess of the Ilo Smelter expansion from 1.2 million tons to 1.8 million tonsof concentrates and the Ilo refinery expansion from 280,000 tons to 360,000tons.

 

32

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Regarding our Company’s explorationproperties, in May 2006, we began a pre-feasibility study at Los Chancas, acopper-molybdenum property in southern Peru. We expect that the study will be completed late this year at which timewe would hope to move forward with a full feasibility study.  It is our plan to fast track thisproject.  Additionally, we have requestedbids for a pre-feasibility study for Tia Maria, a copper deposit in thedepartment of Arequipa, Peru.  We expectto begin this study in the third quarter of 2006 and be completed in early2007.  The Company will continue toinvest this year to complete the $436 million budget for our various capitalprojects, and we expect to invest in the following years in the Los Chancas andTia Maria projects, which represent an estimated investment of around $800million to $1 billion.  Estimatedadditional copper production would be approximately 100 to 210 thousand tonsper year, starting 2009 and 2011, respectively. We intend to invest more than $33 million this year in exploration inthree countries where we operate – Peru, Mexico and Chile.

 

ACCOUNTING ESTIMATES

 

Our discussion and analysis of financialcondition and results of operations are based on our condensed consolidatedcombined financial statements, which have been prepared in accordance with USGAAP.  Preparation of these condensedconsolidated combined financial statements requires our management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosures of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenues and expensesduring the reporting periods.  Managementmakes its best estimate of the ultimate outcome for these items based onhistorical trends and other information available when the financial statementsare prepared.  Changes in estimates arerecognized in accordance with the accounting rules for the estimate, which istypically in the period when new information becomes available tomanagement.  Areas where the nature ofthe estimate makes it reasonably possible that actual results could materiallydiffer from amounts estimated include: ore reserves, estimated mine strippingratios, leachable material and related amortization, the estimated useful livesof fixed assets, asset retirement obligations, litigation and contingencies,valuation allowances for deferred tax assets, fair value of financialinstruments and inventory obsolescence. We base our estimates on historical experience and on various otherassumptions that are believed to be reasonable under the circumstances.  Actual results may differ from theseestimates under different assumptions or conditions.

 

RESULTS OF OPERATIONS

 

The following highlights key financial andoperating results for three and six months ended June 30, 2006 and 2005:

 
| ** **                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                  | ** ** | **(dollars in millions)**             | ** ** |
| ** **                                  | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Statement of Earnings Data                  |       |                                            |       |                                          |       |   |   |   |   |
|                                        |       |                                            |       |                                          |       |   |   |   |   |
| Net sales                                   |       | $                                               | 1,276.7    |                                          | $          | 954.1 |   | $ | 2,398.0 |   | $ | 1,892.9 |   |
| Operating costs and expenses                |       | (627.7                                          | )          | (509.5                                        | )          | (1,116.3 | ) | (984.0 | ) |
| Operating income                            |       | 649.0                                           |       | 444.6                                         |       | 1,281.7 |   | 908.9 |   |
| Non-operating income (expense)              |       | 0.3                                             |       | (24.3                                         | )          | (9.3 | ) | (42.7 | ) |
| Earnings before taxes and minority interest |       | 649.3                                           |       | 420.3                                         |       | 1,272.4 |   | 866.2 |   |
| Taxes on income                             |       | (207.9                                          | )          | (106.8                                        | )          | (407.7 | ) | (252.9 | ) |
| Minority interest                           |       | (2.1                                            | )          | (1.6                                          | )          | (3.8 | ) | (3.0 | ) |
| Net earnings                                |       | $                                               | 439.3      |                                          | $          | 311.9 |   | $ | 860.9 |   | $ | 610.3 |   |

 

33

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Mine copper production amounted to 273.9million pounds in the second quarter of 2006, a decrease of 26.4% compared withthe second quarter of 2005.  Thisdecrease of 98.0 million pounds included a decrease of 110.0 million poundsfrom the Mexican open pit operations, a decrease of 2.7 million pounds from theMexican underground mines and an increase of 14.7 million pounds from thePeruvian open pit mines.

 

The decrease of 110.0 million pounds in theproduction from the Mexican open pit mines was due to the La Caridad mineclosing, as a result of an illegal work stoppage and the illegal work stoppageat the Cananea mine. As a result, the Company has declared force majeure onJune and July copper delivery contracts of our Mexican open pit mines.  The illegal work stoppage at Cananea wasfinally resolved on July 17, 2006.  Theincrease of 14.7 million pounds from the Peruvian open pit mines was the resultof higher ore grades and recoveries in both the Cuajone and Toquepalamines.  The decrease of 2.7 millionpounds in the Mexican underground mines was due to an illegal work stoppage atthe San Martin mine which resulted in 46 days of production loss in the secondquarter of 2006.

 

Molybdenum production decreased from 7.9million pounds in the second quarter of 2005 to 5.1 million pounds in thesecond quarter of 2006.  This 35.2%decrease in production is due to 2.1 million of lower production in the Mexicanoperations as result of the closing of the La Caridad mine and a decrease of0.6 million pounds in Peruvian production, mainly due to lower ore grade andrecovery at the Cuajone mine.

 

Mine zinc production amounted to 70.1 millionpounds in the second quarter of 2006, a 14.3% decrease from the second quarterof 2005. The decrease of 11.7 million in zinc production is due to the illegalwork stoppage at the San Martin mine.  Wehave restored 50% of the zinc production at the San Luis Potosi zinc refineryin June and expect to restore the remaining 50% by August 2006. The refinerywas shut down in January after an electrical fire at a power station.

