FCX 3Q05 10Q

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2005
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from
  
to
Commission File Number: 1-9916
 
 
Freeport-McMoRan Copper & Gold Inc.
(Exact name of registrant as specified in its charter)

Delaware
74-2480931
(State or other jurisdiction of
incorporation or organization)
(IRS Employer Identification No.)
   
1615 Poydras Street
  
New Orleans, Louisiana*
70112
(Address of principal executive offices)
(Zip Code)
 
(504) 582-4000
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No __

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes X No __

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes __ No X

On September 30, 2005, there were issued and outstanding 184,044,962 shares of the registrant’s Class B Common Stock, par value $0.10 per share.

* In the aftermath of Hurricane Katrina, Freeport-McMoRan Copper & Gold Inc. has temporarily moved its corporate headquarters to 5353 Essen Lane, Suite 350, Baton Rouge, Louisiana 70809, office telephone (225) 765-2200.

 

FREEPORT-McMoRan COPPER & GOLD INC.

TABLE OF CONTENTS

   
 
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FREEPORT-McMoRan COPPER & GOLD INC.
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

FREEPORT-McMoRan COPPER & GOLD INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

   
September 30,
    
December 31,
  
   
2005
    
2004
  
   
(In Thousands)
  
ASSETS
                
Current assets:
                
Cash and cash equivalents
  
$
392,845
    
$
551,450
  
Restricted cash
    
500
      
500
  
Accounts receivable
    
418,689
      
435,062
  
Inventories
    
450,031
      
466,712
  
Prepaid expenses and other
    
13,129
      
6,223
  
Total current assets
    
1,275,194
      
1,459,947
  
Property, plant, equipment and development costs, net
    
3,120,311
      
3,199,292
  
Deferred mining costs
    
289,025
      
220,415
  
Other assets
    
142,097
      
159,539
  
Investment in PT Smelting
    
51,154
      
47,802
  
Total assets
  
$
4,877,781
    
$
5,086,995
  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
                
Current liabilities:
                
Accounts payable and accrued liabilities
  
$
440,229
    
$
386,590
  
Current portion of long-term debt and short-term borrowings
    
195,581
      
78,214
  
Accrued income taxes
    
160,641
      
92,346
  
Rio Tinto share of joint venture cash flows
    
68,292
      
60,224
  
Unearned customer receipts
    
57,570
      
33,021
  
Accrued interest payable
    
15,635
      
47,167
  
Total current liabilities
    
937,948
      
697,562
  
Long-term debt, less current portion:
                
Senior notes
    
746,021
      
911,336
  
Convertible senior notes
    
386,565
      
575,000
  
Equipment and other loans
    
57,901
      
67,624
  
Atlantic Copper debt
    
33
      
4,426
  
Redeemable preferred stock
    
-
      
179,880
  
PT Puncakjaya Power bank debt
    
-
      
135,426
  
Total long-term debt, less current portion
    
1,190,520
      
1,873,692
  
Accrued postretirement benefits and other liabilities
    
204,177
      
200,228
  
Deferred income taxes
    
909,141
      
932,416
  
Minority interests
    
187,976
      
219,448
  
Stockholders' equity:
                
Convertible perpetual preferred stock
    
1,100,000
      
1,100,000
  
Class B common stock
    
29,310
      
28,496
  
Capital in excess of par value of common stock
    
2,090,782
      
1,852,816
  
Retained earnings
    
762,823
      
604,680
  
Accumulated other comprehensive income
    
7,181
      
11,342
  
Common stock held in treasury
    
(2,542,077
)
    
(2,433,685
)
Total stockholders’ equity
    
1,448,019
      
1,163,649
  
Total liabilities and stockholders’ equity
  
$
4,877,781
    
$
5,086,995
  

The accompanying notes are an integral part of these financial statements.
 
3
Table of Contents
FREEPORT-McMoRan COPPER & GOLD INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

   
Three Months Ended
    
Nine Months Ended
  
   
September 30,
    
September 30,
  
   
2005
    
2004
    
2005
    
2004
  
   
(In Thousands, Except Per Share Amounts)
  
Revenues
$
983,270
  
$
600,556
  
$
2,689,244
  
$
1,447,075
  
Cost of sales:
                        
Production and delivery
  
434,368
    
368,016
    
1,189,960
    
1,015,307
  
Depreciation and amortization
  
61,646
    
55,755
    
172,731
    
123,755
  
Total cost of sales
  
496,014
    
423,771
    
1,362,691
    
1,139,062
  
Exploration expenses
  
2,159
    
1,963
    
6,421
    
6,977
  
General and administrative expenses
  
25,546
    
26,186
    
72,539
    
64,322
  
Total costs and expenses
  
523,719
    
451,920
    
1,441,651
    
1,210,361
  
Operating income
  
459,551
    
148,636
    
1,247,593
    
236,714
  
Equity in PT Smelting earnings (losses)
  
1,315
    
2,678
    
6,473
    
(228
)
Interest expense, net
  
(33,330
)
  
(37,848
)
  
(106,170
)
  
(110,577
)
Losses on early extinguishment and
                        
conversion of debt
  
(38,416
)
  
(11
)
  
(38,379
)
  
(14,011
)
Other income, net
  
3,605
    
373
    
19,700
    
3,547
  
Income before income taxes and minority
                        
interests
  
392,725
    
113,828
    
1,129,217
    
115,445
  
Provision for income taxes
  
(186,712
)
  
(71,343
)
  
(539,424
)
  
(127,894
)
Minority interests in net income of
                        
consolidated subsidiaries
  
(25,083
)
  
(10,227
)
  
(72,971
)
  
(12,914
)
Net income (loss)
  
180,930
    
32,258
    
516,822
    
(25,363
)
Preferred dividends
  
(15,125
)
  
(15,125
)
  
(45,375
)
  
(30,366
)
Net income (loss) applicable to common stock
$
165,805
  
$
17,133
  
$
471,447
  
$
(55,729
)
                         
Net income (loss) per share of common stock:
                        
Basic
  
$0.93
    
$0.10
    
$2.64
    
$(0.30
)
Diluted
  
$0.86
    
$0.10
    
$2.48
    
$(0.30
)
Average common shares outstanding:
                        
Basic
  
177,895
    
177,137
    
178,513
    
183,426
  
Diluted
  
219,824
    
179,805
    
220,285
    
183,426
  
                         
Dividends paid per share of common stock
  
$0.75
    
$0.20
    
$1.75
    
$0.60
  

The accompanying notes are an integral part of these financial statements.
 
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Table of Contents

FREEPORT-McMoRan COPPER & GOLD INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

   
Nine Months Ended
 
   
September 30,
  
   
2005
    
2004
  
   
(In Thousands)
  
Cash flow from operating activities:
                
Net income (loss)
  
$
516,822
    
$
(25,363
)
Adjustments to reconcile net income (loss) to net cash provided by
      
(used in) operating activities:
                
Depreciation and amortization
    
172,731
      
123,755
  
Losses on early extinguishment and conversion of debt
    
38,379
      
14,011
  
Deferred income taxes
    
(24,085
)
    
76,107
  
Equity in PT Smelting (earnings) losses
    
(6,473
)
    
228
  
Minority interests' share of net income
    
72,971
      
12,914
  
Increase in deferred mining costs
    
(68,610
)
    
(81,383
)
Amortization of deferred financing costs
    
5,979
      
6,509
  
Currency translation gains
    
(4,924
)
    
(1,086
)
Elimination of profit on PT Freeport Indonesia sales to PT Smelting
    
3,120
      
2,473
  
Provision for inventory obsolescence
    
4,500
      
3,050
  
Other
    
17,888
      
5,825
  
(Increases) decreases in working capital:
                
Accounts receivable
    
5,582
      
(60,280
)
Inventories
    
7,772
      
(59,879
)
Prepaid expenses and other
    
(5,696
)
    
(43,299
)
Accounts payable and accrued liabilities
    
56,084
      
35,394
  
Rio Tinto share of joint venture cash flows
    
8,068
      
(31,994
)
Accrued income taxes
    
82,919
      
(39,866
)
(Increase) decrease in working capital
    
154,729
      
(199,924
)
Net cash provided by (used in) operating activities
    
883,027
      
(62,884
)
Cash flow from investing activities:
                
PT Freeport Indonesia capital expenditures
    
(85,793
)
    
(90,111
)
Atlantic Copper and other capital expenditures
    
(9,814
)
    
(18,295
)
Proceeds from insurance settlement
    
2,016
      
-
  
Investment in PT Smelting and other
    
-
      
(1,463
)
Sale of restricted investments
    
-
      
21,804
  
Decrease in Atlantic Copper restricted cash
    
-
      
11,000
  
Net cash used in investing activities
    
(93,591
)
    
(77,065
)
Cash flow from financing activities:
                
Net proceeds from sale of senior notes
    
-
      
344,354
  
Proceeds from other debt
    
47,308
      
80,208
  
Repayments of debt
    
(447,808
)
    
(379,427
)
Redemption of preferred stock
    
(12,716
)
    
(13,664
)
Net proceeds from sale of convertible perpetual preferred stock
    
-
      
1,067,000
  
Purchase of FCX common shares from Rio Tinto
    
-
      
(881,868
)
Purchases of other FCX common shares
    
(80,227
)
    
(99,477
)
Cash dividends paid:
                
Common stock
    
(312,936
)
    
(109,406
)
Preferred stock
    
(45,376
)
    
(20,345
)
Minority interests
    
(104,773
)
    
(1,172
)
Net proceeds from exercised stock options
    
8,508
      
5,765
  
Bank credit facilities fees and other
    
(21
)
    
(1,561
)
Net cash used in financing activities
    
(948,041
)
    
(9,593
)
Net decrease in cash and cash equivalents
    
(158,605
)
    
(149,542
)
Cash and cash equivalents at beginning of year
    
551,450
      
463,652
  
Cash and cash equivalents at end of period
  
$
392,845
    
$
314,110
  

The accompanying notes are an integral part of these financial statements.
 
