CONTENTS. 02 Highlights. 04 Letter to Shareholders. 10 Sales. 14 Mining Division. 14 Copper. 18 Molybdenum. 20 Zinc. 24 Precious Metals.

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2 CONTENTS 02 Highlights 04 Letter to Shareholders 10 Sales 14 Mining Division 14 Copper 18 Molybdenum 20 Zinc 24 Precious Metals 27 Lead 27 Coal 28 Exploration 34 Environmental Activities 36 Community Responsibility 38 Geographic Mining Location 44 Transport Division 47 Geographic Location of Principal Routes 50 Financial Analysis 58 Corporate Structure 62 Board of Directors

3 Highlights Real Var. % 2006 / 2005 Sales Volumes * Copper (Tons) 828, , , ,873 (21) Zinc (Tons) 122, , , ,496 (4) Silver (Ounces) 21,157,341 20,236,254 20,601,905 19,792,863 (4) Gold (Ounces) 49,319 46,104 52,084 55,749 7 Molybdenum (Tons) 12,498 14,349 14,585 11,753 (19) Average Price (dollars) Copper (pound) Zinc (pound) Silver (ounce) Gold (ounce) Molybdenum (pound) (21) Railroad Division Statistics Tons transported (thousands of tons) 36,809 40,158 41,994 47, Net ton-kilometers (millions of tons) 28,184 32,384 35,359 39, Loaded cars (thousands of units) Balance Sheet (Millions of dollars) Current Assets 1,448 2,341 2,335 3, Fixed Assets 4,089 4,280 4,132 4,518 9 Total Assets 6,555 7,476 7,477 8, Bank Debt 2,943 2,457 1,618 2, Total Liability 4,359 4,353 3,090 3, Equity Capital 1,391 2,191 3,206 3, Earnings (Millions of dollars) Total Sales 2,491 4,206 5,189 6, Cost of Sales 1,668 2,125 2,422 2,593 7 Operating Profit plus Depreciation (EBITDA) 693 1,950 2,612 3, Net Profit (Loss) (75) 783 1,063 1, Cash Flow (Millions of dollars) From Operations (135) 1,106 1,863 2, Resources provided by (used in) Financing Activities 320 (520) (999) (499) (50) Total Cash Flow , Applied to Investments (138) (184) (563) (968) 72 Cash flow after investments GRUPO MEXICO

4 Real Var. % 2006 / 2005 Stock Information ** Total Shares in Circulation (thousands) 865, ,000 2,594,699 2,576,863 (1) EBITDA per Share Cash Flow per Share Earnings (Loss) per Share (0.03) Book Value Financial Ratios Operating Margin 17% 40% 43% 52% 21 Operating Margin plus Depreciation 28% 46% 50% 57% 14 Current Assets to Current Liabilities (times) Total Liabilities to Total Assets 67% 58% 41% 40% (2) Debt / Capital + Debt 68% 53% 34% 34% - EBITDA / Interests (times) Employees 20,817 21,068 19,143 18,931 (1) Annual Inflation Mexico 4% 5% 3% 4% 33 United States 2% 3% 3% 3% - Peru 2% 3% 1% 1% - Exchange Rate at the End of Each Year Mexico (pesos/dollar) Peru (soles/dollar) (7) Average Exchange Rate Mexico (pesos/dollar) Peru (soles/dollar) (1) Expressed according to US GAAP * Throughout this report, all tons are metric and all ounces are troy. ** Refers to 2,576,862,500 shares. ANNUAL REPORT 06 03

5 Letter to Shareholders Grupo México obtained highly satisfactory financial results for Total sales increased 23% to reach $6.359 billion dollars from $5.189 billion dollars in Sales costs increased only 7% to $2.593 billion dollars and the EBITDA increased 39%, from $2.612 to $3.628 billion dollars in The net profit for Grupo México reached $1.530 billion dollars in 2006, 44% higher that the $1.063 billion dollars reported for These results are, without a doubt, the product of a strong world demand for metals, especially copper, molybdenum, and zinc, which led to better metal prices. The price of copper, representing 65% of sales, increased 84% on average from $1.68 to $3.09 dollars. Zinc (137% higher than 2005) and silver (58% higher) also increased, with only molybdenum presenting a decrease (21%). The results also reflect strong railroad activity, freight tons per kilometer transported increased 10.5% due to greater competition with freight transport by truck and economic growth in Mexico and in the United States. However, the results also reflect that the bases of Grupo México s subsidiary companies are very solid. Southern Copper Corporation (SCC) continues to be a low-cost company highly competitive in the mining industry, with large reserves and significant projects in both the expansion of their own mines and in new deposits and the company adheres to disciplines and best business practices in their operation. Infraestructura y Transportes México (ITM) is expanding their capabilities and productivity in both freight transport and in their intermodal efforts. Their financial structure, now fully healed, has been significantly consolidated, which gives the company more flexibility to face important growth and to also offer attractive dividends. This strength has allowed Grupo México to face serious labor challenges at their Cananea and La Caridad mines, which suffered illegal stoppages and affected production of copper and molybdenum concentrates, impacting our results. As a result of the illegal stoppage at the La Caridad mine, the collective bargaining agreement was cancelled by means of payment being made to the employees concerned, as stipulated by law, and operations were started up again with new employees, which required an intense training program; the technical capacities required were reached by the end of the year, with much greater efficiency and productivity. With regards to Cananea, the employees decided to return to work after 30 days of work stoppage, normalizing operations and avoiding legal consequences. All in all, both interruptions obligated the company to purchase concentrate from third parties at a higher cost than that produced in our minas during the third quarter to ensure the operation of the smelter and refinery at the La Caridad industrial complex and to meet customer commitments. Mining operations normalized during the last quarter. 04 GRUPO MEXICO

6 In the mining division, the consolidated production of Grupo México s subsidiary Southern Copper Corporation, consequently reported a reduction of 12.2%, from 689,930 tons of copper in 2005 to 605,660 tons of copper in Production of molybdenum also decreased 20% from 14,803 tons in 2005 to 11,837 tons in The purchase of minerals and concentrates from third parties and the restrictions resulting from the increase in steel prices and a scarcity of parts increased the cost of sales to $2.042 billion dollars in 2006 from $1.659 billion dollars in However, the operating profit margin rose from 50.6% in 2005 to reach 55.9% in The EBITDA for SCC rose a strong 41% to $3.315 billion dollars with a margin of 61%, higher than the 57% obtained for SCC s net profit was $2.038 billion dollars in 2006, 46% higher than the $1.400 billion dollars reported for The transport division once again reported very good results. Infraestructura y Transportes México increased their freight volume by 10.5%, sales by 21.7% to $934 million dollars, their EBITDA 16.7% from $262 to $306 million dollars in 2006, which led to a net profit of $141 million dollars, 64% higher than the $86 million obtained in The expansion and modernization of the mining division continues make steady advances. In Mexico, the new SX/EW (ESDE) plant project is in its detailed engineering phase and construction will start in 2007 and a new crusher and transport system (Quebalix III) for Cananea has begun its engineering phase, both projects are scheduled to enter into operation in 2008 and A new molybdenum plant is progressing at Cananea and studies continue for the development of a new concentrator in In Peru, the Leachable Deposits Project has practically been completed and also the construction of new dams, both at Toquepala. Above all, the conclusion of the new smelter at Ilo must be noted, which in addition to improving all the smelting processes, recovers over 95% of the sulfur generated from these processes, concluding the Environmental Improvement Program (PAMA) and complying with the strictest national and international standards. The mining division increased its exploration activities in Mexico, Peru, and in Chile. The following projects are of note: in Mexico, explorations at El Arco, a copper and gold deposit in Baja California, and at Angangueo, a copper, gold, and silver deposit in the state of Michoacán; in Peru, Los Chancas, a copper and molybdenum deposit, the pre-feasibility study well underway, and the Tía María project, a copper and gold deposit that has concluded its diamond drilling phase; in Chile, the El Salado project in the Region of Atacama, with good prospects for copper and gold. ANNUAL REPORT 06 05

7 In December, SCC announced a very significant increase in the reserves at Toquepala and Cuajone, in Peru. The former verified a 60% increase in their reserves and the latter 22%. These reserves were measured at a price of $0.90 dollars per pound, amount that had been reported in the past, however, the Securities and Exchange Commission has set the calculation of the reserves at the price of $1.21 dollars per pound of copper, which considerably increases these reserves. Investments made by Grupo México during 2006 were in the neighborhood of $773 million dollars, 8.9% higher than in Southern Copper Corporation invested over $520 million dollars, which was slightly less than in 2005, due to the conclusion of the new smelter project at Ilo. The infrastructure and transport division invested more than $253 million dollars, 180% higher than in This significant increase in investments reflects the aggressive program to purchase 120 locomotives and miscellaneous railroad cars and also track modernization and refurbishment and the construction of multimodal facilities. In terms of social responsibility, Grupo México will soon publish their 2006 report including both the environmental aspects and relations with the communities where their subsidiaries operate. With regards to the environment, the conclusion of the smelter at Ilo, Peru stands out, which recovers 95% of the sulfur dioxide, and also the environmental improvement plant at San Luís Potosí, México, advances in obtaining the clean industry certification for various mining and metallurgic units in Mexico, the reforestation program making Grupo México the Mexican company that contributes the most trees to its units and to the community. The companies in 06 GRUPO MEXICO

8 the group participate actively in education, with over 3,000 students, in healthcare with two hospitals and 12 clinics, in support to locate sources of drinking water for communities, and production supports for different types of farming and livestock raising groups. A tragic accident occurred during 2006 at the Pasta de Conchos coal mine in the state of Coahuila, Mexico. The company provided an immediate and decisive response to this serious accident in the rescue, and later, search efforts to locate our miners, in addition to humanitarian aid for their families in the form of financial support, education, health care, and social assistance, without precedent in Mexico. Asarco llc, 100% subsidiary of Americas Mining since 1999 and with an annual copper production in the neighborhood of 200,000 tons, filed under Chapter 11 to have their environmental responsibilities defined and quantified by the court system in the United States, and also to have the responsibilities of Laq and Capco defined, subsidiaries of Asarco Llc, closed in This under the objective of having the certainty needed in order to proceed with their financial and operative reorganization. During 2006, and according to the rules of Chapter 11, the company Asarco Llc. did not consolidate their operating, financial, and accounting figures within Grupo México was a year of significant results and difficult challenges. The strength of the company is a key factor in the obtaining of the former and in facing and meeting the latter. The support of investors and the work of company officers, employees, and workers has been exceptional. GERMAN LARREA MOTA VELASCO CHAIRMAN OF THE BOARD ANNUAL REPORT 06 07

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10 Annual Report 2006 Record [1] Level or result that exceeds any previous. [2] As an adjective, expresses that something is outstanding and surpasses that which is common. [ This year GRUPO MEXICO has reached a historic high in sales: US $6.359 billion in 2006, compared to US $5.189 billion in 2005 a 23% increase over last year. ] $5,189 millions USD : : $6,359 millions USD 23% INCREASE: 23%

11 The Mining Division s net sales increased US $1.011 billion in 2006, representing an increase of 23% over the previous year, due principally to better copper, molybdenum, zinc, and silver prices. Sales Total Sales (millions of DOLLARS) 6,500 6,000 5,500 5,000 4,500 4,000 3,500 3,000 2,500 2,000 2,492 2,491 4,206 5,189 6, Consolidated net sales for Grupo México during the year 2006 rose to US $6.359 billion, compared to US $5.189 billion reported for 2005, and US $4.206 billion in Sales increased US $1.170 billion in 2006, representing a 23% increase on the previous year, reaching a historic high for the company, due to better discipline in the mining industry and the strong demand for copper, especially from China and India. The net sales of the Mining Division for US $5.460 billion represented 86% of the net sales for Grupo México. Sales increased US $1.011 billion in 2006, representing a 23% increase on the previous year, principally due to better copper, molybdenum, zinc, and silver prices; which compensated for lower production in 2006, due to illegal stoppages at the open pit mines in Mexico. The infrastructure and transport sector contributed with 14% of the consolidated net sales for Grupo México. Net sales in 2006 rose 21% to reach US $899.2 million, compared to US $740.2 million in 2005, thanks to a 10.5% increase in the volume of freight transported per kilometer. In 2006 the volume was billion tons/km compared to billion tons/ kilometer in Sales Product Volume in Tons Thousands of Dollars VAR.% VAR.% Copper 798, ,873 (21) 3,066,102 4,143, Zinc 133, ,496 (4) 178, , Silver (Ounces) 20,601,905 19,792,863 (4) 149, , Molybdenum 14,585 11,753 (19) 926, ,983 (38) Gold (Ounces) 52,084 55, ,007 33, Lead 20,237 20,282 19,533 24, Sulfuric Acid 1,022,123 1,023,627 48,368 48,585 Other Products 37,479 20,779 (45) Loaded Cars (Thousands of units) , , Total Sales $ 5,189,403 $ 6,359, GRUPO MEXICO

12 Participation IN SALES BY PRODUCT A 59.0% A Copper 18.0% B Molybdenum 14.0% C Transport Services 3.0% D zinc 3.0% E Silver 1.0% F Gold 1.0% G Sulfuric Acid 1.0% H Others F E H G D B C 2005 A 65.0% A Copper 9.0% B Molybdenum 14.0% C Transport Services 6.0% D Zinc 4.0% E Silver 1.0% f Gold 1.0% g Sulfuric Acid E G F B D C 2006 Participation in Sales by Region D E 34.0% A United States 32.0% B Mexico 16.0% C Europe C % D Latin America 4.0% E ASIA B A D E F 23.0% A United States 31.0% B Mexico 27.0% C Europe C A % D Latin America 6.0% E ASIA 2.0% F AUSTRALIA B ANNUAL REPORT 06 11