 

The table below outlines the average metalprices during the three and six months periods ended June 30, 2006 and 2005:

 

Average Metals Prices

 
| ** **                             | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                             | ** ** | **2006**                                            | ** ** | **2005**                                          | ** ** | **% Change** | ** ** | **2006** | ** ** | **2005** | ** ** | **% Change** | ** ** |
| Copper ($ per pound – LME)   |       | $                                                   | 3.27       |                                              | $          | 1.54 |   | 112 |   | $ | 2.76 |   | $ | 1.51 |   | 83 |   |
| Copper ($ per pound – COMEX) |       | $                                                   | 3.37       |                                              | $          | 1.53 |   | 120 |   | $ | 2.81 |   | $ | 1.50 |   | 87 |   |
| Molybdenum ($ per pound)          |       | $                                                   | 24.22      |                                              | $          | 34.64 |   | (30 | ) | $ | 23.23 |   | $ | 32.54 |   | (29 | ) |
| Zinc ($ per pound – LME)     |       | $                                                   | 1.49       |                                              | $          | 0.58 |   | 157 |   | $ | 1.26 |   | $ | 0.59 |   | 114 |   |
| Silver ($ per ounce – COMEX) |       | $                                                   | 12.22      |                                              | $          | 7.16 |   | 71 |   | $ | 10.96 |   | $ | 7.07 |   | 55 |   |

 

Net Sales.  Netsales in the second quarter of 2006 increased $322.6 million to $1,276.7million from $954.1 million in the comparable period in 2005.  Net sales in the first six months of 2006increased $505.1 million to $2,398.0 million from $1,892.9 million in thecomparable period in 2005.  The increasesin net sales were principally the result of higher copper, zinc and silverprices reduced by lower molybdenum prices, lower sales volumes and losses onderivative instruments. Gain and losses on copper derivative instruments arenow included in the net sales amount.  Inprevious reports these amounts were included in non-operating accounts.  Past amounts have been reclassified toconform to the new presentation.  Losseson copper derivative instruments decreased net sales by $257.9 million in boththe second quarter and first six months of 2006; and by $3.9 million and $11.2million in the second quarter and the first six months of 2005, respectively.

 

The table below presents informationregarding the volume of our copper sales by segment for the three and sixmonths ended June 30, 2006 and 2005:

 

34

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Copper Sales (millionpounds):

 
| ** **                | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| Copper:                   |       |                                            |       |                                          |       |   |   |   |   |
| Peruvian operations       |       | 208.3                                           |       | 181.9                                         |       | 395.5 |   | 358.5 |   |
| Mexican open-pit          |       | 129.9                                           |       | 192.9                                         |       | 304.4 |   | 431.1 |   |
| Mexican IMMSA unit        |       | 9.4                                             |       | 10.8                                          |       | 19.1 |   | 74.8 |   |
| Inter segment elimination |       | (18.5                                           | )          | (8.4                                          | )          | (55.8 | ) | (126.9 | ) |
| Total copper sales        |       | 329.1                                           |       | 377.2                                         |       | 663.2 |   | 737.5 |   |

 

The table below presents informationregarding the volume of sales by segment of our significant by-products for thethree and six months ended June 30, 2006 and 2005:

 

By-product Sales:

 
| **(in million pounds except silver - in  million ounces)** | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-----------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                    | **2006**   | ** **                                      | **2005**   | ** **                                    | **2006**   | ** ** | **2005** | ** ** |
| Peruvian operations                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| Molybdenum contained in concentrates                                                          |       | 5.2                                             |       | 5.1                                           |       | 10.9 |   | 11.7 |   |
| Zinc - refined and in concentrate                                                             |       | —                                          |       | —                                        |       | 10.5 |   | — |   |
| Silver                                                                                        |       | 1.3                                             |       | 0.8                                           |       | 2.9 |   | 1.8 |   |
|                                                                                          |       |                                            |       |                                          |       |   |   |   |   |
| Mexican open-pit                                                                              |       |                                            |       |                                          |       |   |   |   |   |
| Molybdenum contained in concentrates                                                          |       | —                                          |       | 2.1                                           |       | 1.6 |   | 4.2 |   |
| Zinc - refined and in concentrate                                                             |       | —                                          |       | 24.5                                          |       | 9.5 |   | 49.9 |   |
| Silver                                                                                        |       | 1.2                                             |       | 1.8                                           |       | 2.6 |   | 4.6 |   |
|                                                                                          |       |                                            |       |                                          |       |   |   |   |   |
| Mexican IMMSA unit                                                                            |       |                                            |       |                                          |       |   |   |   |   |
| Zinc - refined and in concentrate                                                             |       | 60.5                                            |       | 71.4                                          |       | 134.2 |   | 147.4 |   |
| Silver                                                                                        |       | 3.0                                             |       | 3.1                                           |       | 5.9 |   | 5.8 |   |
|                                                                                          |       |                                            |       |                                          |       |   |   |   |   |
| Intersegment elimination                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| Zinc - refined and in concentrate                                                             |       | —                                          |       | (16.9                                         | )          | (13.9 | ) | (39.1 | ) |
| Silver                                                                                        |       | (0.6                                            | )          | (1.0                                          | )          | (1.7 | ) | (2.5 | ) |
|                                                                                          |       |                                            |       |                                          |       |   |   |   |   |
| Total by-product sales                                                                        |       |                                            |       |                                          |       |   |   |   |   |
| Molybdenum contained in concentrates                                                          |       | 5.2                                             |       | 7.2                                           |       | 12.5 |   | 15.9 |   |
| Zinc - refined and in concentrate                                                             |       | 60.5                                            |       | 79.0                                          |       | 140.3 |   | 158.2 |   |
| Silver                                                                                        |       | 4.9                                             |       | 4.7                                           |       | 9.7 |   | 9.7 |   |

 

At June 30, 2006, the Company has recordedprovisionally priced sales of 95.4 million pounds of copper, at an averageforward price of $3.37 per pound.  Alsothe Company has recorded provisionally priced sales of 3.6 million pounds ofmolybdenum at an average price of $25.00 per pound.  These sales are subject to final pricingbased on the average monthly LME or COMEX copper prices and Dealer Oxidemolybdenum prices in the future month of settlement, which will occur largelyin the third quarter of 2006.

 

Management believes that the final pricing ofthese sales will not have a material effect on the Company’s financial positionor results of operations.

 

Operating Costs andExpenses. Operatingcosts and expenses were $627.7 million in the second quarter of 2006 comparedwith $509.6 million in the second quarter of 2005.  Cost of sales (exclusive of depreciation,amortization and depletion) for the three 

 

35

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months ended June 30, 2006 was $521.8 millioncompared with $413.1 million in the comparable 2005 period.