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Table of Contents
FREEPORT-McMoRan COPPER & GOLD INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.   
NEW ACCOUNTING STANDARDS
Deferred Mining Costs. In the mining industry, the costs of removing overburden and waste material to access mineral deposits are referred to as “stripping costs.” Currently, Freeport-McMoRan Copper & Gold Inc. (FCX) applies the deferred mining cost method in accounting for its post-production stripping costs, which FCX refers to as overburden removal costs. The deferred mining cost method is used by some companies in the metals mining industry; however, industry practice varies. The deferred mining cost method matches the cost of production with the sale of the related metal from the open pit by assigning each metric ton of ore removed an equivalent amount of overburden tonnage, thereby averaging overburden removal costs over the life of the mine. The mining cost capitalized in inventory and the amounts charged to cost of goods sold do not represent the actual costs incurred to mine the ore in any given period. The application of the deferred mining cost method has resulted in an asset on FCX’s balance sheets (“Deferred Mining Costs”) totaling $289.0 million at September 30, 2005, and $220.4 million at December 31, 2004. For further information, see Note 1 in FCX’s 2004 Annual Report on Form 10-K.

In March 2005, the Financial Accounting Standards Board (FASB) ratified Emerging Issues Task Force (EITF) Issue No. 04-6, “Accounting for Stripping Costs Incurred during Production in the Mining Industry,” (EITF 04-6) which requires that stripping costs be considered costs of the extracted minerals and recognized as a component of inventory to be recognized in cost of sales in the same period as the revenue from the sale of inventory. As a result, capitalization of stripping costs is appropriate only to the extent product inventory exists at the end of a reporting period. The guidance in EITF 04-6 is effective for financial statements issued for fiscal years beginning after December 15, 2005, with early adoption permitted. Companies may apply this guidance either by recognition of a cumulative effect adjustment to beginning retained earnings in the period of adoption or by restating prior period financial statements. FCX expects to adopt the guidance on January 1, 2006, with the most significant impacts of adoption being the deferred mining costs asset on FCX’s balance sheet on that date will be recorded, net of taxes and minority interest share, as a cumulative effect adjustment to reduce beginning retained earnings and future stripping costs will effectively be charged to cost of sales as incurred. Adoption of the new guidance will have no impact on FCX’s cash flows. The pro forma impact of applying EITF 04-6 to the periods reported in this quarterly report on Form 10-Q would be to reduce net income by $7.9 million or $0.04 per diluted share for the third quarter of 2005, $14.5 million or $0.08 per share for the third quarter of 2004 and $36.0 million or $0.16 per diluted share for the 2005 nine-month period, and to increase the net loss by $42.5 million or $0.23 per share for the 2004 nine-month period. These pro forma amounts are not necessarily indicative of what charges may be for future periods.

Stock-Based Payments. Refer to Note 1 in FCX’s 2004 Annual Report on Form 10-K for FCX’s accounting for share-based payments, including stock options. Through September 30, 2005, FCX has accounted for grants of employee stock options under the recognition principles of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, which require compensation costs for stock-based employee compensation plans to be recognized based on the difference on the date of grant, if any, between the quoted market price of the stock and the amount an employee must pay to acquire the stock. If FCX had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation,” which requires stock-based compensation to be recognized based on the use of a fair value method, FCX’s net income would have been reduced by $3.2 million, $0.02 per basic share and no change in earnings per diluted share, for the third quarter of 2005, $1.5 million, $0.01 per share, for the third quarter of 2004 and $9.5 million, $0.05 per basic share and $0.03 per diluted share, for the first nine months of 2005. FCX’s net loss for the first nine months of 2004 would have been increased by $3.7 million, $0.02 per share.

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R). SFAS No. 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. SFAS No. 123R’s effective date is fiscal periods beginning after June 15, 2005. FCX is still reviewing the provisions of SFAS No. 123R and expects to adopt SFAS No. 123R on January 1, 2006. Based on currently outstanding employee stock options, FCX currently estimates the pro forma charge to earnings before taxes and minority interest sharing for the full year 2005 would total approximately $22 million, and the pro forma reduction in net income would be approximately $13 million, $0.07 per share using average basic shares outstanding for the third quarter of 2005. These 2005 pro forma amounts are not necessarily indicative of what charges may be for future periods.
 
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Table of Contents
 
2.   
EARNINGS PER SHARE
FCX basic net income (loss) per share of common stock was calculated by dividing net income (loss) applicable to common stock by the weighted average number of common shares outstanding during the period. The following is a reconciliation of net income (loss) and weighted average common shares outstanding for purposes of calculating diluted net income (loss) per share (in thousands, except per share amounts):

   
Three Months Ended
  
Nine Months Ended
  
   
September 30,
  
September 30,
  
   
2005
  
2004
  
2005
  
2004
  
Net income (loss) before preferred dividends
  
$
180,930
  
$
32,258
  
$
516,822
  
$
(25,363
)
Preferred dividends
    
(15,125
)
  
(15,125
)
  
(45,375
)
  
(30,366
)
Net income (loss) applicable to common stock
    
165,805
    
17,133
    
471,447
    
(55,729
)
Plus income impact of assumed conversion of:
                          
5½% Convertible Perpetual Preferred Stock
    
15,125
    
-
    
45,375
    
-
  
7% Convertible Senior Notes
    
9,177
    
-
    
29,786
    
-
  
Diluted net income (loss) applicable to common stock
  
$
190,107
  
$
17,133
  
$
546,608
  
$
(55,729
)
                           
Weighted average common shares outstanding
    
177,895
    
177,137
    
178,513
    
183,426
  
Add:
Shares issuable upon conversion of:
                          
5½% Convertible Perpetual Preferred Stock
    
21,224
    
-
    
21,097
    
-
  
7% Convertible Senior Notes
    
18,410
    
-
    
18,553
    
-
  
Dilutive stock options
    
1,817
    
2,188
    
1,642
    
-
  
Restricted stock
    
478
    
480
    
480
    
-
  
Weighted average common shares outstanding for
                          
purposes of calculating diluted net income (loss)
                          
per share
    
219,824
    
179,805
    
220,285
    
183,426
  
                           
Diluted net income (loss) per share of common stock
  
$
0.86
  
$
0.10
  
$
2.48
  
$
(0.30
)
                           
Stock options representing 2.3 million shares and unvested restricted stock representing 0.4 million shares in the 2004 nine-month period that otherwise would have been included in that period’s earnings per share calculation were excluded because of the net loss reported for the period.

Outstanding stock options with exercise prices greater than the average market price of the common stock during the period are excluded from the computation of diluted net income per share of common stock. FCX’s convertible instruments are also excluded when including the conversion of these instruments increases reported diluted net income per share or when FCX reports a net loss for the period. A recap of the excluded amounts follows (in thousands, except exercise prices):

 
Three Months Ended
  
Nine Months Ended
  
 
September 30,
  
September 30,
  
 
2005
  
2004
  
2005
  
2004
  
Weighted average outstanding options
-
  
1,161
  
1,821
  
1,169
  
Weighted average exercise price
-
  
$36.77
  
$36.98
  
$36.34
  
                 
Dividends on 5½% Convertible Perpetual Preferred Stock
-
  
$15,125
  
-
  
$30,418
a
Weighted average shares issuable upon conversion
-
  
20,682
  
-
  
13,936
a
                 
Interest on 7% Convertible Senior Notes
-
  
$10,357
b
-
  
$31,072
b
Weighted average shares issuable upon conversion
-
  
18,625
  
-
  
18,625
  
                 
Interest on 8¼% Convertible Senior Notes
N/A
  
$466
b
N/A
  
$3,829
b
Weighted average shares issuable upon conversion
N/A
  
1,364
  
N/A
  
4,097
  
                 

a.  
FCX’s 5½% Convertible Perpetual Preferred Stock was issued on March 30, 2004.
b.  
Amounts are net of the effective United States federal alternative minimum tax rate of two percent.
 