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14 Annual Report 2006 Solidity [1] Having characteristics of firmness and strength. [2] Firmly rooted, established on base and true reasoning. [ At GRUPO MEXICO we have obtained outstanding results for our mining operations in Mexico and Peru during 2006 and the average prices of our principal products registered a favorable performance compared to ] CHILE MEXICO PERU

15 The price of copper on the world markets continues to be strong, due to a sustained demand from Asian-Pacific countries, maintaining copper prices at levels higher than US $3 per pound. Mining Division Americas Mining Corporation (AMC) Americas Mining Corporation (AMC), the company that consolidates the results for the mining operations in Mexico and Peru for Southern Copper Corporation (SCC), obtained outstanding results in COPPER The average prices for our principal products registered a favorable performance in 2006 in comparison to those in The average price for copper on the London Metals Exchange (LME) and on the New York Commodities Exchange (COMEX) was 309 dollar cents per pound, respectively, compared to 168 cents during The consolidated mining production was 605,660 tons of copper in 2006, compared to 785,196 tons in 2005, represents a reduction of 179,536 tons or 22.8%, principally due to illegal stoppages at the open pit mines in Mexico. The year also saw slightly lower grades at their principal mines. Sales, however, increased 35%, from US $3.066 billion in 2005 to US $4.144 billion in 2006 as a result of better metal prices. The price of copper continues to be strong on the world market due to a sustained demand from Asian-Pacific countries, especially China. The strength of the world s economic growth, especially in this region of the world, has maintained copper prices at levels over $3 dollars per pound. The highly publicized deceleration in both China and the United States has not materialized significantly and therefore, despite an intensified volatility, high prices continue to be sustained. The arrival of new copper on the market has also been more gradual than expected and world production has suffered frequent suspensions due to natural causes and labor issues. All this sug- 14 GRUPO MEXICO

16 gests that although there has been a weak recovery in inventories, prices for 2007 would appear to be relatively sustained at levels higher than $2.90. Despite a severe adjustment in the price of molybdenum in 2006, the price continues to be much higher than in previous years. Molybdenum being the principal subproduct for the Company, this has had a significant impact on the manner in which the Company calculated its cost in cash and, naturally, its comparison with previous periods. Therefore, the Company presents its costs in cash, with and without the incomes from the totality of its subproducts. SCC does not include depreciation, amortization and depletion, employee participation in exploration provisions, or line-items of a non-recurrent nature in their calculation of operating costs in cash. The operating cost for the Company in cash, as so defined, is as follows, to December 31 for each of the last three years: (in $ cents per pound) Cost in cash per pound of copper produced Cost in cash per pound of copper produced (excluding incomes from subproducts) Copper Prices and Inventory PRICES: INVENT.: 1, Dollar cents/pound Thousands of Metric Tons 1, , , i N.Y. COMEX Prices i N.Y. COMES plus London LME Inventories ANNUAL REPORT 06 15

17 Smelter Copper (thousands of tons) Primary Copper Mining Concentrates plus SX/EWs (thousands of tons) concent.: SX/EWs: TOTAL: i Concentrators i SX/EWs Refined Copper Refineries + SX/EWs (thousands of tons) REFINER.: SX/EWs: TOTAL: i Refineries i SX/EWs 16 GRUPO MEXICO

18 PRIMARY COPPER MINING PRODUCTION AND RESERVES FOR 2006 PRODUCTION PROCESSED COPPER MINERAL RESERVES MINERAL CONTENT MILLIONS OF TONS GRADE YEARS IN THOUSANDS OF TONS MINERAL COPPER CONT. % OPERATION MEXICO Sx/ews: Peru Sx/ews: * Concentrator: La Caridad 16, , Cananea 22, , Underground Mines 4, To 16 Subtotal 44, , La Caridad 19, , Cananea 59, , Subtotal 78, , Concentrator: Cuajone 28, , Toquepala 20, , Subtotal 49, , Cuajone Toquepala 42, Subtotal 42, Total Concentrator 93, , Total Sx/ews 121, , Grand Total 214, , * Solutions With Leached Copper From Cuajone Are Sent To The Sx/ews Plant At Toquepala. COPPER SMELTER PRODUCTION DURING 2006 THOUSANDS OF TONS REFINED COPPER PRODUCTION DURING 2006 THOUSANDS OF TONS COPPER SEMI-MANUFACTURED PRODUCTION DURING 2006 THOUSANDS OF TONS Mexico La Caridad S.L.P Subtotal Peru Ilo total Mexico La Caridad Ref Sx/ews 63.8 Subtotal Peru Ilo Ref Sx/ews 35.8 Subtotal total Wire Rod Mexico La Caridad 96.6 total 96.6 ANNUAL REPORT 06 17

19 The significant adjustment in the price of molybdenum, principal by-product for the Company, used in special steel alloys, reached an average price of $24.38 dollars per pound. Molybdenum The significant adjustment in the price of molybdenum, principal by-product for the Company, used in special steel alloys, reached an average price of $24.38 dollars per pound in 2006, presenting a decrease of almost 30% compared to the price of $31.05 dollars per pound registered in Despite this, prices continue to be relatively strong. The consolidated production of molybdenum by Southern Copper decreased 20% to 11,837 tons in 2006, compared to 14,803 tons in 2005, principally due to the illegal stoppages of operations at the La Caridad mine. In terms of sales, the difference is 38% lower between sales in 2005 and those in Sales for the year 2006 were US $575 million. Primary Molybdenum Mining (thousands of tons) Molybdenum Prices dollars / pound i MW Dealer Oxide Prices 18 GRUPO MEXICO

20 MOLYBDENUM MINING PRODUCTION AND RESERVES FOR 2006 PROCESSED MOLYBDENUM MINERAL RESERVES PRODUCTION MINERAL CONTENT MILLIONS OF GRADE THOUSANDS OF TONS TONS % Mining Units Mexico Peru La Caridad 16, , Toquepala 20, , Cuajone 28, , Subtotal 49, ,139.5 total 65, ,561.6 ANNUAL REPORT 06 19

21 Zinc has maintained a consistent demand on the international markets. Its average price for 2006 was dollars cents per pound, 137% higher than in Zinc Zinc has maintained a consistent demand on the international markets. Its average price for 2006 was dollar cents per pound, 137% higher that the dollar cents per pound registered in Zinc production decreased 5% to 136,592 tons during 2006, compared to 143,609 tons for The principal reason was the impact of a serious electrical problem at the start of the year at the refined zinc plant in San Luis Potosí, Mexico, and the illegal stoppage at the San Martín mine in Zacatecas during the second quarter of The subsidiary company IMMSA sold zinc principally in concentrates. Sales, however, rose 118%, from US $178.8 million in 2005 to US $389 million in 2006 due to better metal prices. Zinc Prices and Inventories PRICES: INVENT.: Dollar cents / pound Thousands of metric tons i London LME Prices i London LME Inventories Primary Zinc Mining (thousands of tons) Refined Zinc (thousands of tons) GRUPO MEXICO

22 PRIMARY ZINC MINING PRODUCTION AND RESERVES FOR 2006 PROCESSED ZINC MINERAL RESERVES PRODUCTION MINERAL CONTENT MILLIONS GRADE YEARS IN THOUSANDS OF TONS OF TONS % OPERATION Mining Units Mexico Charcas 1, Santa Barbara 1, San Martin Taxco Santa Eulalia total 4, Refined Zinc Production Thousands Of Tons. Refineries Mexico San Luis Potosi 45.3 ANNUAL REPORT 06 21

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24 Annual Report 2006 Constant [1] Tenacity, to persevere with something started. [2] Continuing with something without interruption. [ Gold sales increased 46%, silver 51%, and lead sustained its demand on the international markets. We also maintained our exploration programs to locate new deposits in Mexico, Peru, and Chile. ]

25 Gold sales, however, increased 46%, from US $23.0 million in 2005 to US $33.6 million in 2006, while silver sales rose 51% from US $149.3 million in 2005 to US $224.8 million in Precious Metals The average price for gold was $ dollars per ounce on the world markets during 2006, 35.7% higher than the price of $ dollars per ounce registered for The average price for silver was $11.54 dollars per ounce during 2006, representing an increase of 57.6% compared with the price of $7.32 dollars per ounce registered for Regarding the production of precious metals from our mines, gold decreased 14.6% to 27,680 ounces in 2006, compared with 32,444 ounces in Silver presented a slight decrease in production, 15%, at 16.2 million ounces compared with 19.0 million ounces in Gold sales, however, increased 46%, from US $23.0 million in 2005 to US $33.6 million in 2006, while silver sales rose 51% from US $149.3 million in 2005 to US $224.8 million in 2006, due to better metal prices. Primary gold mining (thousands of ounces) Refined Gold (thousands of ounces) Primary silver mining (millions of ounces) Refined Silver (millions of Ounces) GRUPO MEXICO

26 Gold Prices and Inventories PRICES: INVENT.: 2, , , , , Dollars / Ounce Thousands of Troy Ounces 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, i N.Y. COMEX Prices i N.Y. COMEX Inventories Silver Prices and Inventories PRICES: INVENT.: Dollars / Ounce Millions of Troy Ounces i N.Y. COMEX Prices i N.Y. COMEX Inventories ANNUAL REPORT 06 25

27 GOLD AND SILVER MINING PRODUCTION AND RESERVES FOR 2006 SILVER MINERAL PRODUCTION OUNCE RESERVES CONTENT MILLIONS GRADE GOLD SILVER OF TONS gr/ton Mining Units Mexico Peru In Concentrates: La Caridad 3,279 1,055,380 3, Cananea 12,153 1,616,025 6, Underground Mines 4,484 9,276, Subtotal 19,916 11,947,665 9,581.3 Toquepala 2,808 2,083,271 3, Cuajone 4,956 2,140,661 2, Subtotal 7,764 4,223,932 6,139.5 total 27,680 16,171,597 15,720.8 GOLD AND SILVER SMELTER PRODUCTION FOR 2006 OUNCES GOLD SILVER REFINED GOLD AND SILVER PRODUCTION FOR 2006 OUNCES GOLD SILVER San Luis Potosi 33,308 9,709,716 Caridad 29,746 5,175,787 Ilo 11,424 4,958,287 Total 74,478 19,843,790 Refineries La Caridad 23,201 4,210,525 Ilo 8,389 3,831,402 total 31,590 8,041, GRUPO MEXICO

28 Lead Lead has continued to be in demand on the international markets. Its average price during 2006 was 58.5 dollar cents per pound, 32% higher than the price of 44.2 dollar cents per pound registered in This price helped sales to grow 27% to US $24.7 million and production was maintained at 19,081 tons, without variation. Lead Prices and Inventories Primary lead mining (thousands of tons) PRICES: INVENT.: Dollar cents / pound Thousands of Metric Tons i London LME Prices i London LME Inventories LEAD MINING PRODUCTION FOR 2006 CONTENT THOUSANDS OF TONS Mining Units Mexico Charcas 1.2 Santa Barbara 10.9 Santa Eulalia 4.0 San Martin 0.9 Taxco 2.1 total 19.1 Coal and Coke Incomes were US $10 million in 2006, compared to US $18 million in 2005, 44% lower. Early morning on February 19, 2006, there was a high magnitude explosion at the Pasta de Conchos mine, after 27 years of operation without any fatal accidents. Thirteen miners managed to get out, sixty-five more were trapped. The IMMSA rescue brigades immediately went into the mine, assisted by other companies in the region, to attempt to rescue our trapped colleagues. After drilling holes with a depth of 160 meters, at different points in the mine to measure the air quality, on February 25 it was determined that the high concentrations of gas ruled out any possibility of life. From day one, the company offered response to the families of the trapped and injured miners, and organized an effort, without precedent, to assist the families of the employees, which included humanitarian, social, and financial aid, health care, education, and housing. ANNUAL REPORT 06 27

29 Grupo México continues with an intense Exploration program to locate new deposits and to increase the reserves in our mines in Mexico and Peru, in addition to exploration projects in Chile. Exploration Grupo México continues with an intense Exploration program to locate new deposits and to increase the reserves in our mines in Mexico and Peru, in addition to exploration projects in Chile. In 2006, $22.7 million were invested in exploration programs, compared to $24.4 million invested in 2005 and $15.6 million in We currently hold 513,936 hectares of Mining Concessions in Mexico. In Peru, we hold direct control over 114,133 hectares, and in Chile, we hold 35,258 hectares in exploration concessions. NEW INVESTMENTS MEXICO In November 2006, the Engineering was started for the Quebradora Project, at the Cananea mine, which is a system of moving and fixed belts known as Quebalix III, and will have a crushing capacity of 3,200 tons per hour. The detailed engineering is currently being developed and operations are expected to start during the second half of The basic engineering for the new Solvent Extraction Electrowinning (SX-EW III) plant at Cananea was concluded at the end of 2006 and, the detailed engineering phase will begin this year and construction on this plant will also start, which will have a copper production capacity of 90 MT/day. The metallurgical research and the basic engineering for the new molybdenum processing plan project were started in The detailed engineering phase is scheduled to begin during the second half of With this plant, the molybdenum contents that exist at the mineral deposit at Cananea will be recovered, the plant is expected to reach a processing capacity of 1,600 MT/ day, to produce 10.4 MT/day of Molybdenum concentrate. The concentrator expansion project is currently under development with the objective of expanding the concentrate production capacity at the Cananea unit. This project consists of expanding the grinding and recovery capacity of the concentrator plant from 76,700 MT/Day to 95,000 MT/ Day. The Operations Diagnostic is currently being conducted on the plant and it is expected that the information for the General Design and Scope Criteria will be completed during the second half of The construction of a new concentrator with a copper content production capacity of 200,000 tons projected for 2011 is also currently being studied. The project engineering for the 50% expansion in the capacity of the Zinc Electrolyte Plant at San Luis Potosí has begun and is expected to be concluded by the end of This expansion will allow the processing of all the concentrates produced by our underground mining units. In terms of the underground mines, the deepening of the shaft at the San Martín Unit in Zacatecas, Mexico stands out. By , the Interior Shaft II will need to be deepened, and new freight facilities will need to be built. In this stage, the shaft will be extended 330 meters, giving continuity to the operations of the Unit, allowing mineral levels with greater potential to be reached. The Transport System of mineral by belt project is in development at the Santa Bárbara mine, which will reduce cartage costs. 28 GRUPO MEXICO