 

The principal reason for the increase in costof sales in the second quarter 2006, as compared to the second quarter of 2005,is the illegal work stoppage activity in Mexico in 2006.  In order to meet smelting requirements andfulfill customer deliveries we were required to increase our purchases ofcopper concentrates on the open market. This coupled with the increased copper prices in 2006 added anincremental $131.8 million to our 2006 cost of sales over the 2005 amount.  Other factors increasing cost of salesinclude, the effect of our new accounting policy of charging to production costall mine stripping cost, an increase in cost of $26.7 million, an increase inmining royalties of $13.1 million and increased workers’ participation of $23.4million.  Factors partially reducing costof sales include lower fuel, power and repair costs at the Mexican operationsaffected by the illegal work stoppages and an exchange gain of $23.5 milliondue to the devaluation of the Mexican peso.

 

Operating costs and expenses were $1,116.4million in the first six months of 2006 compared with $984.0 million in thefirst six months of 2005.  Cost of sales(exclusive of depreciation, amortization and depletion) for the six monthsended June 30, 2006 was $928.7 million compared with $802.7 million in thecomparable 2005 period.

 

The increase in cost of sales in thesix-month 2006 period is due principally to $124.7 million of higher cost ofcopper concentrates purchased from third parties, to cover production workstoppages losses and an increase of $50.1 million due to our new accounting formine stripping cost. Also, increases in workers’ participation of $28.1 millionand higher mining royalties of $14.5 million added to 2006 cost of sale.  These increases were partially offset by adecrease in production cost due to $15.2 million of lower fuel and power costand $18.4 million of lower operating and repair material cost, reflecting theloss in production in our Mexican operations during part of the secondquarter.  Additionally, cost of salesincludes a positive effect for an exchange difference of $21.7 million due tothe devaluation of the Mexican peso.

 

Depreciation, amortization and depletion forthe three months ended June 30, 2006, were $78.0 million compared with $70.5million in the second quarter of 2005. The increase of $7.5 million is mainly attributable to $9.7 million ofhigher amortization of leachable material and $ 3.8 of higher depreciation inour Peruvian operations partially offset by $6.0 million of lower capitalizedinterest amortization.

 

Selling and administrative expenses for thesix months ended June 30, 2006, were $47.3 million compared with $39.0 millionin the first six months of 2005.  Theincrease of $8.3 million is mainly attributable to $2.7 million of highersalaries and wages, $2.2 million of higher fees for consulting and otherservices.

 

Non-Operating Income(Expense):  Interest expense in the second quarter andthe first six months of 2006 were approximately 30.8% and 5.3% higher,respectively, than the comparable 2005 periods. These increases are the result of the increase in long-term debt.

 

In the three and six months ended June 30,2006 we recorded a loss on debt prepayments of $0.9 million due to therepurchased of $16.5 million of our Yankee bonds compare with $6.0 million and$7.7 million, in the three and six months ended June 2005 related to aprepayment penalty on the retirement of our Peruvian bonds and the repurchaseof Yankee bonds.

 

Interest income was $14.3 million and $23.6million in the second quarter and first six months of 2006 compared to $3.0 and$8.5 million in the second quarter and first six months of 2005.  These increases were principally the resultof higher cash balances in the periods and higher rates of interest earned.

 

36

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Taxes on income for the six months ended June30, 2006 and 2005 were $407.7 million and $252.9 million, respectively.  These provisions include income taxes forPeru, Mexico and the United States.  Theeffective tax rates for the 2006 and 2005 periods are 32.0% and 29.2%,respectively.  The increase in the 2006effective tax rate is attributable to the following factors: 1) anon-deductible expense in our Peruvian operation of $138.4 million for copperderivative losses in the 2006 period, 2) a non-deductible expense of $28.2million for workers’ participation resulting from a change in Mexican lawregarding the basis of calculation in the 2005 period, 3) a tax refund of $43.4million received by our Mexican subsidiary in the 2005 period for asset-basedtaxes (minimum income tax) paid in prior years, and 4)a decrease of 1% in the2006 statutory tax rate for our Mexican operations.

 

Segment Results Analysis

 

Peruvian Open Pit Operations

 

The following table sets forth net sales,operating cost and expenses and operating income for our Peruvian open pitoperations segment, for the three and six months ended June 30, 2006 and 2005:

 
| ** **                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                   | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                   | ** ** | **(in millions)**                          | ** ** |
| Net sales                    |       | $                                               | 786.7      |                                          | $          | 477.9 |   | $ | 1,402.5 |   | $ | 959.2 |   |
| Operating costs and expenses |       | (319.9                                          | )          | (203.8                                        | )          | (618.9 | ) | (406.2 | ) |
| Operating income             |       | $                                               | 466.8      |                                          | $          | 274.1 |   | $ | 783.6 |   | $ | 553.0 |   |

 

Net sales in the second quarter 2006increased $308.8 million to $786.7 million from $477.9 million in thecomparable period of 2005.  Net sales inthe first six months of 2006 increased $443.3 million to $1,402.5 million from$959.2 million in the first half of 2005. The increase in net sales is principally the result of higher copperprices.  Copper sales volume increased in2006, principally as a result of the copper purchased from our Mexicanoperations.  Molybdenum sales volume,however, decreased in the 2006 period, due to lower production, and lowermolybdenum sales prices.  Additionally, aloss on copper derivatives of $138.4 is included in the second quarter of 2006.

 

Operating cost and expenses in the secondquarter of 2006 increased by $116.1 million to $319.9 million from $203.8million in the second quarter of 2005, principally due to higher cost ofsales.  Cost of sales (exclusive ofdepreciation, amortization and depletion) for the three months ended June 30,2006 was $286.7 million compared to $174.4 million in the same period of2005.  The increase in cost of salesincludes $66.3 million of metals purchased from our Mexican operations, $11.6million of capitalized mine stripping cost in 2005, $16.7 million of higherworkers’ participation and $11.2 million of higher mining royalties.

 

Operating cost and expenses in the first halfof 2006 increased by $212.7 million to $618.9 million form $406.2 million inthe first half of 2005, principally due to higher cost of sales.  Cost of sales (exclusive of depreciation,amortization and depletion) for the six months ended June 30, 2006 was $554.2million compared to $346.7 million in the same period of 2005.  The increase in cost of sales includes $144.2million of metals purchased from our Mexican operations, $21.2 million of lowercapitalized mine stripping cost, $21.7 million of higher workers’ participationand $12.5 million of higher mining royalties.