7
 
Stock-Based Compensation Plans. As of September 30, 2005, FCX has four stock-based employee compensation plans and two stock-based director compensation plans, which are more fully described in Note 7 of FCX’s 2004 Annual Report on Form 10-K. As discussed in Note 1, FCX accounts for options granted under all of its plans using the recognition and measurement principles of APB Opinion No. 25 and related interpretations. Because all the plans require that the option exercise price be at least the market price on the date of grant, FCX recognizes no compensation expense on the grant or exercise of its employees’ and directors’ options. The following table illustrates the effect on net income and earnings per share if FCX had applied the fair value recognition provisions of SFAS No. 123, as discussed in Note 1 (in thousands, except per share amounts).

   
Three Months Ended
  
Nine Months Ended
  
   
September 30,
  
September 30,
  
   
2005
  
2004
  
2005
  
2004
  
Net income (loss) applicable to common stock, as reported
  
$
165,805
  
$
17,133
  
$
471,447
  
$
(55,729
)
Add: Stock-based employee compensation expense
                          
included in reported net income (loss) for stock option
                          
conversions, stock appreciation rights (SARs) and
                          
restricted stock units, net of taxes and minority interests
    
4,675
    
2,252
    
9,132
    
2,626
  
Deduct: Total stock-based employee compensation
                          
expense determined under fair value-based method for
                          
all awards, net of taxes and minority interests
    
(7,892
)
  
(3,766
)
  
(18,646
)
  
(6,349
)
Pro forma net income (loss) applicable to common stock
  
$
162,588
  
$
15,619
  
$
461,933
  
$
(59,452
)
                           
Earnings (loss) per share:
                          
Basic - as reported
  
$
0.93
  
$
0.10
  
$
2.64
  
$
(0.30
)
Basic - pro forma
  
$
0.91
  
$
0.09
  
$
2.59
  
$
(0.32
)
                           
Diluted - as reported
  
$
0.86
  
$
0.10
  
$
2.48
  
$
(0.30
)
Diluted - pro forma
  
$
0.86
  
$
0.09
  
$
2.45
  
$
(0.32
)
                           

For the pro forma computations, the values of option grants were calculated on the dates of grant using the Black-Scholes option pricing model. No other discounts or restrictions related to vesting or the likelihood of vesting of stock options were applied. The following table summarizes the calculated average fair values and weighted-average assumptions used to determine the fair value of FCX’s stock option grants under SFAS No. 123 during the periods presented.

 
Three Months Ended
  
Nine Months Ended
  
 
September 30,
  
September 30,
  
 
2005
  
2004a
  
2005
  
2004
  
Fair value per stock option
$
14.52
    
N/A
  
$
13.97
  
$
15.00
  
Risk-free interest rate
  
3.8
%
  
N/A
    
3.9
%
  
3.7
%
Expected volatility rate
  
45
%
  
N/A
    
46
%
  
49
%
Expected life of options (in years)
  
6
    
N/A
    
6
    
6
  
Assumed annual dividend
$
1.00
    
N/A
  
$
1.00
  
$
0.80
  

a.  
No options were granted in the third quarter of 2004.

See Note 1 above and Note 1 in FCX’s Annual Report on Form 10-K for a discussion of SFAS No. 123R.

3.   
BUSINESS SEGMENTS
FCX has two operating segments: “mining and exploration” and “smelting and refining.” The mining and exploration segment consists of FCX’s Indonesian activities including PT Freeport Indonesia’s copper and gold mining operations, PT Puncakjaya Power’s power-generating operations (after eliminations with PT Freeport Indonesia) and FCX’s Indonesian exploration activities. The smelting and refining segment includes Atlantic Copper’s operations in Spain and PT Freeport Indonesia’s equity investment in PT Smelting in Gresik, Indonesia. The segment data presented below were prepared on the same basis as FCX’s consolidated financial statements.
 
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Table of Contents

   
Mining
and Exploration
  
Smelting and Refining
  
Eliminations and Other
  
FCX Total
  
   
(In Thousands)
  
Three months ended September 30, 2005:
                          
Revenues
  
$
771,190
a
$
378,412
  
$
(166,332
)
$
983,270
  
Production and delivery
    
247,001
    
351,517
    
(164,150
)b
  
434,368
  
Depreciation and amortization
    
51,143
    
7,415
    
3,088
    
61,646
  
Exploration expenses
    
2,099
    
-
    
60
    
2,159
  
General and administrative expenses
    
38,394
c
  
2,268
    
(15,116
)c
  
25,546
  
Operating income
  
$
432,553
  
$
17,212
  
$
9,786
  
$
459,551
  
Equity in PT Smelting earnings
  
$
-
  
$
1,315
  
$
-
  
$
1,315
  
Interest expense, net
  
$
5,342
  
$
4,140
  
$
23,848
  
$
33,330
  
Provision for income taxes
  
$
146,610
  
$
-
  
$
40,102
  
$
186,712
  
Capital expenditures
  
$
32,447
  
$
1,444
  
$
2,425
  
$
36,316
  
Total assets
  
$
3,889,800
d
$
723,149
e
$
264,832
  
$
4,877,781
  
                           
Three months ended September 30, 2004:
                          
Revenues
  
$
447,876
a
$
222,184
  
$
(69,504
)
$
600,556
  
Production and delivery
    
198,872
    
223,384
    
(54,240
)b
  
368,016
  
Depreciation and amortization
    
46,135
    
7,114
    
2,506
    
55,755
  
Exploration expenses
    
1,939
    
-
    
24
    
1,963
  
General and administrative expenses
    
21,451
c
  
3,248
    
1,487
c
  
26,186
  
Operating income (loss)
  
$
179,479
  
$
(11,562
)
$
(19,281
)
$
148,636
  
Equity in PT Smelting earnings
  
$
-
  
$
2,678
  
$
-
  
$
2,678
  
Interest expense, net
  
$
5,133
  
$
3,300
  
$
29,415
  
$
37,848
  
Provision for income taxes
  
$
62,729
  
$
-
  
$
8,614
  
$
71,343
  
Capital expenditures
  
$
30,526
  
$
3,038
  
$
2
  
$
33,566
  
Total assets
  
$
3,713,690
d
$
723,839
e
$
345,535
  
$
4,783,064
  
                           
Nine months ended September 30, 2005:
                          
Revenues
  
$
2,136,974
a
$
982,425
  
$
(430,155
)
$
2,689,244
  
Production and delivery
    
664,234
    
937,003
    
(411,277
)b
  
1,189,960
  
Depreciation and amortization
    
142,285
    
21,645
    
8,801
    
172,731
  
Exploration expenses
    
6,263
    
-
    
158
    
6,421
  
General and administrative expenses
    
90,001
c
  
8,173
    
(25,635
)c
  
72,539
  
Operating income (loss)
  
$
1,234,191
  
$
15,604
  
$
(2,202
)
$
1,247,593
  
Equity in PT Smelting earnings
  
$
-
  
$
6,473
  
$
-
  
$
6,473
  
Interest expense, net
  
$
16,966
  
$
12,332
  
$
76,872
  
$
106,170
  
Provision for income taxes
  
$
429,936
  
$
-
  
$
109,488
  
$
539,424
  
Capital expenditures
  
$
85,955
  
$
7,307
  
$
2,345
  
$
95,607
  
                           
Nine months ended September 30, 2004:
                          
Revenues
  
$
965,901
a
$
605,137
  
$
(123,963
)
$
1,447,075
  
Production and delivery
    
525,387
    
637,042
    
(147,122
)b
  
1,015,307
  
Depreciation and amortization
    
96,738
    
21,209
    
5,808
    
123,755
  
Exploration expenses
    
6,807
    
-
    
170
    
6,977
  
General and administrative expenses
    
114,802
c
  
9,344
    
(59,824
)c
  
64,322
  
Operating income (loss)
  
$
222,167
  
$
(62,458
)
$
77,005
  
$
236,714
  
Equity in PT Smelting losses
  
$
-
  
$
228
  
$
-
  
$
228
  
Interest expense, net
  
$
16,346
  
$
10,071
  
$
84,160
  
$
110,577
  
Provision for income taxes
  
$
80,672
  
$
-
  
$
47,222
  
$
127,894
  
Capital expenditures
  
$
90,229
  
$
18,295
  
$
(118
)
$
108,406
  
                           
 
9
 
a.  
Includes PT Freeport Indonesia’s sales to PT Smelting totaling $214.1 million in the 2005 quarter, $181.6 million in the 2004 quarter, $643.1 million in the 2005 nine-month period and $474.8 million in the 2004 nine-month period.
b.  
Includes deferral of intercompany profits on 25 percent of PT Freeport Indonesia’s sales to PT Smelting, for which the final sale to third parties has not occurred, totaling $3.1 million in the 2005 quarter, $0.5 million in the 2004 quarter, $3.1 million in the 2005 nine-month period and $2.5 million in the 2004 nine-month period.
c.  
Includes charges to the mining and exploration segment for the in-the-money value of FCX stock option exercises which are eliminated in consolidation totaling $16.7 million in the 2005 quarter, $2.4 million in the 2004 quarter, $34.1 million in the 2005 nine-month period and $69.3 million in the 2004 nine-month period.
d.  
Includes PT Freeport Indonesia’s trade receivables with PT Smelting totaling $98.2 million at September 30, 2005, and $59.0 million at September 30, 2004.
e.  
Includes PT Freeport Indonesia’s equity investment in PT Smelting totaling $51.2 million at September 30, 2005, and $56.6 million at September 30, 2004.