30 PERU With regards to the expansion and modernization programs that are being executed, the Leachable Deposits Project at Toquepala is noteworthy, presenting a 99% advance, and only the installation of a 16 belt, with a total length of 4.6 kilometers, is still to be completed. This equipment is being used for the formation of the ramp that will give access to the formation of the leachable deposits; 34.5 million tons of material had been deposited by the end of the year, of a total 39.5 million tons to complete the ramp, which is expected to be completed during The new deposits will naturally require new collection dams. These dams report an 85% advance. Construction works were started in Cuajone on the new Phase III Lands for oxidized mineral leaching, where we will be able to operate for another five years, and present a 68% advance. The Smelter Modernization Project at Ilo, Peru, has been completed. The annual copper concentrate processing capacity will be 1.2 million tons. Sulfur recovery will be in the neighborhood of 95%, which exceeds that required by current environmental legislation. The end product of the new Smelter will be copper anodes instead of the blisters previously produced. MINERAL RESERVES AND PROJECTS MEXICO Cananea and La Caridad 22,011 and 6,109 meters were diamond drilled at the Cananea and La Caridad mines, respectively, to define and increase reserves. An additional 14,446 meters were drilled with inverse circulation at Cananea. Part of the cores will be used for metallurgical tests intended to increase recovery in the concentrators at each unit. El Arco The drilling of 8 wells for water exploration was started at El Arco, with 170 million tons with 0.56% copper oxides and 846 millions tons with 0.51% copper sulfates. The first exploratory well indicates that water production could reach 30 l/s. We are expecting the other explorations to result in yields of between 40 and 50 l/s. Coal 59,446 meters were diamond drilled in the region of Coahuila, resulting in reserves of 29 million tons coal being identified at the Esperanza project and 12 million at Guayacán. Buenavista, Sonora Pre-feasibility studies were concluded for this deposit near the Cananea pit mine and where more than 38 million tons have been calculated with zinc grades of 3.3%, 1.0 ounces of silver, and 0.7% copper. The metallurgical tests are being conducted and decision is pending on this being an underground mine or open pit. Angangueo, Michoacán The feasibility and environmental impact studies have been completed and approved by the SEMARNAT. There are reserves of 13 million tons of mineral with silver grades of 8 ounces, 1% copper, and 3.5% zinc. ANNUAL REPORT 06 29

31 As part of our exploration programs in 2006, 2,410 meters have been diamond drilled at the El Fiscal prospect, in the south, exploring for copper. Explorations are projected to intensify during Chalchihuites, Zacatecas Geological works, exploration, and metallurgical tests are being conducted on two projects, Guantes and Dos de Marzo, where reserves of 23 million tons of mineral have been determined containing copper sulfates and oxides and zinc with silver grades of 3 ounces, 3.1% zinc, and close to 1% copper. Sierra de Lobos, Guanajuato 2,977 meters were drilled on the reduction project at León in Guanajuato. Analysis of the drill holes present good results for copper and silver. PERU Los Chancas Los Chancas. The Los Chancas Project is located in the region of Apurímac, in the south of Peru, this is a porphyritic deposit of copper and molybdenum. The exploration program and the final phase of the metallurgical tests were concluded at the beginning of Pre-feasibility studies were started mid-2006 and are scheduled to be completed by the beginning of 2007, when we will know the commercially exploitable reserves, and the projections to conclude the feasibility studies. To date there are 200 million tons with a copper grade of 1.0%, 0.07% molybdenum, and 0.12 grams of gold per ton. Tantahuatay The Tantahuatay project is located in the region of Cajamarca in the north of Peru. The objective of the exploration works is to evaluate the upper portion of the deposit, principally for the recovery of gold. To date, the resource has been estimated to be 27.1 million tons, with an average gold content of 0.89 grams per ton and 13.0 grams of silver per ton. SPCC holds a 30 GRUPO MEXICO

32 participation of 44.25% in this project. Over the past few years, projects have been directed towards community aspects; relationships with the authorities have improved and works have advanced more quickly. Tía Maria The Tía Maria Project is located in the Arequipa region on the southern coast of Peru, and involves a copper porphyritic system. The drilling program was completed in 2006 and feasibility studies have begun on the Project, which consider the deposit at La Tapada, this being part of the Tía María Project and which includes a new discovery of a copper-gold porphyritic deposit in southern Peru; a total of 41,195 meters have been diamond drilled at this deposit during 2006, and the infill drilling is expected to be completed at the beginning of The feasibility study for the Tía María Project is expected to be concluded during the third quarter of Other prospects in Peru As part of our exploration programs in 2006, 2,410 meters have been diamond drilled at the El Fiscal prospect, in the south, exploring for copper. Explorations are projected to intensify during 2007; the Portuguesa prospect has been explored for gold, in the Ayacucho region in central Peru, where a total of 2,580 meters have been diamond drilled. CHILE In Chile, Southern Copper Corporation holds control of 35,258 hectares, on which the company has been developing various exploration programs. El Salado In the Atacama Region, 8,326 and 1,128 meters have been diamond drilled at the El Salado and Sierra Áspera prospects, respectively, resulting in copper-gold deposits. Resguardo de la Costa There is a purchase option on this prospect, located in the Tercera Region. In 2006, 2,323 meters were diamond drilled, resulting in a gold epithermal system. Other Projects There are other prospects, such as Esperanza, located in the Atacama Region; where drilling began at the end of 2006; and exploration continues at the Catanave prospect, located in the region of Tarapacá. ANNUAL REPORT 06 31

33

34 Annual Report 2006 Response [1] Answer to a doubt, question, or problem. [2] Taking responsibility for something and taking action. [ GRUPO MEXICO is stimulating significant growth in the economy of southern Peru and the company is particularly interested in the sustainable development and wellbeing of these towns, promoting Social Investment and actively participating in these communities. ]

35 The company s environmental programs include water recovery for conservation and to minimize impact on nearby streams, reforestation programs to stabilize the surfaces of tailings dams. Environmental Activities 2006 The company has implemented broad environmental conservation programs at their mining facilities in Peru and Mexico. The company s environmental programs include water recovery for conservation and to minimize impact on nearby streams, reforestation programs to stabilize the surfaces of tailings dams, and the implementation of technology to reduce dust emissions from the mines. Operations in Mexico Conclusion of the Environmental Improvement Plan tasks. These tasks represent the commitment undertaken by the company with federal and state authorities, which consisted of works for the reduction of emissions at the San Luís Copper Plant; and also the construction, refurbishment, and improvement of walkways, streets, gardens, drainage, paving, and sports and recreational centers for the neighborhoods of Morales, Los Pirules, Infonavit Morales, Verde Campestre, and Las Piedras in the city of San Luís Potosí. In 2006 the states of San Luís Potosí and Sonora have two tree nurseries, thanks to which, the company was able to deliver more than 120,000 trees, for the reforestation of various municipalities, towns, and Company mining units. The internal reforestation at the Cananea unit was completed, planting 694,000 trees, making this the Unit that contributes the most trees, nationally, to the program currently sponsored by the National Forest Commission (CONAFOR). In terms of reforestation, outreach has continued with all the municipalities within the surrounding area of the mining units and plants. 13 municipalities were reforested during 2006 in the Sonora mountains, San Luís Potosí, Chihuahua, Zacatecas with a total of 1,655,000 trees grown and planted. This was achieved with the support of the Ministry of National Defense and the Forest Commission. 1,100,000 trees are currently being cultivated in nurseries. The Santa Barbara Unit, located in the state of Chihuahua, is in the process of obtaining its Clean Industry certification, under the program managed by the Office of the Federal Attorney for Environmental Protection (PROFEPA). 34 GRUPO MEXICO

36 The San Martín Unit, located in the state of Zacatecas, has begun the process to obtain its Clean Industry certification. The Clean Industry certification process was started in 2006 for the Concentrator Plant at the Cananea mine and the La Caridad mine, and also for the Molybdenum plant at La Caridad. The Plan of Action was also filed with the Office of the Federal Attorney for Environmental Protection (PROFEPA), after completion of the corresponding environmental audits. The Voluntary Environmental Audit process has been started at the Cananea Concentrator Plant. Clean Industry certification was achieved for the Natural Gas Transport System facilities (the Douglas Nacozari gas pipeline), under the Environmental Audit Program of the Office of the Federal Attorney for Environmental Protection (PROFEPA). Similarly, certification is in its final phase for the facilities at: La Caridad in Sonora at the Hydrometallurgic, Wire Rod, Precious Metals, Concentrator, and Molybdenum Plants, and the Lime Plant, in Agua Prieta, Sonora. The Clean Community programs, in communities where the company is active, included talks given at elementary and middle schools, and the delivery of waste receptacles. These activities were conducted in 12 cities within the state of Sonora. The company actively participates on the Technical Consulting Board and in the Workgroup for the protection and preservation of the flora and faunae of the Valle de los Cirios, in Baja California. The Reserve Management Plan in the region corresponding to the El Arco project has been completed, obtaining authorization to conduct mining activities within the protected conservation area. A PET recycling program was started (soft drink, water, milk, and juice containers, etc.) and paper and cardboard recycling, the money obtained is donated to charity institutions in the communities that participate in this program. The Gildo Sá Albuquerque International award was granted to the Formerly Monterrey Plant reclamation project. Operations in Peru By the end of 2006, 32 of these projects were concluded, and all commitments made under the Environmental Improvement Program (PAMA) related to Company operations in Cuajone and Toquepala were met. The two PAMA projects left pending, involving the operations of the smelter at Ilo, were completed in January As of December 31, 2006, the cost of this project was $549.4 million. SCC has now fulfilled their PAMA commitments. SCC contracted Walsh Peru S.A., Peruvian subsidiary of Walsh Environmental Scientists and Engineers, Inc. (Boulder, Colorado), and Mines Group Inc. (Reno, Nevada) independent consulting firm, to develop a mine closing plan in accordance with new Peruvian legislation. Capital expenses for Company operations in Peru on environmental activities were $169.9 million, $234 million, and $65.6 million in 2006, 2005, and 2004, respectively. The Company expects to allocate approximately $40.5 million in capital expenses to environmental concerns in 2007, for the modernization project of the Ilo smelter to be completed. ANNUAL REPORT 06 35

37 Community Responsibility Operations in Mexico In Mexico, Minera México, S.A. de C.V. participates in various programs focusing on education, housing, and cultural, recreational, and sports activities in the different mining units and communities where the company operates. The Company has and maintains 3,544 houses and apartments for company employees and workers; 271 in Cananea, Sonora; 2,633 at the La Caridad mining unit and Metallurgic Complex, which includes the communities of Nacozari and Esqueda in Sonora; and 640 at the Minera México industrial plants and units located in Santa Bárbara, Chihuahua; San Antonio, Chihuahua; San Martín, Zacatecas; Parral, Chihuahua; Charcas, San Luis Potosí; the city of San Luis Potosí; Taxco, Guerrero, and Nueva Rosita, Coahuila. The company operates seven supermarkets in isolated areas offering our personnel food and general product items at reduced prices. In terms of education, the company provides education and training in local communities to more than 5,100 students, operating, directly or through boards of trustees, seven kindergartens, eight elementary schools, three middle schools, and two high schools. The company also created an educational trust that awards scholarships for basic, pre-college, and college education. The Company is concerned with the education and development of the community and offers free courses and workshops in: languages, computer studies, trades, and handicrafts. The public library in the city of Cananea, rated sixth in the state of Sonora, is under the care of the Cananea Unit. The Cananea Unit also maintains the City Museum, where historic objects, documents, and photographs are on display and which also hosts temporary exhibitions. Minera México subsidiaries coordinate with various institutions in the health care sector to conduct educational training activities, including courses on topics such as hygiene, nutrition, and drug addiction, in addition to supporting vaccination campaigns. Sports are promoted among the communities, granting access to their fields and facilities for over 40 amateur soccer teams and more than 50 baseball teams for inter-mural and state competitions. The Company also participates in the organization, promotion, and co-sponsoring of different athletic events. The Company operates fifteen sports facilities and clubs that have pools, soccer fields, baseball diamonds, tennis and paddle tennis courts, bowling lanes, and billiard tables. We also support the municipalities in the supply of drinking water, paving, drainage, access road construction, and in the beautification of local communities with parks and landscaping. In the state of Sonora, in the community of Cananea, the company refurbished the city s residential water supply system, comprised of various wells, and donated this to the Municipality for the benefit of the community and in Nacozari the Company has participated in the drilling of wells and in the construction of a supply line for a backup water system for the city, to guarantee supply during the dry seasons. 36 GRUPO MEXICO