 

Mexican Open Pit Operations

 

The following table sets forth net sales,operating cost and expenses and operating income for our Mexican open pitoperations segment for the three and six months periods ended June 30, 2006 and2005:

 

37

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| ** **                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                   | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                   | ** ** | **(in millions)**                          | ** ** |
| Net sales                    |       | $                                               | 400.2      |                                          | $          | 420.5 |   | $ | 885.0 |   | $ | 895.1 |   |
| Operating costs and expenses |       | (259.4                                          | )          | (294.1                                        | )          | (478.3 | ) | (591.9 | ) |
| Operating income             |       | $                                               | 140.8      |                                          | $          | 126.4 |   | $ | 406.7 |   | $ | 303.2 |   |

 

Net sales in the second quarter of 2006decreased $20.3 million to $400.2 million from $420.5 million in the secondquarter of 2005.  Net sales in the firsthalf of 2006 decreased $10.1 million to $885.0 million from $895.1 million inthe first half of 2005.  The decrease innet sales is the result of lower copper sales volume due to the illegal workstoppage in both mines and a loss on copper derivatives of $119.6 million,partially offset by the increase in metal prices.

 

Operating cost and expenses in the secondquarter of 2006 decreased by $34.7 million to $259.4 million from $294.1million in the second quarter of 2005, principally due to lower cost ofsales.  Cost of sales (exclusive ofdepreciation, amortization and depletion) decreased $38.4 million to $200.7million from $239.1 million in 2005.  Thedecrease in cost of sales was principally due to a decrease of $62.9 million ininventory and $54.7 million of lower power, fuel and other production cost dueto the loss in production consequence of La Caridad mine closing and theCananea illegal work stoppage. In addition, cost of sales includes $81.6million of higher copper concentrates purchased from third parties to cover theloss in production and $15.5 million of capitalized mine stripping cost in2005.

 

Operating cost and expenses in the first halfof 2006 decreased by $113.6 million to $478.3 million from $591.9 million inthe first half of 2005, principally due to lower cost of sales anddepreciation, amortization and depletion. Cost of sales (exclusive of depreciation, amortization and depletion)decreased $108.7 million to $384.6 million from $493.3 million in 2005.  The decrease in cost of sales was principallydue to a decrease of $84.5 million in inventory and $38.0 million of lowerpower, fuel and other production cost due to the loss in production consequenceof La Caridad mine closing and the Cananea illegal work stoppage. In addition,cost of sales includes $31.1 million of gain in translation difference due tothe devaluation of the Mexican peso.

 

Mexican UndergroundOperations (IMMSA)

 

The following table sets forth net sales,operating cost and expenses and operating income for our IMMSA segment, for thethree and six months periods ended June 30, 2006 and 2005:

 
| ** **                   | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                   | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                   | ** ** | **(in millions)**                          | ** ** |
| Net sales                    |       | $                                               | 161.8      |                                          | $          | 86.4 |   | $ | 295.5 |   | $ | 243.0 |   |
| Operating costs and expenses |       | (100.5                                          | )          | (76.3                                         | )          | (187.8 | ) | (210.3 | ) |
| Operating income             |       | $                                               | 61.3       |                                          | $          | 10.1 |   | $ | 107.7 |   | $ | 32.7 |   |

 

Net sales in the second quarter 2006increased $75.4 million to $161.8 million from $86.4 million in the comparableperiod of 2005.  Net sales in the firstsix months of 2006 increased $52.5 million to $295.5 million from $243.0million in the comparable period of 2005. The increase in net sales is principally due to higher market pricespartially offset by a decrease in volume as a result of lower copper productiondue to illegal work stoppage activity in the San Martin mine.

 

Operating cost and expenses in the secondquarter of 2006 increased by $24.2 million to $100.5 million from $76.3 millionin the second quarter of 2005.  Cost ofsales 

 

38

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(exclusive of depreciation, amortization anddepletion) increased $21.6 million to $86.8 million in the second quarter of2006 from $65.2 million in the second quarter of 2005 principally due to $16.5million of higher purchases of metals from third parties, $4.3 million ofhigher operating and repair material cost and $1.3 million of higher workers’participation.

 

Operating costs and expenses in the firsthalf of 2006 decreased by $22.5 million to $187.8 million from $210.3 millionin the first six months of 2005.  Cost ofsales (exclusive of depreciation, amortization and depletion) decreased $26.9million to $161.7 million in the first half of 2006 from $188.6 million in thefirst half of 2005 principally due to $49.9 million of lower purchases ofmetals from third parties, $9.6 million of lower power and fuel cost, partiallyoffset by $12.1 million of higher workers’ participation.

 

Intersegment Eliminationsand Adjustments

 

The net sales, operating costs and expensesand operating income displayed above will not be directly equal to amounts inour condensed consolidated combined statement of earnings because theadjustments of intersegment operating revenues and expenses must be taken intoaccount.  Please see Note K of thefinancial statements.

 

CASH FLOW

 

The following table shows the cash flow forthe three and six months ended June 30, 2006 and 2005:

 
| ** **                                  | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|---------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                  | ** ** | **2006**                                        | ** ** | **2005**                                      | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                  | ** ** | **(in millions)**                          | ** ** |
| Net cash provided from operating activities |       | $                                               | 132.8      |                                          | $          | 181.8 |   | $ | 570.5 |   | $ | 534.3 |   |
| Net cash used for investment activities     |       | $                                               | (83.8      | )                                             | $          | (8.0 | ) | $ | (228.7 | ) | $ | (113.1 | ) |
| Net cash used for financing activities      |       | $                                               | (46.8      | )                                             | $          | (452.5 | ) | $ | (454.1 | ) | $ | (672.3 | ) |

 

Second Quarter:  Netcash provided by operating activities was $132.8 million in the second quarterof 2006, compared with $181.8 million in the 2005 period. The decrease of $49.0million was principally due to an increase in the build-up of working capitalof $158.4 million, mainly due to a net increase in accounts receivablepartially offset by higher earnings.