4.   
INVENTORIES
The components of inventories follow (in thousands):
     
September 30,
  
December 31,
  
     
2005
  
2004
  
PT Freeport Indonesia:
Concentrates - Average cost
  
$
9,468
  
$
11,830
  
Atlantic Copper:
Concentrates - First in, first out (FIFO)
    
101,222
    
148,246
  
 
Work in process - FIFO
    
93,254
    
86,710
  
 
Finished goods - FIFO
    
1,127
    
6,479
  
Total product inventories
    
205,071
    
253,265
  
Total materials and supplies, net
    
244,960
    
213,447
  
Total inventories
  
$
450,031
  
$
466,712
  

The average cost method was used to determine the cost of essentially all materials and supplies inventory. Materials and supplies inventory is net of obsolescence reserves totaling $17.2 million at September 30, 2005 and $17.1 million at December 31, 2004.

5.   
DEBT AND EQUITY TRANSACTIONS
As of September 30, 2005, FCX had total outstanding debt of $1.39 billion. Debt was reduced by $565.8 million during the first nine months of 2005, primarily reflecting the following transactions:

·  
first-quarter prepayment of $187.0 million of bank debt associated with PT Puncakjaya Power’s power-generating facilities at PT Freeport Indonesia’s mining operations;
·  
first-quarter purchases in open market transactions of $11.0 million of 7.50% Senior Notes due 2006 and 7.20% Senior Notes due 2026;
·  
third-quarter purchases in open market transactions of $149.9 million of 10⅛% Senior Notes due 2010 and $4.5 million of 7.5% Senior Notes due 2006; and
·  
third-quarter privately negotiated transactions to induce conversion of $188.4 million of 7% Convertible Senior Notes due 2011 into 6.1 million shares of FCX common stock.

FCX recorded net charges of $38.4 million, $30.3 million to net income or $0.14 per share, in the third quarter and first nine months of 2005 as a result of these transactions. On August 1, 2005, FCX funded the seventh of eight scheduled annual redemption payments on its Silver-Denominated Preferred Stock for $17.5 million. The mandatory redemption resulted in a $12.5 million decrease in debt and a reduction of revenues of $5.0 million, $2.6 million to net income or $0.01 per share, in the third quarter of 2005.

In October 2005, FCX induced conversion of an additional $21.0 million of 7% Convertible Senior Notes due 2011 into 0.7 million shares of FCX common stock and purchased in open market transactions an additional $18.4 million of 10⅛% Senior Notes due 2010. FCX expects to record a net charge of $4.4 million, $3.4 million to net income, in the fourth quarter of 2005 as a result of these transactions.
 
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6.   
EMPLOYEE BENEFITS
The components of net periodic pension benefit cost for the three months ended September 30, 2005 and 2004 follow (in thousands):

 
FCX
  
PT Freeport Indonesia
  
Atlantic Copper
  
 
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
Service cost
$
180
  
$
213
  
$
850
  
$
810
  
$
-
  
$
-
  
Interest cost
  
480
    
901
    
888
    
812
    
1,199
    
1,266
  
Expected return on plan assets
  
(118
)
  
(300
)
  
(333
)
  
(441
)
  
-
    
-
  
Amortization of prior service cost
  
1,057
    
944
    
212
    
234
    
-
    
-
  
Amortization of net actuarial loss
  
-
    
-
    
168
    
69
    
224
    
223
  
Net periodic benefit cost
$
1,599
  
$
1,758
  
$
1,785
  
$
1,484
  
$
1,423
  
$
1,489
  

The components of net periodic pension benefit cost for the nine months ended September 30, 2005 and 2004 follow (in thousands):

 
FCX
  
PT Freeport Indonesia
  
Atlantic Copper
  
 
2005
  
2004
  
2005
  
2004
  
2005
  
2004
  
Service cost
$
524
  
$
497
  
$
2,681
  
$
2,512
  
$
-
  
$
-
  
Interest cost
  
1,594
    
1,894
    
2,800
    
2,519
    
3,727
    
3,809
  
Expected return on plan assets
  
(374
)
  
(369
)
  
(1,052
)
  
(1,369
)
  
-
    
-
  
Amortization of prior service cost
  
3,020
    
2,832
    
668
    
725
    
-
    
-
  
Amortization of net actuarial loss
  
-
    
-
    
531
    
215
    
696
    
672
  
Net periodic benefit cost
$
4,764
  
$
4,854
  
$
5,628
  
$
4,602
  
$
4,423
  
$
4,481
  

7.   
INTEREST COST
Interest expense excludes capitalized interest of $1.1 million in the third quarter of 2005, $0.8 million in the third quarter of 2004, $2.9 million in the first nine months of 2005 and $1.9 million in the first nine months of 2004.

8.   
COMPREHENSIVE INCOME
A summary of FCX’s comprehensive income is shown below (in thousands).

   
Three Months Ended
 
Nine Months Ended
 
   
September 30,
  
September 30,
  
   
2005
  
2004
  
2005
  
2004
  
Net income (loss)
  
$
180,930
  
$
32,258
  
$
516,822
  
$
(25,363
)
Other comprehensive income (loss):
                          
Change in unrealized derivatives’ fair value, net of taxes
                          
of $1.8 million for the three months ended
                          
September 30, 2005, $(0.9) million for the three months
                          
ended September 30, 2004, $2.9 million for the nine
                          
months ended September 30, 2005 and $(0.8) million for
                          
the nine months ended September 30, 2004
    
(2,387
)
  
1,103
    
(3,732
)
  
989
  
Reclass to earnings, net of taxes of $0.2 million
                          
for the nine months ended September 30, 2005 and
                         
none for the other periods
    
(20
)
  
319
    
(115
)
  
1,301
  
Total comprehensive income (loss)
  
$
178,523
  
$
33,680
  
$
512,975
  
$
(23,073
)
                           
9.   
RATIO OF EARNINGS TO FIXED CHARGES
The ratio of earnings to fixed charges for the first nine months of 2005 and 2004 was 11.1 to 1 and 2.0 to 1, respectively. For this calculation, earnings consist of income from continuing operations before income taxes, minority interests and fixed charges. Fixed charges include interest and that portion of rent deemed representative of interest.

----------------------
Remarks

The information furnished herein should be read in conjunction with FCX's financial statements contained in its 2004 Annual Report on Form 10-K. The information furnished herein reflects all adjustments which are, in the opinion of management, necessary for a fair statement of the results for the periods. All such adjustments are, in the opinion of management, of a normal recurring nature.

 
11

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE BOARD OF DIRECTORS AND STOCKHOLDERS OF
FREEPORT-McMoRan COPPER & GOLD INC.

We have reviewed the condensed consolidated balance sheet of Freeport-McMoRan Copper & Gold Inc. (a Delaware Corporation) and subsidiaries as of September 30, 2005 and the related consolidated statements of operations for the three-month and nine-month periods ended September 30, 2005 and 2004, and the consolidated statements of cash flows for the nine-month periods ended September 30, 2005 and 2004. These financial statements are the responsibility of the Company’s management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with United States generally accepted accounting principles.

We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Freeport-McMoRan Copper & Gold Inc. as of December 31, 2004, and the related consolidated statements of income, stockholder’s equity, and cash flows for the year then ended (not presented herein), and in our report dated March 9, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2004, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.

ERNST & YOUNG LLP


New Orleans, Louisiana
October 25, 2005

 
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Table of Contents

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

OVERVIEW

In management’s discussion and analysis, “we,”“us” and “our” refer to Freeport-McMoRan Copper & Gold Inc. (FCX) and its consolidated subsidiaries. References to “aggregate” amounts mean the total of our share and Rio Tinto plc’s share as our joint venture partner. You should read this discussion in conjunction with our financial statements, the related discussion and analysis of financial condition and results of operations and the discussion of our “Business and Properties” in our Form 10-K for the year ended December 31, 2004, filed with the Securities and Exchange Commission. The results of operations reported and summarized below are not necessarily indicative of future operating results.

We operate through our majority-owned subsidiaries, PT Freeport Indonesia and PT Puncakjaya Power (Puncakjaya Power), and through Atlantic Copper, S.A. (Atlantic Copper) and PT Irja Eastern Minerals (Eastern Minerals), our principal wholly owned subsidiaries. PT Freeport Indonesia, our principal operating subsidiary, conducts exploration, mining and production activities in a 24,700-acre area called Block A located in Papua, Indonesia. PT Freeport Indonesia also conducts exploration activities (which are currently suspended, but are under review for resumption) in an approximate 500,000-acre area called Block B in Papua. Puncakjaya Power’s sole business is to supply power to PT Freeport Indonesia’s operations. Our principal asset is the Grasberg minerals district, which contains the largest single gold reserve and the second-largest copper reserve of any mine in the world.