38 Minera México subsidiaries coordinate with various institutions in the health care sector to conduct educational training activities, including courses on topics such as hygiene, nutrition, and drug addiction, in addition to supporting vaccination campaigns. The Company maintains three water drilling units, the use of which is offered free of charge to the state governments where the Company operates. Operations in Peru In Peru, Southern Copper is concerned with the socioeconomic reality of the high Andean communities of Moquegua and Tacna and through their Social Responsibility policy, Southern Copper is taking action, operatively, in the design and development of Social Investment Projects and Programs. During 2006, SCC developed the following projects, among others: Water resource management: In the Torata valley (Moquegua), the Valle Torata Integral Study is about to be completed, which will determine the real offer and demand for water to prioritize and direct future social projects. Also, 50 gates were installed to optimize irrigation. SCC continued to provide logistical and technical support to the Torata, Locumba, and Candarave User Boards in their participation in local participatory budgeting processes. In Candarave (Tacna), works are being completed on the Marisol Water Divide, benefiting the districts of Cairani, Huanuara, Candarave, and Quilahuani. Minor irrigation infrastructure is also being built and refurbished for 10 Irrigation Committees. Work is being conducted on minor irrigation infrastructure in the valleys of Locumba and Ite. Agriculture: In Candarave, potato and oregano seed areas continue to strengthen. A greenhouse has been built for the production and sale of oregano seedlings, increasing the value of the product, in addition to actions taken to promote exports. In Torata, SCC, in conjunction with the Municipality, is supporting the production and sale of products such as avocados, oregano, and apricots. Cattle: In Candarave, SCC continues to support the genetic improvement of sheep and the promotion of cows through an artificial insemination program. In Torata, SCC provides technical and veterinary assistance. We help the Tora Alta Farming Producer Association to sell on the Moquegua market, through their family guinea pig farms. The company also offers technical farming support in Ilubaya. In Suches-Huaytire, Santa Cruz, Quebrada Honda, and Tacalaya the genetic research program is being reestablished with South American camelids. In a parallel manner, SCC continues working to control sarcosistosis and in promoting the sale of camelid meat. For this, a slaughterhouse has been built in Huaytire. In Higuerani, (Ilabaya-Tacna), the guinea pig raising project was strengthened and permanent technical support is offered on animal health and cattle management to the different communities working in this field. In Arondaya (Cuajone), a program to develop the existing subsistence cattle raising program continues so as to improve the raising of camelids, sheep, and goats, by training area youths in veterinary management. study for farming products in Moquegua, Ilo, and Tacna, as well as a training program for rural entrepreneurs. Basic infrastructure: Construction was started on a 12-kilometer highway in the district of Huanuara (Candarave) joining this district with its provincial capital. In the alpaca producing zone of Huaytire, the building of shelters, reproduction modules (for controlled population) and fences around paddocks continued, to facilitate the rational use of pastures. At the end of 2006, the mining companies decided to make an annual Voluntary Contribution for the next five years, while the price of the principal product remains high (for SCC, copper). As part of this program, under the name Programa Minero de Solidaridad con el Pueblo, the company will contribute to the improvement of equipment and also to the infrastructure and strengthening of the quality of educational and health services offered to communities living in extreme poverty in the regions where we conduct our mining operations. The company will also participate in Nutrition and Strengthening of Abilities programs. In 2006, the results obtained by the company s Social Investment Programs were highly satisfactory and the programs are contributing to the improvement of socio-productive conditions in our neighboring communities to thus improve the standard of living and to efficiently manage the relationship between our company and the surrounding community. Commercial development: In Candarave, the sale of meats through the Farmer Producer Association continues to strengthen. This Association is made up of the same cattle raisers who are trained and advised by SCC technicians. In Higuerani, the guinea pig sale channel has been strengthened and an integral program with our communities has started, developing a market ANNUAL REPORT 06 37

39 Geographic Location Mining in Mexico and Peru Cananea EL ARCO SANTA EULALIA LA CARIDAD BUENAVISTA NUEVA ROSITA SANTA BÁRBARA SAN MARTÍN charcas rosario san luis potosí bolaños ANGANGUEO MÉXICO, D.F. TAXCO TANTAHUATAY SIMBOLOGY MINES PLANTS MAIN OFFICE OFFICES LIMA LOS CHANCAS CUAJONE TOQUEPALA TÍA MARÍA ILO EXPLORATIONS CATANAVE EL SALADO SIERRA ASPERA ESPERANZA 38 GRUPO MEXICO

40 Minera MExico MINES: MEXICANA DE COBRE La Caridad, Sonora Copper, Molybdenum, Gold and Silver MEXICANA DE CANANEA Cananea, Sonora Copper, Gold and Silver INDUSTRIAL MINERA MÉXICO Charcas, San Luis Potosí Silver, Copper, Lead and Zinc San Martín, Zacatecas Silver, Lead, Zinc and Copper Santa Eulalia, Chihuahua Silver, Lead and Zinc Santa Bárbara, Chihuahua Gold, Silver, Copper, Lead and Zinc Taxco, Guerrero Gold, Silver, Lead and Zinc Rosario, Sin. Lead, Zinc, Silver and Gold Nueva Rosita, Coahuila Coal Smelters, Refineries, and other Plants: MEXICANA DE COBRE La Caridad, Sonora Copper Smelter Electrolytic Copper Refinery Copper Electrodeposition Plant Sulfuric Acid Plant Wire Rod Plant Gold and Silver Refinery Agua Prieta, Sonora Lime Plant MEXICANA DE CANANEA Cananea, Sonora Copper Electrodeposition Plants INDUSTRIAL MINERA MÉXICO San Luis Potosí, San Luis Potosí Copper Smelter and Arsenic Trioxide Refinery Zinc Electrolytic: Refining of Zinc and Cadmium Gold and Silver Concentrates Sulfuric Acid Plant Nueva Rosita, Coahuila Cokeable Coal and By-Products Washed Coal, Coke and By-Products Principal Exploration or Development Projects: El Arco, B.C.N.: Copper and Gold Bolaños, Jal.: Gold, Silver, Copper and Zinc Angangueo, Mich.: Gold, Silver, Lead and Zinc Buenavista, Sonora: Silver, Copper and Zinc PERU MINES: CUAJONE Copper, Silver, Molybdenum and Gold TOQUEPALA Copper, Silver, Molybdenum and Gold Smelters, Refineries, and other Plants: ILO Smelter and Refineries Copper, Silver and Gold Sulfuric Acid Plant TOQUEPALA Copper Electrodeposition Plant Principal Exploration or Development Projects: Los Chancas, Peru: Copper Tantahuatay, Peru (Joint Venture): Gold and Copper Tía María, Peru: Copper Catanave, Chile: Copper Sierra Aspera, Chile: Copper and Gold El Salado, Chile: Copper and Gold Esperanza, Chile: Copper ANNUAL REPORT 06 39

41 Mining Production Summary* Distribution 2006 Tons ** Copper Concentrates 1,884,549 2,348,120 2,618,992 2,430,348 2,447,225 Copper Content in Concentrates 506, , , , ,830 Copper Content SX/EWs (Cathodic) 99, , , , ,517 Total Copper Mine Content 605, , , , ,347 Smelter Copper Content 588, , , , ,185 Copper in Refineries 473, , , , ,318 Refined Copper (Refineries + SX/EWs) 573, , , , ,835 Refined copper converted into Wire Rod 96, , , , ,761 Refined copper converted into Cake - 18,840 57,718 29,472 46,960 Zinc concentrates 252, , , , ,619 Zinc Content in Concentrates 136, , , , ,442 Zinc in Refineries 45, , , ,069 92,012 Lead Concentrates 38,896 38,543 37,544 40,211 43,870 Lead Content in Concentrates 19,081 19,545 18,842 20,884 23,800 Gold Content in Concentrates (ounces) 27,680 32,444 33,726 32,327 30,839 Gold in Refineries (ounces) 31,590 40,940 40,714 47,251 99,322 Silver Content in Concentrates (ounces) 16,171,597 19,032,917 19,420,590 19,034,943 19,566,010 Silver in Refineries (ounces) 8,041,927 10,145,584 11,020,437 13,091,009 25,432,779 Molybdenum Content in Concentrates 11,837 14,803 14,373 12,521 11,747 Coal 215, , , ,761 1,050,296 Coke 55,728 44,406 46,235 76,645 83,456 Sulfuric Acid 1,145,463 1,550,473 1,660,167 1,461,755 1,726,043 Cadmium Arsenic Trioxide 1,595 1,664 1,830 1,728 1,947 Lime 71, , , ,800 96,256 * Figures expressed in metric tons, except where indicated. ** Includes ASARCO production to August 9, GRUPO MEXICO

42 ANNUAL REPORT 06 41

43

44 Annual Report 2006 Advance [1] Improvement, advantage, perfecting. [2] Foreword, progress, impulse from action, condition, of the state of something. [ Incomes from railroad services in 2006 were 21% higher than in Investments were made in infrastructure to increase capacity, to improve the safety of operations, and to increase train speed. ]

45 Ferromex generated incomes of US $928.2 million in 2006, with a transported freight volume of 47.7 million tons, with an average distance traveled of kilometers, resulting in a total of 39,087 million tons-kilometer. Transport Division INFRAESTRUCTURA Y TRANSPORTES MÉXICO Ferrocarril Mexicano Ferromex generated incomes of US $928.2 million in 2006, with a transported freight volume of 47.7 million tons, with an average distance traveled of kilometers, resulting in a total of 39,087 million tons-kilometer. During 2006, US $253 million were invested for a cumulative investment of US $1.055 billion over the period from 1998 to These investments, which include the accumulated refurbishment of kilometers of track with new rails and kilometers with recovered rails, have allowed the infrastructure to increase its capacity to 130 gross tons per car on the base network, which is a standard in North America, to improve the safety of the operation and to increase train speed. Operating efficiency and safety indicators improved during 2006 compared to Fuel consumption per thousand gross tons-kilometer was reduced by 2.05%, to 4.98 liters; with regards to the rate of accidents, necessary actions continue to be taken to reduce this number; and lastly, locomotive and rail car availability for 2006 reached average levels of 90.1% and 95.14%, respectively. Export volumes for North America increased 45.7% over the previous year, due to the strong economic recovery of our principal trading partner. Operations National and International Freight Service Ferromex provides national and international freight services through unit, direct, and intermodal trains. These services may consist of interchanges received, interchanges originated, passing through, or local traffic. Approximately 38.5% of the cars operated by Ferromex are owned by the company and the remaining cars belong to private railroad companies, domestic and foreign (principally from the United States and, to a lesser extent, from Canada). Financial Information by Business Line, Geographic Region, and Export Sales During 2006, 88.8% of Ferromex incomes were obtained from the following business sectors: agriculture, minerals, industrial products, cement, chemicals and fertilizers, intermodal, oil and oil products, metals, and automotive. The other services that represent 11.2% of the general incomes, include incomes from fuel variations, passenger transportation services, car hire, and other miscellaneous services. The diverse 44 GRUPO MEXICO

46 nature of the business base offers Ferromex a certain degree of stability with regards to the seasonal nature of some sectors, such as the agriculture sector, which is compensated by continual flows from other sectors, such as the cement, minerals, and the chemical products sectors. Incomes (Millions of dollars to December 31) SECTOR Year ending December Incomes from Freight $ $ $ Incomes from Passengers Interlineal Incomes (Expenses) (4.6) Incomes from Freight Diesel Car-Hire Incomes Other Incomes Total Incomes $ $ $ The above table shows the total incomes for 2006, these being US $928.2 million, 21.5% higher than Cost of the Railroad Operation The consolidated cost of operation includes labor, materials, indirect expenses, and car hire, which increased 24.6%, from US $473.8 million in 2005 to US $590.6 million in Labor costs increased 13.7% from US $118.7 million in 2005 to US $135 million in The price of diesel increased 4.4% from dollars to dollars, which, combined with the higher consumption of liters, represented an increase of US $26.5 million; leasing of locomotives increased to US $7.5 million, principally due to the rental of 48 new locomotives. The Environment The concessions that Ferromex obtained from the Mexican Federal Government to operate the Pacific-North Trunk Line, the Ojinaga-Topolobampo short line, and the Nacozari railroad route contain an agreement regarding the responsibilities of the Federal Government and of Ferromex on environmental matters. To complement the environmental attachments to the concessions, Ferromex signed 19 (nineteen) cooperation agreements with PROFEPA for the Pacific-North Trunk Line concession, and the environmental actions agreed to with this authority have been completed in their totality. ANNUAL REPORT 06 45