 

Net cash used in investing activities was$83.8 million in the second quarter of 2006 compared with $8.0 million in thesecond quarter of 2005 and included $87.6 million for capitalexpenditures.  The capital expendituresincluded investments at our Peruvian operations of $23.1 million for the Ilosmelter modernization project and $15.5 million for various other replacementexpenditures.  In addition, we spent$49.0 million for replacement assets at our Mexican operations, of which $37.2million was at our Mexican open pit operations and $11.8 million in our IMMSAunit.  In the second quarter of 2005,cash used for investment activities was $8.0 million; this amount includescapital spending of $70.0 million, $34.7 million which was in the Ilo smeltermodernization project, $16.5 from other replacement expenditures in Peru and$18.8 million from replacement expenditures in Mexico.  Investing activities in the second quarter of2005 also included sales of marketable securities of $74.3 million.

 

Net cash used in financing activities in thesecond quarter of 2006 was $46.8 million, compared with $452.5 million in thesecond quarter of 2005.  The secondquarter of 2006 includes a dividend distribution of $404.9 million and $367.7million of net debt incurred.  The secondquarter of 2005 includes a dividend distribution of $350.0 million and $99.6million of net debt repayment.

 

39

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Six Months:  Netcash provided by operating activities was $570.5 million in the first sixmonths of 2006 compared with $534.3 million in the same period of 2005.  The increase of $36.2 million was principallydue to $303.1 million of higher earnings including the $52.5 million effect ofthe change in accounting policy for mine stripping, net of an increase in thebuild-up of working capital of $226.0 million mainly due to a net increase inaccounts receivable.

 

Net cash used in investing activities was$228.7 million in the first six months of 2006 compared with $113.1 million inthe first six months of 2005 and included $230.7 million for capitalexpenditures.  The capital expendituresincluded investments at our Peruvian operations of $86.4 million for the Ilosmelter modernization project and $36.7 for various other replacementexpenditures.  In addition, we spent$107.6 million for replacement assets at our Mexican operations, of which $88.0million belongs to our Mexican open pit operations and $19.6 million to ourIMMSA unit.  In the first half of 2005,cash used for investing activities was $113.1 million; this amount includescapital spending of $145.2 million, $65.3 million of which was in the Ilosmelter modernization project, $36.3 million from other replacementexpenditures in Peru and $43.7 million from replacement expenditures inMexico.  Investing activities in 2005also included net sales of marketable securities of $45.3 million.

 

Net cash used in financing activities in thefirst six months of 2006 was $454.1 million, compared with $672.3 million inthe first six months of 2005.  The firstsix months of 2006 includes a dividend distribution of $809.8 million and netdebt incurred of $367.7 million.  Thefirst six months of 2005 includes a dividend distribution of $450.0 million andnet debt repaid of $218.6 million.

 

LIQUIDITY AND CAPITAL RESOURCES

 

On June 2, 2006, the Company paid a quarterlydividend of $2.75 per share, totaling $404.9 million.  On July 12, 2006, the Board of Directorsapproved a quarterly dividend of $2.00 per share, totaling $294.5 million, tobe paid on August 25, 2006, to shareholders of record as of August 2, 2006.

 

The Company’s biggest outstanding capitalinvestment project is the Ilo smelter modernization.  This project will modernize the smelter andbring SCC into compliance with PAMA requirements.  In July 2003, we awarded the contract toprovide the technology and basic engineering for the modernization of the Ilosmelter to Fluor Chile S.A. and Xtrata plc (formerly M.I.M. HoldingLimited).  The project is using theAustralian ISASMELT technology and the Company believes that it will complywith the current environmental regulations. It is estimated that the construction of the project will be completedbefore January 2007, the deadline established by the PAMA.  The estimated cost of this project is $500million including $474.9 million expended through June 30, 2006.

 

On May 9, 2006, we issued an additional $400million 7.5% notes due 2035. The notes are in addition to the $600 million ofexisting 7.5% notes due 2035 that we issued in July 2005. The currenttransaction was issued at a spread of +240 basis points over the 30-year U.S.Treasury bond. The original issue in July 2005 was issued at a spread of +315basis points over the 30-year U.S. Treasury bond. The notes are InvestmentGrade rated Baa2 by Moody’s, BBB- by Standard & Poor’s, and BBB- byFitch.  Proceeds from the issuance of thenotes will be used to partially fund our $600 million expansion program, whichincludes an expansion of productive capacity at the Ilo, Peru smelter andrefinery, construction of a new SX/EW plant at Cananea, the initial cost todevelop our Los Chancas and Tia Maria projects and the remaining investment tocomplete the Ilo smelter modernization.

 

The notes issued in July 2005 and the newnotes issued in May 2006 are treated as a single series of notes under theindenture, including for purposes of covenants, waivers and amendments.  The Company has filed a registrationstatement with the 

 

40

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Securities and Exchange Commission, whichregistration statement has become effective, to exchange the new notes fornotes registered under the Securities Act of 1933, as amended.

 

We expect that we will meet our cashrequirements for 2006 and beyond from internally generated funds, cash on handand from additional external financing, if required.  At June 30, 2006 the Company’s debt as a percentageof total capitalization (the total of debt, minority interest and stockholders’equity) was 32.5% as compared with 26.0% at December 31, 2005.  At June 30, 2006, the Company’s cash and cashequivalent amounted to $801.0 million compared to $876.0 million at December31, 2005.

 

CONTRACTUAL OBLIGATIONS:

 

Thefollowing table summarizes our significant contractual obligations as of June30, 2006. The following table, as of June 30, 2006, reflects an update of themajor changes to the similar table presented in the Company’s Form 10K-A atDecember 31,2005:

 
| ** **                    | ** ** | ** **                          | ** ** | **Payments due by Period** | ** ** |
|-------------------------------|------------|-------------------------------------|------------|-------------------------------------------|------------|
| ** **                    | ** ** | **Total**                           | ** ** | **2nd half  2006**                   | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **2010** | ** ** | **2011 and  Thereafter** | ** ** |
| ** **                    | ** ** | **(dollars in millions)** | ** ** |
| Long-term debt                |       | $                                   | 1,556.8    |                                      | $          | 5.0 |   | $ | 10.0 |   | $ | 166.8 |   | $ | 10.0 |   | $ | 10.0 |   | $ | 1,355.0 |   |
| Interest on debt              |       | 2,621.9                             |       | 70.9                                      |       | 116.7 |   | 116.1 |   | 102.5 |   | 101.9 |   | 2,113.8 |   |
| Purchase obligations:         |       |                                |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Commitment to purchase energy |       | 1,625.7                             |       | 144.2                                     |       | 134.7 |   | 134.7 |   | 134.7 |   | 134.7 |   | 942.7 |   |
| Capital purchase obligations  |       | 104.6                               |       | 69.5                                      |       | 35.1 |   | — |   | — |   | — |   | — |   |
|                          |       |                                |       |                                      |       |   |   |   |   |   |   |   |   |   |   |
| Total                         |       | $                                   | 5,909.0    |                                      | $          | 289.6 |   | $ | 296.5 |   | $ | 417.6 |   | $ | 247.2 |   | $ | 246.6 |   | $ | 4,411.5 |   |