Atlantic Copper’s operations are in Spain and involve the smelting and refining of copper concentrates and the marketing of refined copper and precious metals in slimes. PT Freeport Indonesia owns a 25 percent interest in PT Smelting, an Indonesian company which operates a copper smelter and refinery in Gresik, Indonesia. Eastern Minerals conducts mineral exploration activities (which are currently suspended) in Papua, Indonesia.

We own 90.64 percent of PT Freeport Indonesia, of which 9.36 percent is owned through our wholly owned subsidiary, PT Indocopper Investama. The Government of Indonesia owns the remaining 9.36 percent of PT Freeport Indonesia. In July 2004, we received a request from the Indonesian Department of Energy and Mineral Resources that we offer to sell shares in PT Indocopper Investama to Indonesian nationals at fair market value. In response to this request and in view of the potential benefits of having additional Indonesian ownership in our project, we have agreed to consider a potential sale of an interest in PT Indocopper Investama at fair market value. Neither our Contract of Work nor Indonesian law requires us to divest any portion of our ownership interest in PT Freeport Indonesia or PT Indocopper Investama.

Outlook
Annual sales are expected to approximate 1.47 billion pounds of copper and 2.8 million ounces of gold in 2005, increases of nearly 50 percent for copper and nearly 100 percent for gold compared with 2004. PT Freeport Indonesia expects its fourth-quarter operations to benefit from access to higher grade material and more flexible set-ups for its mining equipment in the high-grade areas of the Grasberg mine than in the third quarter, which we currently anticipate would allow PT Freeport Indonesia to generate sales estimated to approximate 480 million pounds of copper and 1.1 million ounces of gold, 39 percent more than third-quarter copper sales and more than twice the third quarter gold sales. Achieving this high level of production and sales is dependent, among other factors, on the successful operations of PT Freeport Indonesia production facilities and systems, and sales volumes could be reduced if year-end weather conditions or other factors delay concentrate loading operations, which would defer sales volumes to 2006.

Using estimated sales volumes for the fourth quarter of 2005 and assuming average fourth-quarter 2005 prices of $1.75 per pound of copper and $465 per ounce of gold, we would generate operating cash flows approximating $1.4 billion in 2005, with approximately $500 million in the fourth quarter. Each $0.10 per pound change in copper prices in the fourth quarter is currently estimated to affect 2005 cash flows by approximately $24 million and each $25 per ounce change in gold prices is currently estimated to affect 2005 cash flows by approximately $14 million.

At the Grasberg mine, the sequencing in mining areas with varying ore grades causes fluctuations in the timing of ore production, which impacts sales volumes, particularly for gold. Based on its current mine plan, PT Freeport Indonesia estimates its share of sales for 2006 will approximate 1.4 billion pounds of copper and 1.9 million ounces of gold. Average annual sales volumes over the five-year period from 2005 through 2009 are expected to approximate 1.35 billion pounds of copper and 2.2 million ounces of gold.
 
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Table of Contents
 
Sales volumes may vary from these estimates depending on the areas being mined within the Grasberg open pit. Quarterly variations in sales volumes are expected to vary significantly. Based on current estimates of average annual sales volumes over the next five years and copper prices of approximately $1.75 per pound and gold prices of approximately $465 per ounce, the impact on our annual cash flow for each $0.10 per pound change in copper prices would approximate $69 million, including the effects of price changes on related royalty costs, and for each $25 per ounce change in gold prices would approximate $28 million.

Copper and Gold Markets
As shown in the graphs below, world metal prices for copper have fluctuated during the period from 1992 through October 2005 with the London Metal Exchange (LME) spot copper price varying from a low of approximately $0.60 per pound in 2001 to a high of $1.90 per pound on October 20, 2005, and world gold prices have fluctuated during the period from 1998 through October 2005 from a low of approximately $250 per ounce in 1999 to a high of approximately $479 per ounce on October 12, 2005. Copper and gold prices are affected by numerous factors beyond our control as described further in our Form 10-K for the year ended December 31, 2004.

* Excludes Shanghai stocks, producer, consumer and merchant stocks.

The graph above presents LME spot copper prices and reported stocks of copper at the LME and New York Commodity Exchange (COMEX) through October 31, 2005. Market fundamentals for copper continued to be positive in the first nine months of 2005. LME and COMEX inventories are at levels of less than 75,000 metric tons. Copper prices averaged $1.70 per pound in the third quarter of 2005, with prices ranging from $1.56 per pound to $1.80 per pound. The LME spot copper price closed at $1.86 per pound on October 31, 2005. Global copper demand in the first nine months of 2005 has been lower than expectations; however, disruptions associated with strikes and other operational issues have reduced copper supply and continue to keep inventories at very low levels. Many market analysts expect copper supplies to increase in the near term as smelter capacity is projected to increase and project lower than current prices once supplies begin to grow. Nevertheless, analysts’ price expectations for 2006 are generally higher than they were earlier in the year, partly because of the disruptions discussed above. Future copper prices are expected to continue to be determined by demand from China, economic performance in the United States (U.S.) and other industrialized countries, the timing of the development of new supplies of copper, production levels of mines and copper smelters and other factors. We consider the underlying supply and demand conditions in the global copper markets to be positive for our company.
 
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Table of Contents
 

The environment for gold continues to be positive with gold prices recently reaching new 17-year highs supported by ongoing geopolitical tensions, investment demand for gold as a hedge against inflation, increasing jewelry demand, falling production for older mines, limited development of new mines and actions by gold producers to reduce hedge positions. Gold prices averaged $440 per ounce in the third quarter of 2005, with prices ranging from $418 per ounce to $473 per ounce. The London gold price closed at approximately $471 per ounce on October 31, 2005.

CONSOLIDATED RESULTS

Summary comparative results for the third-quarter and nine-month periods follow (in millions, except per share amounts):

 
Third Quarter
  
Nine Months
  
 
2005
  
2004
  
2005
  
2004
  
Revenues
$
983.3
  
$
600.6
  
$
2,689.2
  
$
1,447.1
  
Operating income
  
459.6
    
148.6
    
1,247.6
    
236.7
  
Net income (loss) applicable to common stock
  
165.8
    
17.1
    
471.4
    
(55.7
)
Diluted net income (loss) per share of common stock
  
0.86
    
0.10
    
2.48
    
(0.30
)

Consolidated revenues include PT Freeport Indonesia’s sale of copper concentrates, which also contain significant quantities of gold, and the sale by Atlantic Copper of copper anodes, copper cathodes, and gold in anodes and slimes. Consolidated revenues for the third quarter of 2005 and the first nine months of 2005 were significantly higher than consolidated revenues for the 2004 periods, reflecting substantially higher copper and gold sales volumes and prices than the 2004 periods. Third-quarter and nine-month 2004 results were adversely affected by lower ore grades and reduced mill throughput as PT Freeport Indonesia completed efforts to restore safe access to the higher-grade ore areas in its Grasberg open-pit mine following the fourth-quarter 2003 slippage and debris flow events. In addition, Atlantic Copper’s scheduled major maintenance turnaround adversely affected its nine-month 2004 revenues.

At September 30, 2005, we had consolidated embedded derivatives on copper sales totaling 298.6 million pounds recorded at an average price of $1.74 per pound. Final prices on these sales will be established over the next several months pursuant to terms of sales contracts. We estimate that a two-cent change in the average price used for these embedded derivatives and realized prices for these sales would have an approximate $6 million impact on our 2005 consolidated revenues and an approximate $3 million impact on our 2005 consolidated net income.
 
15

Third-quarter 2005 consolidated revenues included net additions of $48.8 million ($25.9 million to net income or $0.12 per share) primarily for final pricing of concentrates sold in prior quarters, compared with $13.6 million ($7.0 million to net income or $0.04 per share) to third-quarter 2004 revenues. Nine-month 2005 consolidated revenues included net additions of $8.6 million ($4.5 million to net income or $0.02 per share) compared with $7.3 million ($3.7 million to net income or $0.02 per share), primarily for final pricing of concentrates sold in prior years.

Consolidated revenues and net income vary significantly with fluctuations in the market prices of copper and gold and other factors. Based on PT Freeport Indonesia’s projected share of copper sales for the fourth quarter of 2005 (480 million pounds) and assuming an average price of $1.75 per pound of copper, each $0.10 per pound change in the average price realized in the fourth quarter of 2005 would have an approximate $48 million impact on our fourth-quarter revenues and an approximate $24 million impact on our fourth-quarter net income. A $25 per ounce change in the average price realized in the fourth quarter on PT Freeport Indonesia’s projected share of gold sales for the fourth quarter of 2005 (1.1 million ounces) would have an approximate $28 million impact on our fourth-quarter revenues and an approximate $14 million impact on our fourth-quarter net income.

On limited past occasions, in response to market conditions, we have entered into copper and gold price protection contracts for a portion of our expected future mine production to mitigate the risk of adverse price fluctuations. We currently have no copper or gold price protection contracts relating to our mine production. We have outstanding gold-denominated and silver-denominated preferred stock with dividends and redemption amounts determined by commodity prices. Our gold-denominated preferred stock is mandatorily redeemable in February 2006 and the final scheduled redemption for our silver-denominated preferred stock is in August 2006 (see “Capital Resources and Liquidity - Financing Activities”).