47 Locomotives and Railroad Equipment As of December 31, 2006, Ferromex had 567 locomotives, including 60 GE4400 locomotives and 15 EMD4300 locomotives acquired during 2006, and 75 locomotives purchased between 1998 and Ferromex s railroad equipment includes a total of 10,406 freight cars. The Company also leases 3,773 hauling units of different types. Ferrosur On November 25, 2005 the shareholders of the GMEXICO subsidiary Infraestructura y Transportes México, S.A. de C.V., at their Annual Ordinary General Shareholders Meeting, agreed to increase the shareholder capital of ITM by US $307 million through the issuance of new Series C shares subscribed by the companies Grupo Carso, S.A. de C.V. (GCarso) and Sinca Inbursa, S.A. de C.V. (Sinca). As a result of the increase in capital, the new shareholding composition of ITM includes GMEXICO holding 75% and GCarso and Sinca holding the remaining 25%. This resolution was filed with the Federal Competition Bureau, in accordance with applicable legislation. Simultaneously, GMEXICO, through their subsidiary Infraestructura y Transportes Ferroviarios, S.A. de C.V. (ITF) acquired 100% of the shareholder capital of the company Ferrosur, S.A. de.c.v. (Ferrosur), owned by Sinca and GCarso. The Federal Government granted Ferrosur the concession to operate the Southeast Trunk Line for a period of 50 years (exclusive for 30 years), renewable for an equal period, subject to certain conditions, and transferred some fixed assets and materials to Ferrosur that were required for operation, and 25% of the shares in Ferrocarril y Terminal del Valle de México, S. A. de C. V. ( FTVM ), company charged with the operation of the railroad terminal in Mexico City. In December 2005, Ferrosur obtained the operating rights for the Oaxaca - South Short Line concession for a period of 30 years, renewable not to exceed 50 years, starting December 1, Intermodal México Sales reached US $18 million between January and December 2006, 50.8% higher than the previous year, making this the fourth consecutive year reporting significant growth. Two new intermodal terminals were opened in Hermosillo and Silao. 9 intermodal terminals and 15 freight transfer stations are in operation throughout the country. 46 GRUPO MEXICO

48 Geographic Location Principal Routes albuquerque san diego phoenix calexico mexicali tucson ft.worth dallas nogales ciudad juárez el paso sierra blanca san angelo jct b.hill hermosillo guaymas presidio ojinaga chihuahua alpine piedras negras eagle pass corpus christi houston iowa new orleans to polobampo cd. frontera escalón torreón saltillo monterrey durango mazatlán aguascalientes felipe pescador san luis potosí pto.altamira tampico progreso guadalajara viborillas huehuetoca veracruz SIMBOLOGY manzanillo colima valle de méxico coatzacoalcos FERROMEX TRACKAGE RIGHTS TFM salina cruz FERROSUR SHORT LINES TP UP BNSF TEXAS PACIFIC UNION PACIFIC BNSF ANNUAL REPORT 06 47

49

50 Annual Report 2006 Growth [1] Advance or improvement in advantages, riches, size, amount, or importance. [2] In economics, increase in the amount of available assets. [ GRUPO MEXICO obtained excellent financial results: in 2006, share prices reported an appreciation of 60%, reaching a historic high, compared to an appreciation of 56% in ] 56% 60%

51 The earnings per share during 2006 increased from US $0.13 in the first quarter to US $0.17 in the fourth quarter, representing an increase of approximately 30%. Financial Analysis 2006 Behavior of Grupo México stocks (GMEXICO) During 2006, the GMEXICO share price reported an appreciation of 60% reaching a historic high, compared with an appreciation of 56% in The following table shows the share behavior for each quarter over the last two years: US$/Share High Low High Low First Quarter Second Quarter Third Quarter Fourth Quarter ,576,862,500 shares were in circulation as of December 31, 2006 and therefore the market value of Grupo México on this date was approximately US $9.435 billion. The following graph shows a comparative of the last three years between the behavior of the Mexican Stock Exchange Prices and Quotations Index (IPC) and Grupo México stocks. The appreciation of Grupo México stocks during this period has been 107% higher than the IPC, thus reflecting the good performance of the company s operating results. 500% 450% 400% 407% 350% 300% 300% 250% 200% 150% 100% 0% ipc GMEXICO 50 GRUPO MEXICO

52 Stock dividends During 2006, Grupo México distributed approximately US $635 million in dividends, 42% higher than the dividends distributed during 2005, which were approximately US $371 million. The following table shows the dividend amounts per share distributed for each quarter over the last two years: US $/share 2006 Date of Payment First Quarter May 17, 2006 Second Quarter August 01, 2006 Third Quarter November 06, 2006 Fourth Quarter February 15, 2007 US $/share 2005 Date of Payment First Quarter May 17, 2005 Second Quarter August 31, 2005 Third Quarter November 28, 2005 Fourth Quarter February 15, 2006 EARNINGS PER SHARE The earnings per share during 2006 increased from US $0.13 in the first quarter to US $0.17 in the fourth quarter, representing an increase of approximately 30%. The details are shown as follows: 2006 Net Profit (Thousands US $) Profit per share (US $/Share) First Quarter 331,024 $ 0.13 Second Quarter 353,046 $ 0.14 Third Quarter 392,686 $ 0.15 Fourth Quarter 447,310 $ Net Profit Thousands (US $) Profit/share (US $/Share) First Quarter 250,620 $ 0.29 Second Quarter 238,870 $ 0.09 Third Quarter 275,620 $ 0.11 Fourth Quarter 298,318 $ 0.11 ANNUAL REPORT 06 51

53 By December 31, 2006, Grupo México had repurchased a total of 24,246,485 shares for an approximate amount of US $61.1 million, leaving a Fund balance of approximately US $140.1 million. Stock Repurchase Fund On April 29, 2005, the Grupo México s Ordinary General Shareholders Meeting authorized the creation of a fund of approximately US $208.4 million for the repurchase of stocks. By December 31, 2006, Grupo México had repurchased a total of 24,246,485 shares for an approximate amount of US $61.1 million, leaving a Fund balance of approximately US $140.1 million. 6,108,985 shares (approximately US $10.3 million) were transferred to Trust Number to be used in the officers and employees stock Sale Plan. Shares Purchased 2006 US $ (Thousands) First Quarter 346,400 $ 905 Second Quarter 9,148,385 $ 23,875 Third Quarter 6,204,100 $ 18,491 Fourth Quarter 2,137,500 $ 6,949 Shares Purchased 2005 Amount in Dollars First Quarter - - Second Quarter 3,250,000 $ 5,053 Third Quarter 1,750,000 $ 3,174 Fourth Quarter 1,410,100 $ 2, GRUPO MEXICO

54 Debt Profile for Grupo México and Subsidiaries In May 2005, Southern Copper Corporation placed a 30-year term bond maturing in 2035 for the amount of US $400 million at a fixed rate of 7.5%. The funds were allocated to partially finance the US $600 million needed for the SCC expansion program, involving their operations in both Mexico and Peru. This operation was consummated on May 9, and the rate decreased 75 basis points in relation to the July 2005 issue, to be set at 240 basis points on the US Treasury Bond. It should be mentioned that the demand exceeded the offer on this operation two and half times. Millions of US $ Grupo México Holding Infraestructura y Transportes México Americas Mining Corporation Southern Copper Corporation Ferromex Grupo México Consolidated Total Debt $ 0 $ 0 Cash and Banks $ $ Net Debt ($ ) ($ ) Total Debt $ 0 $ 0 Cash and Banks $ $ Net Debt ($ 50.50) ($ 19.18) Total Debt $ $ Cash and Banks $ $ Net Debt ($ ) $ Total Debt $ 1, $ 1, Cash and Banks $ 1, $ Net Debt $ $ Total Debt $ $ Cash and Banks $ $ Net Debt $ $ Total Debt $ 2, $ 1, Cash and Banks $ 2, $ 1, Net Debt ($ 75.10) $ ANNUAL REPORT 06 53

55 The consolidated investment program of Grupo México as of December 31, 2006 rose to US $773 million, 8.9% more than the US $667.5 million invested in 2005, of which US $520 million corresponds to the Mining Division and US $253 million to the Railroad Division. Debt Details Millions of US $ Loan TOTAL Balance RATE Date of Limit Available last Amortization Americas Mining Corporation Southern Peru Holdings Corp. $ $ $ % 31-Oct-09 Southern Peru Holdings Corp. $ $ $ % 31-May-10 Southern Copper Corporation Yankee Bond Series A $ $ $ % 01-Apr-08 Yankee Bond Series B $ $ $ % 01-Apr-28 Mitsui Loan $ $ $ 70.0 L+1.25% 15-Dec-13 Unsecured Bond 2015 $ $ $ % 27-Jul-15 Unsecured Bond 2035 $ 1,000.0 $ 1,000.0 $ 1, % 27-Jul-35 Ferromex Inbursa* $ $ $ TIEE+0.91% 31-Dec-10 JP Morgan* $ $ $ Cetes+2.15% 04-Dec-08 Bank of America* $ 31.5 $ 31.7 $ 31.7 TIEE+1.55% 21-Sep-07 Banamex* $ $ $ TIEE+0.60% 23-Apr-07 Eximbank $ 79.8 $ 79.8 $ 23.9 L+0.10% 25-Aug-09 BNP Paribas $ 39.5 $ 39.5 $ 31.3 L+0.09% 25-Jul-13 HSBC $ 24.4 $ 24.4 $ 22.9 L+0.08% 27-Nov-14 HSBC $ 4.2 $ 4.2 $ 4.0 L+0.04% 27-Nov-14 * Loan contracted in pesos, the interest rate is listed in pesos, but this summary reflects the debt in dollars at the exchange rate of $ Debt Maturity Millions of US $ Americas Mining Corporation $ $ $ $ Southern Copper Corporation $ $ $ $ $ 1, Ferromex $ $ $ $ $ Grupo México Consolidado $ $ $ $ $ 1, GRUPO MEXICO

56 Investments The consolidated investment program of Grupo México as of December 31, 2006 rose to US $773 million, 8.9% more than the US $667.5 million invested in 2005, of which US $520 million corresponds to the Mining Division and US $253 million to the Railroad Division. Of the total investment, 30.5% was allocated to Mining Division maintenance and improvement projects, 22.7% to the completion of the modernization of the copper smelter in Ilo, Peru, 11.0% to development, expansion, and remodeling projects for mining and metallurgic plants, and 0.2% was allocated to exploration projects. Also, 35.6% of the total investment was allocated to new infrastructure and equipment for the Railroad Division, the most significant investment being made in 75 locomotives, approximately US $159 million, which brings with it higher production and freight volumes transported. It is expected that our consolidated capital investments will be approximately US $796 million in Some of the projects SCC has invested in this year are as follows: Modernization of the Ilo Smelter: With the conclusion of this project in January 2007, we have complied with our commitments acquired under the PAMA, which we signed with the Peruvian government on January 31, With the smelter modernization project, the Company increased its sulfur recovery rate to above the 92% required by the PAMA. The new smelter will maintain the current production levels and will use advanced technology to reduce sulfur emissions, in order to achieve the principal objective of the project. Construction on the anode plant was completed and the plant started operations in January The sea water sluice and two desalination plants have been working since August Three converters have been modernized and one new converter has been installed; all of which are in operation. The residual gas pipeline for the converter and Isasmelt smelter was completed. The new oxygen plant has been in operation since October 2006 and construction is complete on the new acid plant. The expense for this project was $549.4 million as of December 31, We have budgeted $40.5 million to finish this project in 2007, not including the capitalization of interests. Leaching dams project at Toquepala: We started this project in 2003 to improve production costs and efficiency, through the installation of a breaker and a conveyor belt and distribution system for heap leaching at Toquepala. The approved budget for this project is $81 million, $78.8 million having been spent as of December 31, The project had reached a 99.1% advance by December 31, The new system has improved mineral recovery at our leaching plants and has also eliminated the expensive cartage process using trucks. The conveyor belt system is working with conveyor belts 1, 2, 3, 15, and partially with belt 16, on the production line. The volume transported reached its registered capacity of 8,500 tons/hour in September The construction of a ramp will continue until the end of the project, which is expected to be in March Cananea SX/EW Plant: Our objective is to increase copper cathode production at our Cananea Unit, building a new SX/EW (SX/EW III) plant. The plant will produce ASTM Grade 1 or LME Grade A copper cathodes. The project includes the installment of warehouse space for the deliveries required for the operation, the installment of an emergency power plant, and a fire extinguishing system. The project is currently underway and when it is completed in 2009, we expect to produce 33,000 tons of cathodes by electrowinning annually. Other expenses: Availability of tailings at Quebrada Honda: The engineering study has been completed and the capital costs estimated. The purchase process has begun for the principal equipment with an extended operating life. A pre-feasibility study for the Los Chancas is currently being conducted by independent consultants and is expected to be concluded by the second quarter of The feasibility study for the Tía María project was awarded to Bechtel, and is expected for the third quarter of The objective of the dam project at Huanaquera is to build a PLS deposit dam for the Toquepala leaching plant. As of December 31, 2006 this project has presented an advance of approximately 84.5%. The budget for this project, including the acid addition, is $38.1 million, $26.1 million of which had been spent as of December 31, ANNUAL REPORT 06 55

57 On December 21, 2006, Fitch upgraded their credit rating for Grupo México from BB to BB+. This is a reflection of a better consolidated debt profile and the improved performance of their two operative subsidiaries. The following table shows SCC s capital expenses for the fiscal years ending December 31, 2006 and 2005: Fiscal year ending December Projects Modernization of the Ilo smelter $ $ La Caridad SX/EW plant Crushing system and conveyor belts for leachable material San Martín, Santa Bárbara, Charcas, and Nueva Rosita Units Pasta de Conchos Mine Smelter, sulfuric acid, and refinery at La Caridad Expansion of the Toquepala concentrator Cananea SX/EW plant New copper filter at Toquepala Availability of tailings Quebrada Honda Dam New leaching lands at Cuajone PLS Dams at Huanaquera Total project expenses Capital expenses for replacements Mexico Peru Others stripping 64.2 Total expenses for replacements Total capital expenses $ $ GRUPO MEXICO