 

Intereston debt calculated at rates in effect at June 30, 2006.  Please refer to “Liquidity and capitalresources” above for an update of our long-term debt arrangements and creditfacilities.

 

Wehave a commitment to purchase power for our Peruvian operations from Energiadel Sur, S.A. until 2017.  Amountsindicated on the above table are based on power costs in 2005, which aresubject to change as energy generation costs change and our forecasted powerrequirements through the life of the agreements change.

 

Pursuantto our PAMA we have committed to bring our operations into compliance withenvironmental standards established by the government of Peru.  The capital purchase obligation in the abovetable is for the estimated cost of completing the Ilo smelter modernization,our remaining obligation under our PAMA.

 

Foran update on this matter see “Expansion and Modernization Programs”.

 

NON-GAAP INFORMATION RECONCILIATION

 

Reconciliation of operating cash cost to GAAPcost of sales in millions of dollars and cents per pound.

 

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| ** **                                                                 | ** ** | **Three Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-------------------------------------------------|------------|
| ** **                                                                 | ** ** | **2006**                                        | ** ** | **2005** | ** ** |
| ** **                                                                 | ** ** | **$  million**                                  | ** ** | **¢ per  pound** | ** ** | **$  million** | ** ** | **¢ per  pound** | ** ** |
| CASH COST                                                                  |       |                                            |       |   |   |   |   |   |   |
| Cost of sales (including depreciation,  amortization and depletion) - GAAP |       | $                                               | 599.8      |   | 169.8 |   | $ | 483.7 |   | 128.4 |   |
| Add:                                                                       |       |                                            |       |   |   |   |   |   |   |
| Selling, general and administrative  expenses                              |       | 23.3                                            |       | 6.6 |   | 20.4 |   | 5.4 |   |
| Treatment and refining charges                                             |       | 12.4                                            |       | 3.5 |   | 22.5 |   | 6.0 |   |
| Less:                                                                      |       |                                            |       |   |   |   |   |   |   |
| By-products revenue                                                        |       | (327.2                                          | )          | (92.6 | ) | (389.6 | ) | (103.5 | ) |
| Depreciation, amortization and depletion                                   |       | (78.0                                           | )          | (22.1 | ) | (70.5 | ) | (18.7 | ) |
| Workers’ participation                                                |       | (74.4                                           | )          | (21.3 | ) | (50.8 | ) | (13.8 | ) |
| Royalty charge and other                                                   |       | (53.8                                           | )          | (15.2 | ) | (37.8 | ) | (10.0 | ) |
| Inventory change                                                           |       | 25.5                                            |       | 7.2 |   | 11.4 |   | 3.0 |   |
| Operating cash cost                                                        |       | 127.6                                           |       | 36.5 |   | (10.7 | ) | (2.9 | ) |
|                                                                       |       |                                            |       |   |   |   |   |   |   |
| Add by-product revenue                                                     |       | 327.2                                           |       | 92.6 |   | 389.6 |   | 103.5 |   |
|                                                                       |       |                                            |       |   |   |   |   |   |   |
| Operating cash cost, without by-product  revenue                           |       | $                                               | 454.8      |   | 129.1 |   | $ | 378.9 |   | 100.6 |   |
|                                                                       |       |                                            |       |   |   |   |   |   |   |
| Total pounds of copper produced and  purchased (in millions)               |       | 353.2                                           |       |   |   | 376.6 |   |   |   |

 
| ** **                                                                 | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                 | ** ** | **2006**                                      | ** ** | **2005** | ** ** |
| ** **                                                                 | ** ** | **$  million**                                | ** ** | **¢ per  pound** | ** ** | **$  million** | ** ** | **¢ per  pound** | ** ** |
| CASH COST                                                                  |       |                                          |       |   |   |   |   |   |   |
| Cost of sales (including depreciation,  amortization and depletion) - GAAP |       | $                                             | 1,059.8    |   | 150.8 |   | $ | 934.2 |   | 125.6 |   |
| Add:                                                                       |       |                                          |       |   |   |   |   |   |   |
| Selling, general and administrative  expenses                              |       | 47.3                                          |       | 6.7 |   | 39.0 |   | 5.2 |   |
| Treatment and refining charges                                             |       | 16.7                                          |       | 2.4 |   | 27.1 |   | 3.6 |   |
| Less:                                                                      |       |                                          |       |   |   |   |   |   |   |
| By-products revenue                                                        |       | (660.6                                        | )          | (94.0 | ) | (800.0 | ) | (107.5 | ) |
| Depreciation, amortization and depletion                                   |       | (131.1                                        | )          | (18.7 | ) | (131.5 | ) | (17.7 | ) |
| Workers’ participation                                                |       | (136.0                                        | )          | (19.3 | ) | (107.6 | ) | (14.5 | ) |
| Royalty charge and other                                                   |       | (53.3                                         | )          | (7.6 | ) | (46.0 | ) | (6.1 | ) |
| Inventory change                                                           |       | 59.7                                          |       | 8.5 |   | 14.9 |   | 2.0 |   |
| Operating cash cost                                                        |       | 202.5                                         |       | 28.8 |   | (69.9 | ) | (9.4 | ) |
|                                                                       |       |                                          |       |   |   |   |   |   |   |
| Add by-product revenue                                                     |       | 660.6                                         |       | 94.0 |   | 800.0 |   | 107.5 |   |
|                                                                       |       |                                          |       |   |   |   |   |   |   |
| Operating cash cost, without by-product  revenue                           |       | $                                             | 863.1      |   | 122.8 |   | $ | 730.1 |   | 98.1 |   |
|                                                                       |       |                                          |       |   |   |   |   |   |   |
| Total pounds of copper produced and  purchased (in millions)               |       | 702.9                                         |       |   |   | 743.9 |   |   |   |

 

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Impact of New AccountingStandards

 

Please see note L to our condensedconsolidated financial statements.