Consolidated production and delivery costs were higher for the 2005 periods than the 2004 periods primarily because of higher production costs at PT Freeport Indonesia and higher costs of concentrate purchases at Atlantic Copper caused by increased production volumes and higher metals prices. Consolidated depreciation and amortization expense increased to $61.6 million in the third quarter of 2005 and $172.7 million in the first nine months of 2005, compared with $55.8 million in the third quarter of 2004 and $123.8 million in the first nine months of 2004, primarily because of higher copper sales volumes at PT Freeport Indonesia during the 2005 periods. Exploration expenses totaled $2.2 million in the third quarter of 2005 and $6.4 million in the first nine months of 2005 compared with $2.0 million in the third quarter of 2004 and $7.0 million in the first nine months of 2004 (see “Mining and Exploration - Exploration Activities”). Consolidated general and administrative expenses decreased to $25.5 million in the third quarter of 2005 from $26.2 million in the third quarter of 2004 and increased to $72.5 million in the first nine months of 2005 from $64.3 million in the first nine months of 2004 (see “Other Financial Results”).

Net interest expense decreased to $33.3 million in the third quarter of 2005 from $37.8 million in the third quarter of 2004 primarily because of lower debt levels. Losses on early extinguishment and conversion of debt totaled $38.4 million ($30.3 million to net income or $0.14 per share, net of related reduction of interest expense), for the third quarter and first nine months of 2005 resulting from the open-market purchases of our 10⅛% Senior Notes and 7.5% Senior Notes and the early conversions of our 7% Convertible Senior Notes (see “Capital Resources and Liquidity - Financing Activities”). Losses on early extinguishment and conversion of debt totaled $14.0 million ($7.4 million to net income or $0.04 per share, net of related reduction of interest expense), for the first nine months of 2004 resulting primarily from the early conversions of our 8¼% Convertible Senior Notes (see “Capital Resources and Liquidity - Financing Activities”).

Other income includes interest income of $4.7 million in the third quarter of 2005, $1.0 million in the third quarter of 2004, $11.7 million in the first nine months of 2005 and $4.2 million in the first nine months of 2004. Other income also includes the impact of translating into U.S. dollars Atlantic Copper’s net euro-denominated liabilities, primarily its retiree pension obligations. Changes in the U.S. dollar/euro exchange rate require us to adjust the dollar value of our net euro-denominated liabilities and record the adjustment in earnings. The exchange rate was $1.36 per euro at December 31, 2004, $1.21 per euro at June 30, 2005 and $1.20 per euro at September 30, 2005. Exchange rate effects on our net income from euro-denominated liabilities were gains (losses) of $(1.3) million in the third quarter of 2005, $(0.8) million in the third quarter of 2004, $4.9 million in the first nine months of 2005 and $1.1 million in the first nine months of 2004.
 
16
Table of Contents
 
PT Freeport Indonesia’s Contract of Work provides for a 35 percent corporate income tax rate. PT Indocopper Investama pays a 30 percent corporate income tax on dividends it receives from its 9.36 percent ownership in PT Freeport Indonesia. In addition, the tax treaty between Indonesia and the U.S. provides for a withholding tax rate of 10 percent on dividends and interest that PT Freeport Indonesia and PT Indocopper Investama pay to their parent company, FCX. Prior to 2005, we also incurred a U.S. alternative minimum tax at an effective rate of two percent based primarily on consolidated income, net of smelting and refining results. As a result of the enactment of the American Jobs Creation Act of 2004, the 90 percent limitation on the use of foreign tax credits to offset the U.S. federal alternative minimum tax liability has been repealed effective January 1, 2005. The removal of this limitation will reduce our U.S. federal taxes beginning in 2005. In 2004, our U.S. federal alternative minimum tax liability totaled $8.2 million. We currently record no income taxes at Atlantic Copper, which is subject to taxation in Spain, because it has not generated significant taxable income in recent years and has substantial tax loss carryforwards for which we have provided no financial statement benefit. We receive no consolidated tax benefit from these losses because they cannot be used to offset PT Freeport Indonesia’s profits in Indonesia.

Parent company costs consist primarily of interest, depreciation and amortization, and general and administrative expenses. We receive minimal tax benefit from these costs, including interest expense, primarily because our parent company generates no taxable income from U.S. sources. As a result, our provision for income taxes as a percentage of our consolidated income before income taxes and minority interests will vary as PT Freeport Indonesia’s income changes, absent changes in Atlantic Copper and parent company costs. Summaries of the approximate significant components of the calculation of our consolidated provision for income taxes are shown below (in thousands, except percentages).

 
Three Months Ended
  
Nine Months Ended
  
 
September 30,
  
September 30,
  
 
2005
  
2004
  
2005
  
2004
  
Mining and exploration segment operating incomea
$
449,248
  
$
181,896
  
$
1,268,335
  
$
291,427
  
Mining and exploration segment interest expense, net
  
(5,342
)
  
(5,133
)
  
(16,966
)
  
(16,346
)
Intercompany operating profit (deferred) recognized
  
(1,904
)
  
(15,056
)
  
(17,124
)
  
23,563
  
Income before taxes
  
442,002
    
161,707
    
1,234,245
    
298,644
  
Indonesian corporate income tax rate (35%) plus U.S.
                       
alternative minimum tax rate (2%) for 2004
  
35
%
  
37
%
  
35
%
  
37
%
Corporate income taxes
  
154,701
    
59,832
    
431,986
    
110,498
  
                         
Approximate PT Freeport Indonesia net income
  
287,301
    
101,875
    
802,259
    
188,146
  
Withholding tax on FCX’s equity share
  
9.064
%
  
9.064
%
  
9.064
%
  
9.064
%
Withholding taxes
  
26,041
    
9,234
    
72,717
    
17,054
  
                         
PT Indocopper Investama corporate income tax
  
9,840
    
3,005
    
30,921
    
3,005
  
Other, net
  
(3,870
)
  
(728
)
  
3,800
    
(2,663
)
FCX consolidated provision for income taxes
$
186,712
  
$
71,343
  
$
539,424
  
$
127,894
  
                         
FCX consolidated effective tax rate
  
48
%
  
63
%
  
48
%
  
b
  
                         
a.  
Excludes charges for the in-the-money value of FCX stock option exercises, which are eliminated in consolidation, totaling $16.7 million for the 2005 quarter, $2.4 million for the 2004 quarter, $34.1 million for the 2005 nine-month period and $69.3 million for the 2004 nine-month period.
b.  
Rate is not meaningful given the small amount of consolidated income before taxes and minority interests for the 2004 nine-month period.

RESULTS OF OPERATIONS

We have two operating segments: “mining and exploration” and “smelting and refining.” The mining and exploration segment consists of our Indonesian activities including PT Freeport Indonesia’s copper and gold mining operations, Puncakjaya Power’s power generating operations (after eliminations with PT Freeport Indonesia) and our Indonesian exploration activities, including those of Eastern Minerals. The smelting and refining segment includes Atlantic Copper’s operations in Spain and PT Freeport Indonesia’s equity investment in PT Smelting. Summary comparative operating income (loss) data by segment follow (in millions):
 
17
Table of Contents
 
 
Third Quarter
  
Nine Months
  
 
2005
  
2004
  
2005
  
2004
  
Mining and explorationa
$
432.6
  
$
179.5
  
$
1,234.2
  
$
222.2
  
Smelting and refining
  
17.2
    
(11.6
)
  
15.6
    
(62.5
)
Intercompany eliminations and othera, b
  
9.8
    
(19.3
)
  
(2.2
)
  
77.0
  
FCX operating income
$
459.6
  
$
148.6
  
$
1,247.6
  
$
236.7
  
                         
a.  
Includes charges to the mining and exploration segment for the in-the-money value of FCX stock option exercises, which are eliminated in consolidation, totaling $16.7 million in the 2005 quarter, $2.4 million in the 2004 quarter, $34.1 million for the 2005 nine-month period and $69.3 million for the 2004 nine-month period.
b.  
We defer recognizing profits on PT Freeport Indonesia’s sales to Atlantic Copper and on 25 percent of PT Freeport Indonesia’s sales to PT Smelting until their sales of final products to third parties. Changes in the amount of these deferred profits impacted operating income by $(1.9) million in the third quarter of 2005, $(15.1) million in the third quarter of 2004, $(17.1) million in the first nine months of 2005 and $23.6 million in the first nine months of 2004. Our consolidated earnings can fluctuate materially depending on the timing and prices of these sales. At September 30, 2005, our deferred profits to be recognized in future periods’ operating income totaled $98.0 million, $52.0 million to net income, after taxes and minority interest sharing.