58 Credit Ratings for Grupo México and Subsidiaries On December 21, 2006, Fitch upgraded their credit rating for Grupo México from BB to BB+. This is a reflection of a better consolidated debt profile and the improved performance of their two operative subsidiaries, Southern Copper Corporation and Grupo Ferroviario Mexicano Moody s Standard & Poor s Fitch Ratings Grupo México International Rating - BBB- BB+ Americas Mining Corporation International Rating - BBB- BB+ Southern Copper Corporation International Rating Baa2 BBB- BBB- US$1 billion Senior Note Baa2 BBB- BBB- Local Rating - - BBB- Minera México Domestic Rating - - BBB- International Rating Baa3 - BBB- Yankee Bond Baa3 - BBB- Ferromex Domestic Long Term Rating - mxaa AA(mex) International Rating - - BBB- Acquisition of Ferrosur On November 25, 2005, Grupo México announced that its subsidiary ITM, through its recently incorporated subsidiary Infraestructura y Transportes Ferroviarios, S.A. de C.V. (ITF), acquired 100% of the shareholder capital in the company FERROSUR, S.A. de C.V., owned by Sinca and GCondumex. According to Accounting Principle SFASB 141, final authorization must be obtained from the Federal Competition Bureau (CFC) in order to consolidate the accounting. On June 22, 2006, the CFC passed a resolution to not authorize the concentration of Ferrosur in ITM, therefore a motion for reconsideration was filed during the third quarter of 2006, which the CFC ruled to be based on inadequate relevant market criteria. On November 16, 2006, Grupo México reported that the CFC had rejected the motion for reconsideration. Therefore, the investment in Ferrosur is presented on these consolidated financial statements valuated under the participation method. To respond to the CFC ruling, the company will take the legal action available to them that best protects their interests. ANNUAL REPORT 06 57

59 Corporate Structure MEXICO CONSTRUCTORA INDUSTRIAL SOUTHERN COPPER USA INFRAESTRUCTURA Y TRANSPORTES MEXICO (ITM) 100% 75.1% 74.99% MINERA MEXICO PERU BRANCH INFRAESTRUCTURA Y TRANSPORTES FERROVIARIOS GRUPO FERROVIARIO MEXICANO 100% 100% 100% 74% LA CARIDAD CANANEA IMMSA CUAJONE TOQUEPALA ILO FERROSUR 100% FERROMEX 100% 58 GRUPO MEXICO

60 Operating Profit-Net Profit (Millions of dollars) P. OPER.: ,670 2,243 3,285 P. NET: ,063 1,530 Current Assets and Liabilities (Millions of dollars) C. assets: 1,388 1,448 2,341 2,335 3,687 c. liabilt.: 1, ,326 1,006 1,270 4,000 3,500 3,000 2,500 2,000 1,500 1, ,500 4,000 3,500 3,000 2,500 2,000 1,500 1, i Operating Profit i NET Profit i Current Assets i Current Liabilities Price Copper cts/pound times Fixed Assets (Millions of dollars) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, ,336 4,089 4,280 4,132 4,518 Equity Capital (Millions of dollars) 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1, ,238 1,391 2,191 3,206 3, Equity Capital and Total Liabilities (Millions of dollars) E. CAPITAL: 1,238 1,391 2,191 3,206 3,967 T. LIABILIT.: 4,663 4,359 4,353 3,090 3,603 5,000 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1,000 Operating Profit per Share (dollars) i Equity Capital i Total LIABILITIES The book value and the profit per share refer to 2,576,862,500 shares. ANNUAL REPORT 06 59

61 Per Share Profit (Dollars) Equity Capital and Total Assets (Millions of dollars) E. CAPITAL: 1,238 1,391 2,191 3,206 3,967 T. ASSETS: 6,662 6,555 7,476 7,477 8,916 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, i Equity Capital i Total Assets Book Value per Share (Dollars) EBITDA / Interests (Times) GRUPO MEXICO

62 Debt / Capital + Debt (Millions of dollars) Debt: 2,959 2,943 2,457 1,618 2,067 C. + Debt: 4,197 4,334 4,648 4,824 6,034 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 EBITDA per Share (Dollars) i Debt i Capital + Debt Net Debt (Millions of dollars) TOTAL DEBT: 2,947 3,171 2,680 1,719 2,155 CASH AND B: ,264 2,230 NET Debt: 2,414 2,610 1, (75) 4,500 4,000 3,500 3,000 2,500 2,000 1,500 1, Cash Flow per Share (Dollars) i TOTAL Debt i Cash AND BANKS i NET Debt ANNUAL REPORT 06 61

63 Members of the Board of Directors Grupo México, S.A.B. de C.V. Members of the Board of Directors Officers Germán Larrea Mota Velasco (Chairman) Genaro Larrea Mota Velasco (Vice-Chairman) Juan Rebolledo Gout Vice President International Relations Emilio Carrillo Gamboa Alfredo Casar Pérez Valentín Diez Morodo Juan I. Gallardo Thurlow Xavier García de Quevedo Oscar González Rocha Claudio X. González Rolando Vega Iñiguez Special Advisor to the Board of Directors and the Auditing Committee Prudencio López Martínez Antonio Madero Bracho José Mendoza Fernández Romulo O Farril Jr. Fernando Ruiz Sahagún Agustín Santamarina Alberto de la Parra Zavala Secretary to the Board Alberto de la Parra Zavala 1 General Counsel Gabino Páez González Human Resources Director Jaime F. Collazo González Administration, Audit, & Information Technologies Director Ernesto Durán Trinidad Corporate Comptrollership Director Vicente Grau Alonso Alternate Secretary Ferrocarril Mexicano, S.A. de C.V. Members of the Board of Directors Officers Germán Larrea Mota Velasco (Chairman) Genaro Larrea Mota Velasco (Vice-Chairman) Alfredo Casar Pérez President and Chief Executive Officer Alfredo Casar Pérez Jaime Corredor Esnaola Valentín Diez Morodo Xavier García de Quevedo Topete Claudio X. González Laporte Robert M. Knight Jr. Robert D. Naro Agustín Santamarina Vázquez Jaime Serra Puche James R. Young Lorenzo Reyes Retana Márquez Padilla Chief Operations Officer Rogelio Vélez López de la Cerda Vice President Sales and Marketing Alberto de la Parra Zavala Secretary Christian Lippert Helguera Alternate Secretary Enrique Nava Escobedo Finances and Administration Director 1 Appointed february 15, GRUPO MEXICO

64 Southern Copper Corporation Members of the Board of Directors Officers Germán Larrea Mota-Velasco (Chairman) Oscar González Rocha Chief Executive Officer Xavier García de Quevedo Chief Executive Officer Genaro Larrea Mota-Velasco (Vice-Chairman) Emilio Carrillo Gamboa Alfredo Casar Pérez Jaime F. Collazo González Xavier García de Quevedo Topete J. Eduardo González Félix Oscar González Rocha Harold S. Handelsman Armando Ortega Luis Miguel Palomino Bonilla Gilberto Perezalonso Juan Rebolledo Gout Carlos Ruiz Sacristán J. Eduardo González Félix Vice President Finances and Chief Financial Officer Vidal Muhech Dip Vice President Projects Armando F. Ortega Gómez General Counsel and Secretary to the Board Remigio Martínez Muller Vice President Exploration Mario Vinageras Barroso Vice President Sales Other SUBSIDIARIES Officers Ferrosur, S.A. de C.V. México Constructora Industrial, S.A. de C.V. Intermodal México, S.A. de C.V. Octavio Ornelas Esquinca Chief Executive Officer Julio Larrea Mena Chief Executive Officer Hilario Gabilondo Picollo Chief Executive Officer ANNUAL REPORT 06 63

65

66 CONTENTS Grupo México, S.A.B. de C.V. and Subsidiaries Consolidated Financial Statements december 31, 2005 and Independent Auditors Report Consolidated Financial Statements: 04 Balance sheets 05 Statements of operations 06 Statements of changes in stockholders equity 08 Consolidated statements of cash flow 09 Notes to the consolidated financial statements

67 Independent Auditors Report Mexico City, April 16, 2007 To the Board of Directors and Stockholders of Grupo México, S. A. B. de C. V. 1. We have audited the accompanying consolidated balance sheets of Grupo México, S. A. B. de C. V. and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of operations, of changes in stockholders equity and of cash flows for the years then ended. These financial statements are the responsibility of the Company s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in Mexico, which are substantially similar in all material respects with auditing standards in the United States of America (USA). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement and that they were prepared in accordance with generally accepted accounting principles. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits and the audit by other auditors, provide a reasonable basis for our opinion. 02 GRUPO MEXICO

68 2. In July 2005, the unionized workers of Asarco commenced a work stoppage, which was settled in November 2005 with the extension of the existing contract for an additional thirteen month period until December 31, Further, as a result of various factors and environmental commitments alleged asbestos liabilities, including the above-mentioned work stoppage on August 9, 2005 Asarco, filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code before the U.S. Bankruptcy Court of Corpus Christi, Texas. Asarco s bankruptcy case is being joined with the bankruptcy cases of its subsidiaries. Asarco is in continuing possession of its properties and is operating and managing its business as a debtor in possession. It is impossible to predict how the bankruptcy court will ultimately rule with respect to such petitions and the impact that such rulings or other related matters will have on Asarco and its subsidiaries and on the Company. As discussed in Note 1, Asarco had net income of $11 million related to the period ended on August 9, 2005 (date at which the Company deconsolidated Asarco). 3. In our opinion, the consolidated financial statements referred to in the first paragraph above present fairly, in all material respects, the financial position of Grupo México, S. A. B. de C. V. and subsidiaries as of December 31, 2006 and 2005, and the results of their operations, the changes in their stockholders equity and the cash flows for the years then ended, in conformity with accounting principles generally accepted in USA. PricewaterhouseCoopers C.P.C. Gildardo Lili Camacho ANNUAL REPORT 06 03

69 Grupo México, S.A.B. de C.V. and Subsidiaries CONSOLIDATED BALANCE SHEETS December 31, (In thousands of US dollars) Assets CURRENT ASSETS: Cash and cash equivalents $ 1,940,384 $ 1,263,781 Marketable securities 290,000 2,230,384 1,263,781 Trade receivables 716, ,720 Other accounts receivable 108,542 70, , ,727 Inventories - Net 450, ,520 Prepaid expenses and other 43,280 60,256 Deferred income tax and employees statutory profit sharing 138,528 39,700 Total current assets 3,687,283 2,334,984 Property, plant and equipment - Net 4,405,800 4,013,281 Concession titles - Net 111, ,176 Investments 279, ,775 Leachable material - Net 231, ,118 Capitalized mine stripping cost - Net 289,369 Intangible assets 172, ,541 Other assets 28,086 44,686 $ 8,915,626 $ 7,476,930 Liabilities and Stockholders Equity CURRENT LIABILITIES: Current portion of long-term debt $ 188,037 $ 69,306 Accounts payable and accrued liabilities 468, ,040 Income and asset taxes payables 295, ,721 Employees statutory profit sharing 317, ,688 Total current liabilities 1,269,846 1,005,755 Long-term debt 1,878,537 1,548,235 Labor liabilities 63,682 41,125 Deferred income tax and employees statutory profit sharing 300, ,800 Other liabilities and reserves 91, ,777 Total liabilities 3,603,375 3,089,692 COMMITMENTS AND CONTINGENCIES Minority interest 1,344,755 1,180,957 STOCKHOLDERS EQUITY: Common stock 1,995,295 2,007,085 Reserve for shares purchase 162, ,410 Additional paid-in capital 9,043 9,043 Treasury stock (109,401) (92,021) Accumulated other comprehensive loss (36,067) (24,056) Retained earnings 1,945,666 1,104,820 Total stockholders equity 3,967,496 3,206,281 $ 8,915,626 $ 7,476,930 The accompanying twenty notes are an integral part of these consolidated financial statements. 04 GRUPO MÉXICO

70 Grupo México, S.A.B. de C.V. and Subsidiaries CONSOLIDATED STATEMENTS OF OPERATIONS Year ended December 31, (In thousands of US dollars) Sales of products and services: Net sales $ 5,460,221 $ 4,449,163 Service revenue 899, ,240 Costs and operating expenses: 6,359,467 5,189,403 Cost of sales (exclusive of depreciation and amortization shown below) 2,569,946 2,397,621 Selling, general and administrative expenses 139, ,392 Depreciation, amortization and depletion 343, ,005 Exploration 22,704 24,356 3,074,940 2,946,374 Income from operations 3,284,527 2,243,029 Net comprehensive financing cost: Interest expense 160, ,207 Interest capitalized (27,951) (22,509) Interest income (87,765) (51,695) Foreign currency transaction losses 5,802 (3,246) Loss on derivative instruments 11,595 22,262 Loss on debt prepayments 1,137 10,559 Other (income) expenses (14,623) (20,999) 48, ,579 Income before income taxes and minority interest 3,236,272 2,120,450 Income and asset tax 1,135, ,893 Income before minority interest 2,100,951 1,479,557 Equity in the results of non consolidated subsidiaries 22,587 Minority interest income (593,839) (416,130) Consolidated net income $ 1,529,699 $ 1,063,427 Income per share $ 0.59 $ 0.41 Weighted average number of shares outstanding (thousands) 2,585,756 2,594,399 The accompanying twenty notes are an integral part of these consolidated financial statements. ANNUAL REPORT 06 05