 

Cautionary Statement:

 

Forward-looking statements in this report andin other Company statements include statements regarding expected commencement datesof mining or metal production operations, projected quantities of future metalproduction, anticipated production rates, operating efficiencies, costs andexpenditures as well as projected demand or supply for the Company’sproducts.  Actual results could differmaterially depending upon factors including the risks and uncertaintiesrelating 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 ofunusual weather or operating conditions, lower than expected ore grades, waterand geological problems, the failure of equipment or processes to operate inaccordance with specifications, failure to obtain financial assurance to meetclosure and remediation obligations, labor relations, litigation andenvironmental risks as well as political and economic risk associated withforeign operations.  Results ofoperations are directly affected by metal prices on commodity exchanges thatcan be volatile.

 

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Item4.  Controls and Procedures

 

EVALUATION OF DISCLOSURECONTROLS AND PROCEDURES

 

As of June 30, 2006, the Company carried outan evaluation, under the supervision and with the participation of the Company’sDisclosure Committee and the Company’s management, including the ChiefExecutive Officer and the Chief Financial Officer, of the effectiveness of thedesign and operation of the Company’s disclosure controls and procedures (assuch term is defined in Rules 13a-15(e) and 15d-15(e) under the SecuritiesExchange Act of 1934, as amended).  Basedupon that evaluation, the Chief Executive Officer and the Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures areeffective in timely alerting them to material information relating to theCompany (including its consolidated subsidiaries) required to be included inthe Company’s periodic SEC filings.

 

CHANGES IN INTERNAL CONTROLSOVER FINANCIAL REPORTING

 

There was no change in the Company’s internalcontrols over financial reporting (as such term is defined in Rules 13a-15(f)and 15d-15(f) under the Securities Exchange Act of 1934, as amended) thatoccurred during the quarter ended June 30, 2006 that has materially affected,or is reasonably likely to materially affect, the Company’s internal controlsover financial reporting.

 

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Mexico City, August 2, 2006

 

REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Shareholders ofSouthern Copper Corporation:

 

We have reviewed the accompanying condensedconsolidated balance sheet of Southern Copper Corporation and its subsidiariesas of June 30, 2006, and the related condensed consolidated combined statementof earnings and cash flows for each of the three-month and six-month periodsended June 30, 2006 and June 30, 2005. These interim financial statements are the responsibility of the Company’smanagement.

 

We conducted our review in accordance withthe standards of the Public Company Accounting Oversight Board (UnitedStates).  A review of interim financialinformation consists principally of applying analytical procedures and makinginquiries of persons responsible for financial and accounting matters.  It is substantially less in scope than anaudit conducted in accordance with the standards of the Public CompanyAccounting Oversight Board, the objective of which is the expression of anopinion regarding the financial statements taken as a whole.  Accordingly, we do not express such anopinion.

 

Based on our review, we are not aware of anymaterial modifications that should be made to the accompanying condensedconsolidated combined interim financial statements for them to be in conformitywith accounting principles generally accepted in the United States of America.

 

We previously audited, in accordance with thestandards of the Public Company Accounting Oversight Board (United States), theconsolidated balance sheet as of December 31, 2005 and the related consolidatedcombined statement of earnings, changes in stockholders’ equity and cash flowsfor the year then ended, management’s assessment of the effectiveness of theCompany’s internal control over financial reporting as of December 31, 2005 andthe effectiveness of the Company’s internal control over financial reporting asof December 31, 2005; and in our report dated March 13, 2006, we expressedunqualified opinions thereon.  Theconsolidated financial statements and management’s assessment of theeffectiveness of internal control over financial reporting referred to aboveare not presented herein.  In ouropinion, the information set forth in the accompanying condensed consolidatedbalance sheet as of June 30, 2006, is fairly stated in all material respects inrelation to the consolidated balance sheet from which it has been derived.

 

 

PRICEWATERHOUSECOOPERS

 

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PARTII – OTHER INFORMATION

 

Item1. – Legal Procedures

 

The information provided in Note J to thecondensed consolidated combined financial statements contained in Part I ofthis Form 10-Q, is incorporated herein by reference.

 

Item4. – Submission of Matters to a Vote of Security Holders

 

The annual meeting of stockholders of theCompany was held on Thursday, April 27, 2006. The meeting was adjourned on April 27, 2006 and reconvened on May 4,2006, and further adjourned and reconvened on May 11, 2006.

 

At the annual meeting, the holders of CommonStock were asked to elect 13 directors. The holders of Common Stock were also asked to approve the amendments tothe by-laws to:

 

•                  eliminatecertain extraneous provisions relating to the retired series of Class A CommonStock;

•                  introducea new provision for advance notice to shareholders seeking to nominatedirectors or to propose other business at annual or special meetings of theCommon Stockholders (as applicable);

•                  substituteGrupo Mexico for ASARCO Incorporated in the “Change in control” definition inthe Corporation’s by-laws; and

•                  eliminatethe 80% supermajority vote requirement for certain corporate actions.

 

The holders of Common Stock were asked to approve the amendments to theAmended and Restated Certificate of Incorporation to increase the number ofshares of Common Stock, which the Corporation is authorized to issue from167,207,640 shares to 320,000,000 shares. The holders of Common Stock were also asked to approve and ratify theselection of PricewaterhouseCoopers S.C., as independent accountants for 2006.