MINING AND EXPLORATION

PT Freeport Indonesia Operating Results

     
Third Quarter
  
Nine Months
  
     
2005
  
2004
  
2005
  
2004
  
PT Freeport Indonesia Operating Data, Net of Rio Tinto’s Interest
            
Copper (recoverable)
                    
Production (000s of pounds)
    
344,500
  
256,400
  
982,400
  
572,800
  
Production (metric tons)
    
156,300
  
116,300
  
445,600
  
259,800
  
Sales (000s of pounds)
    
346,300
  
261,900
  
988,100
  
572,400
  
Sales (metric tons)
    
157,100
  
118,800
  
448,200
  
259,600
  
Average realized price per pound
    
$1.73
  
$1.34
  
$1.67
  
$1.31
  
Gold (recoverable ounces)
                    
Production
    
472,100
  
337,000
  
1,672,800
  
827,200
  
Sales
    
475,000
  
350,000
  
1,686,700
  
824,900
  
Average realized price per ounce
    
$445.79
  
$398.89
  
$431.88
  
$396.33
  
                     
PT Freeport Indonesia, 100% Aggregate Operating Data
                
Ore milled (metric tons per day)
    
216,300
  
194,000
  
209,200
  
170,100
  
Average ore grade
                    
Copper (percent)
    
1.06
  
.83
  
1.06
  
.73
  
Gold (grams per metric ton)
    
1.16
  
.79
  
1.40
  
.73
  
Recovery rates (percent)
                    
Copper
    
87.8
  
87.8
  
88.3
  
87.1
  
Gold
    
80.6
  
81.3
  
82.5
  
81.4
  
Copper (recoverable)
                    
Production (000s of pounds)
    
394,700
  
275,900
  
1,134,200
  
623,800
  
Production (metric tons)
    
179,100
  
125,200
  
514,500
  
283,000
  
Sales (000s of pounds)
    
396,600
  
282,000
  
1,140,500
  
622,900
  
Sales (metric tons)
    
179,900
  
127,900
  
517,300
  
282,500
  
Gold (recoverable ounces)
                    
Production
    
590,700
  
358,600
  
2,082,000
  
873,500
  
Sales
    
594,400
  
372,300
  
2,096,200
  
872,000
  

 
18
Table of Contents
 
Third-quarter sales of 346.3 million pounds of copper and 475,000 ounces of gold were lower than previous estimates of 380 million pounds and 575,000 ounces. Third quarter mining activities included the mining of overburden and low-grade material that will enable large-scale production of high-grade ore during the fourth quarter and the subsequent continuation of the previously announced long-term mine plan for the Grasberg operations, resulting in reduced mining rates in the “6 South” high grade section of the Grasberg open pit and lower than expected ore grades. Production was also affected by an extension to a planned maintenance shutdown of one of PT Freeport Indonesia’s semi-autogenous grinding mills. PT Freeport Indonesia expects fourth quarter operations will benefit from more flexible mining set-ups and access to higher grade material, allowing PT Freeport Indonesia to offset the third quarter shortfall substantially. Fourth-quarter sales are expected to approximate 480 million pounds of copper and 1.1 million ounces of gold.

Mill throughput, which varies depending on ore types being processed, averaged 216,300 metric tons of ore per day in the third quarter of 2005, 194,000 metric tons of ore in the third quarter of 2004, 209,200 metric tons of ore in the first nine months of 2005 and 170,100 metric tons of ore in the first nine months of 2004. Mill rates in the third quarter of 2005 were negatively affected by mill maintenance activities as discussed above. Mill rates are projected to average in excess of 220,000 metric tons of ore per day during the fourth quarter of 2005. Approximate average daily throughput processed at our mill facilities from each of our producing mines follows (metric tons of ore per day):

 
Third Quarter
  
Nine Months
  
 
2005
  
2004
  
2005
  
2004
  
Grasberg open pit
174,500
  
150,800
  
167,200
  
125,400
  
Deep Ore Zone underground mine
41,800
  
43,200
  
42,000
  
44,700
  
Total mill throughput
216,300
  
194,000
  
209,200
  
170,100
  

Third-quarter 2005 copper ore grades averaged 1.06 percent, compared with 0.83 percent for the third quarter of 2004. Third-quarter 2005 copper recovery rates were 87.8 percent, approximating the year-ago period. For the third quarter of 2005, gold ore grades averaged 1.16 grams per metric ton (g/t), compared with 0.79 g/t for the third quarter of 2004. Gold recovery rates averaged 80.6 percent for the third quarter of 2005, compared with 81.3 percent for the third quarter of 2004. The 2005 grades reflect the return to normal mining operations at Grasberg, including accessing higher grade material in accordance with our mine plan.

Production from the Deep Ore Zone (DOZ) underground mine averaged 41,800 metric tons of ore per day in the third quarter of 2005, representing 19 percent of mill throughput as it continued to perform above design capacity of 35,000 metric tons of ore per day. PT Freeport Indonesia is expanding the capacity of the DOZ underground operation to a sustained rate of 50,000 metric tons per day with the installation of a second crusher and additional ventilation, which are expected to be completed by 2007. PT Freeport Indonesia’s share of capital expenditures for the DOZ expansion totaled $9.2 million in the first nine months of 2005 and is expected to approximate $37 million through the projected 2007 ramp-up, with approximately $7.5 million estimated for the fourth quarter of 2005. The DOZ mine, a block cave operation, is one of the world’s largest underground mines.

In 2004, PT Freeport Indonesia commenced its “Common Infrastructure” project, which will provide access to its large undeveloped underground ore bodies located in the Grasberg minerals district through a tunnel system located approximately 400 meters deeper than its existing underground tunnel system. PT Freeport Indonesia’s share of capital expenditures for its Common Infrastructure project totaled $13.1 million in the first nine months of 2005 and is estimated to total approximately $5 million for the fourth quarter of 2005. The Common Infrastructure project is progressing according to plan.

PT Freeport Indonesia is also proceeding with plans to develop Big Gossan, a high-grade deposit located near the existing milling complex. Our Board of Directors has approved this project and aggregate capital expenditures from 2006 to 2009 for Big Gossan are expected to total approximately $225 million ($195 million net to PT Freeport Indonesia, with approximately $50 million in 2006). Production is expected to ramp up to 7,000 metric tons per day by 2010 (average annual aggregate incremental production of 135 million pounds of copper and 65,000 ounces of gold, with PT Freeport Indonesia receiving 60 percent of these amounts). The Big Gossan mine is expected to be an open-stope mine with cemented backfill, which is a higher-cost mining method than the block-cave method used at the DOZ mine.
 
19
 
PT Freeport Indonesia Revenues

A summary of changes in PT Freeport Indonesia revenues between the periods follows (in millions):
 
 
Third
  
Nine
  
 
Quarter
  
Months
  
PT Freeport Indonesia revenues - prior year period
$
447.9
  
$
965.9
  
Sales volumes:
            
Copper
  
113.1
    
545.0
  
Gold
  
49.9
    
341.5
  
Price realizations:
            
Copper
  
134.3
    
358.7
  
Gold
  
22.3
    
60.0
  
Adjustments, primarily for copper pricing on prior period open sales
  
46.1
    
(1.5
)
Treatment charges, royalties and other
  
(42.4
)
  
(132.6
)
PT Freeport Indonesia revenues - current year period
$
771.2
  
$
2,137.0
  
             
PT Freeport Indonesia achieved significantly higher production and sales volumes in the 2005 periods compared with the 2004 periods, reflecting higher ore grades and milling rates than the 2004 periods. Copper sales volumes totaled 346.3 million pounds in the third quarter of 2005, 32 percent higher than the 261.9 million pounds reported in the third quarter of 2004. Third-quarter 2005 copper price realizations of $1.73 per pound were $0.39 per pound higher than the third-quarter 2004 realizations of $1.34 per pound. Gold sales volumes totaled 475,000 ounces in the third quarter of 2005, 36 percent higher than the 350,000 ounces reported in the third quarter of 2004. Gold price realizations of $445.79 per ounce in the third quarter of 2005 were nearly $47 an ounce higher than third-quarter 2004 realizations of $398.89 per ounce. For the nine-month periods, copper sales volumes totaled 988.1 million pounds in 2005, nearly 73 percent more than the 572.4 million pounds in 2004, and gold sales volumes totaled 1,686,700 ounces, more than double the 824,900 ounces in 2004. Copper price realizations of $1.67 per pound in the first nine months of 2005 were $0.36 per pound higher than the 2004 period realizations of $1.31 per pound. Gold price realizations of $431.88 per ounce in the first nine months of 2005 were almost $36 an ounce higher than 2004 period realizations of $396.33 per ounce.

Treatment charges vary with the volume of metals sold and the price of copper, and royalties vary with the volume of metals sold and the prices of copper and gold. In addition, treatment charges vary based on PT Freeport Indonesia’s customer mix as sales to PT Smelting are subject to a minimum rate (see below). Market rates for treatment and refining charge rates began to increase significantly in late 2004, and PT Freeport Indonesia expects its average 2005 rate to slightly exceed its average 2004 rate. Royalties totaled $20.3 million in the third quarter of 2005 and $56.9 million in the first nine months of 2005 compared with $11.6 million in the third quarter of 2004 and $24.3 million in the first nine months of 2004, reflecting higher sales volumes and metal prices.