71 Grupo México, S.A.B. de C.V. and Subsidiaries CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005 Outstanding Reserve shares in Common for shares (In thousands of US dollars) thousands stock purchase Balance as of December 31, ,000 $ 2,007,288 Split of shares 1,730,000 Purchase of own shares (301) (203) Retained earnings capitalization $ 201,742 Dividends paid Increase treasury stock Comprehensive result: Consolidated net income ITM and SCC adjusted in share participation (See Note 1) Other (332) Balances as of December 31, ,594,699 2,007, ,410 Purchase of own shares (17,836) (11,790) (38,450) Dividends paid Increase treasury stock Comprehensive result: Consolidated net income Net effect of change in accounting for mine stripping costs, net of income tax Other Balances as of December 31, ,576,863 $ 1,995,295 $ 162,960 The accompanying twenty notes are an integral part of these consolidated financial statements. 06 GRUPO MEXICO

72 Accumulated Additional Treasury other Retained paid-in capital stock comprehensive loss earnings Total $ 9,043 ($ 72,897) ($ 214,438) $ 462,459 $ 2,191,455 (203) (201,742) (219,324) (219,324) (19,124) (19,124) 1,063,427 1,063, , ,354 36,028 35,696 1,253,477 9,043 (92,021) (24,056) 1,104,820 3,206,281 (50,240) (563,908) (563,908) (17,380) (17,380) 1,529,699 1,529,699 (124,945) (124,945) (12,011) (12,011) 1,392,743 $ 9,043 ($ 109,401) ($ 36,067) $ 1,945,666 $ 3,967,496 ANNUAL REPORT 06 07

73 Grupo México, S.A.B. de C.V. and Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOW Year ended December 31, (In thousands of US dollars) Operating activities: Consolidated net income $ 1,529,699 $ 1,063,427 Charges (credits) not requiring (providing) resources: Minority interests 593, ,130 Provisions for doubtful accounts, voluntary retirements, pensions, seniority premiums and medical services 5,133 4,059 Depreciation, depletion and amortization 343, ,005 Amortization of concession titles and deferred charges 5,199 5,208 Allowance investment Asarco 21,869 Foreign currency transaction losses 11,775 4,814 Remeasurement loss 5,758 8,885 Deferred income tax and employees statutory profit sharing (37,375) (36,954) Unrealized loss on derivate instruments 11,595 Gain on sale of property (1,881) (2,084) Capitalized mine stripping and leachable material (65,930) (116,409) 2,401,027 1,737,950 Changes in current assets and liabilities: Accounts receivable (297,615) 67,193 Inventories (30,560) (37,799) Accounts payable, accrued liabilities and other liabilities 85,301 95,845 Net resources provided by operating activities 2,158,153 1,863,189 Investing activities: Additions to property and equipment, less net book value of retirements (709,014) (559,383) Purchase of marketable securities (290,000) Capitalized of debt issuance cost (3,150) Investment Ferrosur, S. A. de C. V. shares (307,026) Sale of Infraestructura y Transportes México, S. A. de C. V. shares 307,026 Other assets, net 34,169 (49,016) Sale and maturity of marketable securities 45,267 Net resources used in investing activities (967,995) (563,132) Financing activities: Debt incurred (repaid) 452,810 (537,502) Dividends paid to common stockholders (951,406) (461,089) Net resources used in financing activities (498,596) (998,591) Increase in cash and cash equivalents 691, ,466 Effect of exchange rate changes on cash and cash equivalents (14,959) (11,230) 676, ,236 Cash and cash equivalents at beginning of year 1,263, ,545 Cash and cash equivalents at end of year $ 1,940,384 $ 1,263,781 The accompanying twenty notes are an integral part of these consolidated financial statements. 08 GRUPO MEXICO

74 Grupo México, S. A. B. de C. V. and Subsidiaries NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2006 AND 2005 (In million of US dollars) NOTE 1 - DESCRIPTION OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES: The operating companies that comprise Grupo México, S. A. B. de C. V. (formerly named Grupo México, S.A. de C.V.) and subsidiaries (Company or GMEXICO) are in the metallurgical mining and freight railway services industries. They engage in the exploration, mining and processing of metallic and nonmetallic minerals and the mining of coal and provide multi-use and freight railway services. At an Extraordinary Stockholders Meeting it was agreed to change the social regime of Grupo México, S.A. de C.V. to Sociedad Anónima Bursátil de Capital Variable due to the amendments to the Securities Market Law, as result of which the Company now operates as Grupo México, S.A.B. de C.V. The Company s mining operations are contained in a wholly-owned sub-holding company known as Americas Mining Corporation (AMC), which in turn is parent company to Southern Copper Corporation (SCC) (Formerly southern Peru Copper Corporation (SPCC)) and Asarco Inc., presently Asarco LLC (Asarco). Effective April 1, 2005, Grupo México, S. A. B. de C. V., through its subsidiary, AMC, sold its approximately 99.15% shareholding in Minera México, S. A. de C. V. (MM) to SCC in return for the issuance to AMC of 67.2 million new shares of common stock of SCC. The transaction resulted in Grupo México increasing its indirect equity ownership in SCC to approximately 75.1% from its prior indirect interest of approximately 54.2%. This settlement generated a net income of $69.4 million. SCC and subsidiaries is an integrated producer of copper and other minerals, and operates mining, smelting and refining facilities in Peru and Mexico. SCC and subsidiaries conducts its primary operations in Peru through a registered branch (the Branch ). The Branch is not a corporation separate from the Company. The Company s Mexican operations are conducted through subsidiaries. Asarco is primarily engaged in the exploration, mining and processing of copper through its operation of four major open-pit mines, two smelting facilities, one of which is currently on standby, two solvent extraction/ electrowinning (SX/EW) facilities and a refining facility. The United States operations also include a lead smelter, currently on standby, and four zinc mines, all of which are currently on standby. In July 2005, the unionized workers of Asarco commenced a work stoppage, which was settled in November 2005 with the extension of the existing contract for an additional thirteen month period until December 31, Further, as a result of various factors and environmental commitments alleged asbestos liabilities, including the above-mentioned work stoppage on August 9, 2005 Asarco, filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code before the U.S. Bankruptcy Court of Corpus Christi, Texas. Asarco s bankruptcy case is being joined with the bankruptcy cases of its subsidiaries. Asarco is in continuing possession of its properties and is operating and managing its business as a debtor in possession. It is impossible to predict how the bankruptcy court will ultimately rule with respect to such petitions and the impact such rulings will have on Asarco and its subsidiaries and on the Company. Asarco had net income of $11 million related to the period ended on August 9, 2005 (date at which the Company deconsolidated Asarco). Asarco ANNUAL REPORT 06 09

75 Condensed Financial Statements as of August 9, 2005 (date of the deconsolidation) are shown as follows: Condensed Balance Sheet as of August 9, 2005 (million of dollars) Assets Liabilities and Stockholders Equity Current assets $ Current liabilities $ Property and equipment Long-term debt Other assets Other liabilities Total liabilities 1,026.3 Minority Interest 8.4 Stockholders Equity 21.9 Sum Liabilities and Total assets $ 1,056.6 Stockholders Equity $ 1,056.6 The Company s railway system operations is contained in a wholly-owned sub-holding company known as Infraestructura y Transportes México, S. A. de C. V. (ITM), which in turn is parent company of Grupo Ferroviario Mexicano, S. A. de C. V. (GFM), that serves as the parent company holding a 74% interest in Ferrocarril Mexicano, S. A. de C. V. (Ferromex). On November 25, 2005, GMEXICO announced that the shareholders of its subsidiary Infraestructura y Transportes México, S. A. de C. V. (ITM), agreed during the Regular General Annual Assembly to increase ITM s capital stock by $3,260 million pesos, through the emission of new Series C shares subscribed by companies Grupo Carso, S. A. de C. V. (GCarso) and Sinca Inbursa, S. A. de C. V. (Sinca). Due to the said capital increase, ITM s new composition of shareholders consists of GMEXICO, with 75%, and GCarso and Sinca with the remaining 25%. The said transaction was previously notified to the Federal Antitrust Commission, in accordance with the applicable legislation. Condensed Statement of Earnings Period from (million of dollars) January 1 to August 9, 2005 Sales $ Cost of sales Operating expenses 29.6 Operating income 31.7 Financing cost, other (income) expenses and taxes, net 15.5 Minority interest (4.9) Net earnings $ 11.3 In the period from January 1 to August 9, 2005 Asarco obtained a net income of $11 million which was included in the consolidated statements of operations attached. In August 2005 AMC registered a reserve by $21 million corresponding to the net value of the Asarco investment. Likewise, on the same day GMEXICO reported that its ITM subsidiary, through its recently incorporated subsdiary Infraestructura y Transportes Ferroviarios, S. A. de C. V. (ITF), acquired 100% of the capital stock of the company Ferrosur, S. A. de C. V. (Ferrosur) owned by Sinca and GCarso. This settlement generated a net income of $84.9 million. In accordance with SFASB No. 141, Accounting Principle, it is necessary to have the Federal Antitrust Commission s final authorization before we can consolidated the accounting. In November 16, 2006, the Federal Antitrust Commission denied the merger between Ferrosur and ITF. As result ITM and ITF start a legal proceeding to revoke the above mentioned ruled proposed by the Federal Antitrust Commission. As of the date of these financial statement the outcome of this legal proceeding is uncertain. Because of the aforementioned, and as long as the said authorization remains pending, in- 10 GRUPO MEXICO

76 vestments in Ferrosur will be presented valued under the method of participation in GMEXI- CO s consolidated financial statements. Main operations and activities: SCC branch is primarily an integrated producer of copper through the operation of two mining facilities, a smelting facility, an SX/EW facility and a refining facility, all in the southern part of Peru. MM and its subsidiaries is primarily engaged in the exploration, mining and processing of copper in Mexico through its operation of two major open-pit mines, two smelting facilities and a refining facility. These operations also include five complex underground mining facilities producing lead, zinc or copper concentrates, a zinc refining facility, a coal mine and a coke plant. ITM, through its wholly owned subsidiary Grupo Ferroviario Mexicano, S. A. de C. V. (GFM), were formed to participate in the privatization of the Mexican railway system. The principal subsidiary of GFM is Ferromex, which is engaged in providing freight and multi-modal railroad services, as well as, any activity that supports and is related to this activity, including land transportation, storage and other complementary railroad transportation service. The Mexican Federal Government granted Ferromex a 50- year concession to operate the branch lines known as North-Pacific and Ojinaga-Topolobampo Short Line (which for 30-years will be operated on an exclusive basis). The concession is renewable, subject to certain conditions, for a similar period. In addition, the Mexican Federal Government sold 25% of the shares of Ferrocarril y Terminal del Valle de México, S. A. de C. V. (FTVM), the entity responsible for operating the Mexico City Terminal. GFM accounts for this 25% investment in FTVM under the equity method of accounting. The operations under MM, ITM, GFM and their respective subsidiaries are collectively referred to as the Mexican Operations. A large portion of the Company s revenue is derived from the mining and processing of copper. Most of the copper is sold as refined metal under annual contracts or on a spot basis, at price that fluctuate with commodity exchange quotations. These commodity prices can fluctuate widely and are affected by numerous factors beyond the Company s control. The Company does not believe that the loss of any customer would have a material adverse effect on its results since copper is internationally traded and lost customers could be readily replaced. Principles of Consolidation: The consolidated financial statements include the accounts of subsidiaries of which the Company has voting control, in accordance with FAS No. 94 Consolidation of All Majority-Owned Subsidiaries. Such financial statements are prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP). The main subsidiaries are as follows: - AMC 100% direct and indirect ownership. - ITM 75% ownership. - Grupo Minero México Internacional, S. A. de C. V. (GMMI), México Proyectos y Desarrollos, S. A. de C. V. (MPD) and Grupo México Servicios, S. A. de C. V. (GMS) [currently this companies have not significant operations]. On December 31, 2006 GMMI was margen into GMEXICO and as a result, GMEXICO is now the sole shareholder of AMC. Investments over which the Company has significant influence but does not have voting control are accounted for by the equity method. All significant inter-company balances and transactions have been eliminated. The significant accounting policies of the Company are summarize as follows: Use of estimates - The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions include the carrying value of ore reserves that are the basis for future cash flow estimates and amortization calculations; environmental, reclamation, closure and retirement obligations; estimates of recoverable copper in mill and leach stockpiles; asset impairments (including estimates of future cash flows); bad debts; inventory obsolescence; deferred and current income tax; valuation allowances for deferred tax assets; reserves for contingencies and litigation; and fair value of financial instruments. Management bases its estimates on the Company s historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could differ from those estimates. Revenue recognition - Substantially all of the Company s copper is sold under annual or other longer-term contracts. Revenue is recognized when title passes to the customer. The passing of title is based on terms of the contract, generally upon shipment. Copper revenue is determined based on ANNUAL REPORT 06 11