 

Votes cast in the election of directors by holders of Common Stock onApril 27, 2006 were as follows:

 
| ** **                       | ** ** | **For**     | ** ** | **Withheld** | ** ** |
|----------------------------------|------------|-------------|------------|--------------|------------|
| German Larrea Mota-Velasco       |       | 123,109,519 |       | 233,530      |       |
| Oscar Gonzalez Rocha             |       | 123,107,304 |       | 235,745      |       |
| Emilio Carrillo Gamboa           |       | 123,109,519 |       | 233,530      |       |
| Jaime Fernando Collazo Gonzalez  |       | 123,107,504 |       | 235,545      |       |
| Xavier  Garcia de Quevedo Topete |       | 123,109,319 |       | 233,730      |       |
| J. Eduardo Gonzalez Félix   |       | 123,107,504 |       | 235,545      |       |
| Harold S. Handelsman             |       | 123,319,044 |       | 24,005       |       |
| Genaro Larrea Mota-Velasco       |       | 123,109,519 |       | 233,530      |       |
| Armando Ortega Gomez             |       | 123,109,319 |       | 233,730      |       |
| Luis Miguel Palomino Bonilla     |       | 121,395,308 |       | 1,947,741    |       |
| Gilberto Perezalonso Cifuentes   |       | 123,319,044 |       | 24,005       |       |
| Juan Rebolledo Gout              |       | 123,107,504 |       | 235,545      |       |
| Carlos Ruiz Sacristan            |       | 123,109,519 |       | 233,530      |       |

 

Accordingly, each individual was duly elected as a director of theCorporation to serve his term of office or until his successor has been dulyelected and qualified.

 

At the annual meeting, on April 27, 2006, the proposal to amend theby-laws to eliminate certain extraneous provisions relating to the retiredseries of Class A Common Stock had received preliminary votes representing117,566,887 votes for the proposal, 4,988,743 votes against and 787,419abstentions, or an affirmative vote of 79.85% of the required votes.  Because the required vote for the approval ofthis 

 

46

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proposal was 80% and because there were still votes that needed to betabulated, the annual meeting for this proposal was adjourned until May 4,2006.  On May 4, 2006, at the adjournedand reconvened meeting the stockholders approved the proposal, having received 118,681,888votes for the proposal, 5,923,492 votes against the proposal, and 833,450abstentions, or an affirmative vote of 80.61% of the required votes.

 

On April 27, 2006, stockholders approved the amendment to the by-lawsto introduce a new provision for advance notice to shareholders seeking tonominate directors or to propose other business at annual or special meetingsof the Common Stockholders (as applicable). The proposal received the following votes:

 
| ** **   | ** ** | **For**     | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|--------------|------------|-------------|------------|-------------|------------|-------------|------------|
|         |       |        |       |        |       |        |       |
| Common Stock |       | 120,416,238 |       | 2,133,510   |       | 793,301     |       |

 

On April 27, 2006, stockholders approved the amendment to the by-lawsto substitute Grupo Mexico for ASARCO Incorporated in the “Change in control”definition in the Corporation’s by-laws. The Proposal received the following votes:

 
| ** **   | ** ** | **For**     | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|--------------|------------|-------------|------------|-------------|------------|-------------|------------|
|         |       |        |       |        |       |        |       |
| Common Stock |       | 122,435,950 |       | 122,150     |       | 784,949     |       |

 

On April 27, 2006, the proposal to amend the by-laws to eliminate the80% supermajority vote requirement for certain corporate actions had receivedpreliminary votes, representing the affirmative vote of 115,350,082 votes forthe proposal, 7,922,395 votes against the proposal, and 70,572 abstentions, oran affirmative vote of 78.35% of the required votes.  Because the required vote for the approval ofthis proposal was 80% and because there were still votes that needed to betabulated, the annual meeting for this proposal was adjourned first until May4, 2006, and subsequently until May 11, 2006.  On May 11, 2006, at the adjourned and reconvened meeting stockholdersdid not approve the proposal having received 117,204,665 votes for theproposal, 9,136,029 votes against the proposal, and 96,736 abstentions, or anaffirmative vote of 79.61% of the required votes.

 

On April 27, 2006, stockholders approved the amendments to the Amendedand Restated Certificate of Incorporation to increase the number of shares ofCommon Stock, which the Corporation is authorized to issue from 167,207,640shares to 320,000,000 shares.  Theproposal received the following votes:

 
| ** **   | ** ** | **For**     | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|--------------|------------|-------------|------------|-------------|------------|-------------|------------|
|         |       |        |       |        |       |        |       |
| Common Stock |       | 120,638,197 |       | 59,995      |       | 2,644,857   |       |

 

On April 27, 2006, stockholders approved and ratified the selection ofthe independent accountants.  Theproposal received the following votes:

 
| ** **   | ** ** | **For**     | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|--------------|------------|-------------|------------|-------------|------------|-------------|------------|
|         |       |        |       |        |       |        |       |
| Common Stock |       | 123,222,045 |       | 24,942      |       | 96,062      |       |

 

47

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Item6. – Exhibits

 
| **Exhibit No.** | ** ** | **Description of Exhibit**                                                                                                                                             |
|----------------------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                 |       |                                                                                                                                                                             |
| 15                   |       | Awareness letter of  Independent Registered Public Accounting Firm                                                                                                               |
|                 |       |                                                                                                                                                                             |
| 31.1                 |       | Certification Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                         |
|                 |       |                                                                                                                                                                             |
| 31.2                 |       | Certification Pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                         |
|                 |       |                                                                                                                                                                             |
| 32.1                 |       | Certification Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C., Section 1350. This  document is being furnished in accordance with SEC Release No. 33-8238. |
|                 |       |                                                                                                                                                                             |
| 32.2                 |       | Certification Pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C., Section 1350. This  document is being furnished in accordance with SEC Release No. 33-8238. |

 

48

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PART II – OTHER INFORMATION

 

SIGNATURES

 

Pursuant to the requirements of theSecurities Exchange Act of 1934, the Registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 
|           | SOUTHERN  COPPER CORPORATION(Registrant)             |
|----------------|------------------------------------------------------|
|           |                                                 |
|           |                                                 |
|           | /s/  Oscar Gonzalez Rocha                            |
|           | Oscar  Gonzalez Rocha                                |
|           | President  and Chief Executive Officer               |
|           |                                                 |
| August 3, 2006 |                                                 |
|           |                                                 |
|           |                                                 |
|           | /s/ J. Eduardo Gonzalez Felix                        |
|           | J.  Eduardo Gonzalez Felix                           |
|           | Vice  President, Finance and Chief Financial Officer |
|           |                                                 |
| August 3, 2006 |                                                 |

 

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