Substantially all of PT Freeport Indonesia’s concentrate sales contracts provide final copper pricing in a specified future period based on prices quoted on the LME. PT Freeport Indonesia records revenues and invoices its customers based on LME prices at the time of shipment. Under accounting rules, these terms create an “embedded derivative” in our concentrate sales contracts which must be adjusted to fair value through earnings each period until the date of final copper pricing. PT Freeport Indonesia’s third-quarter 2005 revenues include net additions of $74.7 million for adjustments to the fair value of embedded copper derivatives in concentrate sales contracts, compared with $41.8 million in the third quarter of 2004. PT Freeport Indonesia’s nine-month 2005 revenues included net additions of $96.8 million for adjustments to the fair value of embedded derivatives in concentrate sales contracts, compared with $41.0 million in the 2004 period.

PT Freeport Indonesia expects its share of sales to approximate 1.47 billion pounds of copper and 2.8 million ounces of gold for 2005. PT Freeport Indonesia expects its fourth-quarter operations to benefit from access to higher grade material and more flexible set-ups for its mining equipment in the high-grade areas of the Grasberg mine than in the third quarter, which we currently anticipate would allow PT Freeport Indonesia to generate sales estimated to approximate 480 million pounds of copper and 1.1 million ounces of gold, 39 percent more than third-quarter copper sales and more than twice the third quarter gold sales. Achieving this high level of production and sales is dependent, among other factors, on the successful operations of PT Freeport Indonesia production facilities and systems, and sales volumes could be reduced if year-end weather conditions or other factors delay concentrate loading operations, which would defer sales volumes to 2006.
 
20
Table of Contents
 
PT Freeport Indonesia has long-term contracts to provide approximately 60 percent of Atlantic Copper’s copper concentrate requirements at market prices and nearly all of PT Smelting’s copper concentrate requirements. Under the PT Smelting contract, for the first 15 years of PT Smelting’s operations beginning December 1998, the treatment and refining charges on the majority of the concentrate PT Freeport Indonesia provides will not fall below specified minimum rates, subject to renegotiation in 2008. The rate was $0.23 per pound during the period from the commencement of PT Smelting’s operations in 1998 until April 2004, when it declined to a minimum of $0.21 per pound. Market rates for 2005, excluding price participation, under long-term contracts settled in late 2004 approximate $0.21 per pound. Including price participation at current copper prices of approximately $1.86 per pound, PT Smelting’s rates exceed the minimum $0.21 per pound (see “Smelting and Refining”).

PT Freeport Indonesia Costs

Gross profit (loss) per pound of copper (¢)/per ounce of gold and silver ($):
        
Three Months Ended September 30, 2005
                        
Pounds of copper sold (000s)
  
346,300
    
346,300
              
Ounces of gold sold
              
475,000
        
Ounces of silver sold
                    
1,065,500
  
             
   
By-Product
    
Co-Product Method
  
   
Method
    
Copper
    
Gold
    
Silver
  
Revenues, after adjustments shown below
  
172.8
¢
  
172.8
¢
  
$445.79
    
$5.25
  
                         
Site production and delivery, before net non-
                        
cash and nonrecurring costs shown below
  
70.6
a
  
51.7
b
  
133.52
b
  
2.09
b
Gold and silver credits
  
(62.9
)
  
-
    
-
    
-
  
Treatment charges
  
24.9
    
18.2
    
47.06
    
0.74
  
Royalty on metals
  
5.9
    
4.3
    
11.11
    
0.17
  
Unit net cash costsc
  
38.5
    
74.2
    
191.69
    
3.00
  
Depreciation and amortization
  
14.8
    
10.8
    
27.92
    
0.44
  
Noncash and nonrecurring costs, net
  
0.7
    
0.5
    
1.35
    
0.02
  
Total unit costs
  
54.0
    
85.5
    
220.96
    
3.46
  
Revenue adjustments, primarily for pricing
                        
on prior period open sales and silver hedging
  
17.8
    
19.3
    
(2.90
)
  
(2.95
)
PT Smelting intercompany profit elimination
  
(0.9
)
  
(0.7
)
  
(1.69
)
  
(0.03
)
Gross profit (loss) per pound/ounce
  
135.7
¢
  
105.9
¢
  
$220.24
    
$(1.19
)
                         
Three Months Ended September 30, 2004
                        
Pounds of copper sold (000s)
  
261,900
    
261,900
              
Ounces of gold sold
              
350,000
        
Ounces of silver sold
                    
837,800
  
             
   
By-Product
    
Co-Product Method
  
   
Method
    
Copper
    
Gold
    
Silver
  
Revenues, after adjustments shown below
  
134.0
¢
  
134.0
¢
  
$398.89
    
$5.25
  
                         
Site production and delivery, before net non-
                        
cash and nonrecurring costs shown below
  
75.1
d
  
53.0
e
  
158.95
e
  
2.49
e
Gold and silver credits
  
(55.4
)
  
-
    
-
    
-
  
Treatment charges
  
19.6
    
13.9
    
41.52
    
0.65
  
Royalty on metals
  
4.4
    
3.1
    
9.38
    
0.15
  
Unit net cash costsc
  
43.7
    
70.0
    
209.85
    
3.29
  
Depreciation and amortization
  
17.6
    
12.4
    
37.29
    
0.58
  
Noncash and nonrecurring costs, net
  
0.9
    
0.6
    
1.81
    
0.03
  
Total unit costs
  
62.2
    
83.0
    
248.95
    
3.90
  
Revenue adjustments, primarily for pricing
                        
on prior period open sales and silver hedging
  
5.7
    
6.1
    
0.89
    
(0.70
)
PT Smelting intercompany profit elimination
  
(0.2
)
  
(0.1
)
  
(0.42
)
  
(0.01
)
Gross profit per pound/ounce
  
77.3
¢
  
57.0
¢
  
$150.41
    
$0.64
  
                         
 
 
21
Table of Contents
 
a.   
Net of deferred mining costs totaling $15.8 million or 4.6¢ per pound. Upon adoption of Emerging Issues Task Force (EITF) Issue No. 04-6 (EITF 04-6) (see Note 1 of Notes to Consolidated Financial Statements), mining costs will no longer be deferred.
b.   
Net of deferred mining costs totaling $11.6 million or 3.3¢ per pound for copper, $4.1 million or $8.63 per ounce for gold and $0.1 million or $0.14 per ounce for silver. See Note a above.
c.   
For a reconciliation of unit net cash costs to production and delivery costs applicable to sales reported in FCX’s consolidated financial statements refer to “Product Revenues and Production Costs” below.
d.   
Net of deferred mining costs totaling $23.7 million or 9.0¢ per pound. See Note a above.
e.   
Net of deferred mining costs totaling $16.7 million or 6.4¢ per pound for copper, $6.7 million or $19.14 per ounce for gold and $0.3 million or $0.30 per ounce for silver. See Note a above.

Gross profit per pound of copper (¢)/per ounce of gold and silver ($):
        
Nine Months Ended September 30, 2005
                        
Pounds of copper sold (000s)
  
988,100
    
988,100
              
Ounces of gold sold
              
1,686,700
        
Ounces of silver sold
                    
3,393,500
  
             
   
By-Product
    
Co-Product Method
  
   
Method
    
Copper
    
Gold
    
Silver
  
Revenues, after adjustments shown below
  
167.4
¢
  
167.4
¢
  
$431.88
    
$5.59
  
                         
Site production and delivery, before net non-
                        
cash and nonrecurring costs shown below
  
66.7
a
  
45.9
b
  
117.63
b
  
1.93
b
Gold and silver credits
  
(75.8
)
  
-
    
-
    
-
  
Treatment charges
  
22.8
    
15.7
    
40.26
    
0.66
  
Royalty on metals
  
5.8
    
4.0
    
10.15
    
0.17
  
Unit net cash costsc
  
19.5
    
65.6
    
168.04
    
2.76
  
Depreciation and amortization
  
14.4
    
9.9
    
25.40
    
0.42
  
Noncash and nonrecurring costs, net
  
0.5
    
0.4
    
0.94
    
0.02
  
Total unit costs
  
34.4
    
75.9
    
194.38
    
3.20
  
Revenue adjustments, primarily for pricing
                        
on prior period open sales and silver hedging
  
1.6
    
2.1
    
(1.80
)
  
0.01
  
PT Smelting intercompany profit elimination
  
(0.3
)
  
(0.2
)
  
(0.56
)
  
(0.01
)
Gross profit per pound/ounce
  
134.3
¢
  
93.4
¢
  
$235.14
    
$2.39
  
                         
Nine Months Ended September 30, 2004
                        
Pounds of copper sold (000s)
  
572,400
    
572,400
              
Ounces of gold sold
              
824,900
        
Ounces of silver sold
                    
2,216,000
  
             
   
By-Product
    
Co-Product Method
  
   
Method
    
Copper
    
Gold
    
Silver
  
Revenues, after adjustments shown below
  
131.1
¢
  
131.1
¢
  
$396.33
    
$5.54
  
                         
Site production and delivery, before net non-
                        
cash and nonrecurring costs shown below
  
90.9
d
  
62.6
e
  
188.09
e