77 the monthly average of prevailing commodity prices according to the terms of the contracts. The Company provides allowances for doubtful accounts based upon historical bad debt and claims experience and periodic evaluation of specific customer accounts. For certain of the Company s sales of copper and molybdenum products, customers are given the option to select a monthly average LME or COMEX price (as is the case for sales of copper products) or the molybdenum oxide proprietary price of Platt s Metal Week (as is the case for sales of molybdenum products), generally ranging between one and six months subsequent to shipment. In such cases, revenue is recorded at a provisional price at the time of shipment. The provisionally priced copper sales are adjusted to reflect forward LME or COMEX copper prices at the end of each month until a final adjustment is made to the price of the shipments upon settlement with customers pursuant to the terms of the contract. In the case of molybdenum sales, for which there are no published forward prices, the provisionally priced sales are adjusted to reflect the market prices at the end of each month until a final adjustment is made to the price of the shipments upon settlement with customers pursuant to the terms of the contract. These provisional pricing arrangements are accounted for separately from the contract as an embedded derivative instrument under SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended ( FASB No. 133 ). The Company sells copper in concentrate, anode, blister and refined form at industry standard commercial terms. Net sales include the invoiced value and corresponding fair value adjustment of the related forward contract of copper, zinc, silver, molybdenum, acid and other metals. Ferromex recognizes revenues as transportation services in the period services are rendered, generally upon completion of delivery to destination. Shipping and handling fees and costs - Amounts billed to customers for shipping and handling, are classified as sales. Amounts incurred for shipping and handling are included in cost of sales (exclusive of depreciation, amortization and depletion). Cash and cash equivalents - Cash and cash equivalents include bank deposits, certificates of deposit and short term investment funds with original maturities of three months or less at the date of purchase. The carrying value of cash and cash equivalents approximate fair value. Marketable securities - Marketable securities consist primarily of interest bearing instruments with original maturities greater than 90 days but less than one year. These deposits are held to maturity and carried at cost. Due to the short term nature of the investments, cost is deemed to approximate fair value. Inventories - Metal inventories, consisting of work in process and finish goods, are carried at the lower of average cost or market. Costs incurred in the production of metal inventories exclude general and administrative costs. Work-in-process inventories represent materials that are in the process of being converted into a saleable product. Conversion processes vary depending on the nature of the copper ore and the specific mining operation. For sulfide ores, processing includes milling and concentrating and the results from the production of copper and molybdenum concentrates. Molybdenum in-process inventory includes the cost of molybdenum concentrates and the costs incurred to convert those concentrates into various high-purity molybdenum chemicals or metallurgical products. Finished goods include saleable products (e.g., copper concentrates, copper anodes, copper cathodes, copper rod, high-purity molybdenum chemicals and other metallurgical products). Materials and supplies are stated at the lower of average cost or market value. Supplies inventories are carried at average cost less a reserve for obsolescence. Property, plant and equipment - Property, plant and mining and railway equipment are carried at cost, net of accumulated depreciation and amortization. Cost includes major expenditures for improvements and replacements, which extend useful lives or increase capacity and interest costs associated with significant capital additions. Maintenance, repairs, normal development costs at existing mines, and gains or losses on assets retired or sold are reflected in earnings as incurred. Mine development includes primarily the cost of acquiring land rights to an exploitable ore body, pre-production stripping costs at new mines that are commercially exploitable, costs associated with bringing new mineral properties into production, and removal of overburden to prepare unique and identifiable areas outside the current mining area for such future production. Mine development costs are amortized on a unit of production basis over the remaining life of the mines. Buildings and equipment are depreciated on the straight-line method over estimated lives from five to 40 years or the estimated life of the mine if shorter. 12 GRUPO MEXICO

78 Property is reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Assets are determined impaired when the estimated future undiscounted cash flows expected to result from the use of the asset are less than the carrying value of the asset. The Company s estimate as to future undiscounted cash flows takes into consideration, among other things, expected future metal prices, which are based on historical metal prices and price trends. The Company measures an impairment loss as the difference between the carrying value of the asset and its fair value as determined taking into consideration the estimated future discounted cash flows of the asset. The Mexican railway operation uses the straight-line method over estimated lives from five to 30 years. Capitalization of railway improvements and maintenance - Railway improvements and maintenance are capitalized in the caption rails and structures when the components of more than 20% a section of track are changed. The capitalized item is depreciated at a rate between 3.3% and 6.6%. When maintenance or repairs do not require changing the components of more than 20% of one section of track, the cost is expensed as incurred. Capitalization of overhauls - Regular maintenance and repairs are expensed as incurred. The cost of a locomotive overhaul, which extends the useful life of the related asset, is capitalized and amortized over a term ranging between four and eight years, depending on the type of overhaul in question. Concession titles - Concessions titles are recorded at their original cost of acquisition. Amortization is calculated using the straight-line method, based on the remaining estimated useful life of the fixed assets under concession, which was an average of 30 years as of the date the concessions were granted. Asset retirement obligations (reclamation and remediation costs) - The fair value of a liability for asset retirement obligations is recognized in the period in which the liability is incurred. The liability is measured at fair value and is adjusted to its present value in subsequent periods as accretion expense is recorded. The corresponding asset retirement costs are capitalized as part of the carrying value of the related long-lived assets and depreciated over the asset s useful life. Intangible assets - Intangible assets include primarily the excess amount paid over the book value for investment shares and mining and engineering development studies. Intangible assets are carried at acquisition costs, net of accumulated amortization and are amortized principally on a unit of production basis over the estimated remaining life of the mines. Intangible assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Debt issuance costs - Debt issuance costs, which are included in other assets, are amortized using the interest method over the term of the related debt. Ore reserves - The Company periodically reevaluates estimates of its ore reserves, which represent the Company s estimate as to the amount of unmined copper remaining in its existing mine locations that can be produced and sold at a profit. Such estimates are based on engineering evaluations derived from samples of drill holes and other openings, combined with assumptions about copper market prices and production costs at each of the respective mines. The Company updates its estimate of ore reserves at the beginning of each year. In this calculation the Company uses current metal prices which are defined as the average metal price over the preceding three years. However, in the case of the Company s recently acquired Mexican subsidiary, ore reserve estimates prior to 2005 were calculated based on a copper price of $0.90 per pound of copper. The current per pound of copper price, as defined, was $1.261 and $0.939 at the beginning of 2006 and 2005, respectively. In years prior to 2006, these ore reserve estimates were used to determine the amount of mine stripping that is capitalized, units of production amortization of capitalized mine stripping, mine development and amortization of intangible assets. In 2005, the Emerging Issues Task Force of the FASB reached a consensus that stripping costs incurred during the production phase of a mine are variable production costs that should be included in the costs of the inventory produced (extracted) during the period that the stripping costs are incurred. This consensus was ratified by the FASB and became effective for us in On January 1, 2006, the Company adopted this consensus by reversing $289.4 million of net cumulative stripping cost as of December 31, 2005 and recording a net charge of $166.6 million to retained earnings after recognition of workers participation and tax benefits of $122.8 million. Accordingly, mine stripping costs are included in the cost of inventory. The Company continues to use ore reserve estimates to amortize mine development and intangible assets. Leachable material - At one of its mines the Company capitalizes the cost of materials with low copper con- ANNUAL REPORT 06 13

79 tent extracted during the mining process (leachable material), which is collected in areas known as leaching dumps. The amortization of the capitalized costs is determined based on the depletion period of the leaching dumps, which is estimated to be five years (unaudited). Exploration - Tangible and intangible costs incurred in the search for mineral properties are charged against earnings when incurred. Income taxes - Provisions for income taxes are based on taxes payable or refundable for the current year and deferred taxes on temporary differences between the amount of taxable income and pretax financial income and between the tax bases of assets and liabilities and their reported amounts in the financial statements. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized and settled as prescribed in Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred income tax assets are reduced by any benefits that, in the opinion of management, are more likely not to be realized. No US deferred income taxes have been provided for the income tax liability which would be incurred on repatriation of the undistributed earnings of the Company s consolidated foreign subsidiaries and undistributed earnings of SCC prior to 1993, because the Company intends indefinitely to reinvest these earnings outside the United States. Asset tax paid that is expected to be recoverable is recorded as an advance payment of income tax and is presented in the balance sheet together with deferred income tax. Deferred Taxes - In preparing our consolidated financial statements, we recognize income taxes in each of the jurisdictions in which we operate. For each jurisdiction, we estimate the actual amount of currently payable or receivable as well as deferred tax assets and liabilities attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in rate is recognized in income in the period that the change is enacted. A valuation allowance is provided for those deferred tax assets for which it is more likely than not that the related benefits will not be realized. In determining the amount of the valuation allowance, we consider estimated future taxable income as well as feasible tax planning strategies in each jurisdiction. If we determine that we will not realize all or a portion of our deferred tax assets, we will increase our valuation allowance with a charge to income tax expense. Conversely, if we determine that we will ultimately be able to realize all or a portion of the related benefits for which a valuation allowance has been provided, all or a portion of the related valuation allowance will be reduced with a credit to income tax expense. Employee benefit obligations - In September 2006, the FASB issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R). This standard requires employers to recognize the underfunded or overfunded status of defined benefit pension and postretirement plans as an asset or liability in its statement of financial position, and recognize changes in the funded status in the year in which the changes occur through accumulated other comprehensive income, which is a component of stockholders equity. The Company adopted this standard as of December 31, PERU SCC Defined Benefit Pension Plans - The Company has two noncontributory defined benefit pension plans covering former salaried employees in the United States and certain former employees in Peru. Effective October 31, 2000, the Board of Directors amended the qualified pension plan to suspend the accrual of benefits. The components of net periodic benefit costs calculated in accordance with SFAS No. 87, Employers Accounting for Pensions were immaterial. The scheduled maturities of the benefits expected to be paid in each of the next five years, and thereafter, are as follows: (in millions) Year Expected Benefit Payments 2007 $ to Total $ GRUPO MEXICO

80 The Company s funding policy is to contribute amounts to the qualified plan sufficient to meet the minimum funding requirements set forth in the Employee Retirement Income Security Act of 1974, plus such additional amounts as the Company may determine to be appropriate. Plan assets are invested in commingled stock and bond funds. The Company s policy for determining asset mix-targets includes periodic consultation with recognized third party investment consultants. The expected long-term rate of return on plan assets is updated periodically, taking into consideration asset allocations, historical returns and the current economic environment. Based on these factors we expect our assets will earn an average of 4.5% per annum assuming our long-term mix will be consistent with our current mix and an assumed discount rate of 5.5%. The fair value of plan assets is impacted by general market conditions. If actual returns on plan assets vary from the expected returns, actual results could differ. SCC Post-retirement Health Care Plan The Company adopted the post-retirement health care plan for retired salaried employees eligible for Medicare on May 1, The plan is unfunded. Effective October 31, 2000, the health care plan for retirees was terminated and the Company informed retirees that they would be covered by the then in effect post-retirement health care plan of Asarco, a former shareholder of the Company and a subsidiary of Grupo Mexico, which offered substantially the same benefits and required the same contributions. The plan is accounted for in accordance with SFAS No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions, as amended by SFAS No The components of net period benefit costs were not material. The discount rate used in the calculation of other post-retirement benefits and cost as of December 31, 2006 and 2005 was 5.5%. The benefits expected to be paid in each of the next five years, and thereafter, are as follows: (in millions) Year Expected Benefit Payments 2007 $ to Total $ 1.0 For measurement purposes, a 10% annual rate of increase in the per capita cost of covered health care benefits was assumed for The rate is assumed to decrease gradually to 5% for 2014 and remain at that level thereafter. Assumed health care cost trend rates can have a significant effect on the amount reported for the health care plan. A one percentagepoint change in assumed health care trend rate would not have a significant effect. MEXICO MM Defined Benefit Pension Plans - MM has established for both its salaried and union employees a non-contributory defined benefit pension plan. This plan is in addition to benefits granted by the Instituto Mexicano de Seguro Social (IMSS). The benefits earned in the Company s defined benefit plan are based on salaries adjusted by inflation. As Mexico has experienced a period of low inflation in recent years, the benefits earned from the IMSS have exceeded those earned from the Company s non-contributory defined benefit plan. Due to this fact, and due to the fact that the Company wants assure the economic well being of its retired employees, the Company decided in 2006 to create a new defined contribution plan. Certain groups of salaried employees agreed to transfer from the non-contributory defined benefit plan to the new defined contribution plan. Benefits earned by participating employees as of January 1, 2006 were transferred into the new defined contribution plan. The initial transfer of benefits from the non-contributory defined benefit plan to the new defined contribution plan equaled $13.7 million. Under the new plan, the Company will make yearly contributions equaling 3% of participating employee s base salary. In 2006, the company recorded contribution expense of $1.1 million. The change in plan was accounted for as a settlement under SFAS No. 88, Employee s Accounting for Settlements and Curtailments of Deferred Benefit Pension Plans and for Termination Benefits. The Company recorded a $1.7 million settlement gain in relation to the change in plan. The components of net periodic benefit costs calculated in accordance with SFAS No. 87, Employers Accounting for Pensions were immaterial. ANNUAL REPORT 06 15

81 The benefits expected to be paid in each of the next five years, and thereafter, are as follows: (in millions) Year Expected Benefit Payments 2007 $ to Total $ 40.3 The amount of contributions that the Company expects to be paid to the plan during 2007 is not material. MM Post-retirement health care plan - The components of net period benefit costs were immaterial. The benefits expected to be paid in each of the next five years, and thereafter, are as follows: (in millions) Year Expected Benefit Payments MM s policy for determining asset mix targets includes periodic consultation with recognized third party investment consultants. The expected long-term rate of return on plan assets is updated periodically, taking into consideration assets allocations, historical returns and the current economic environment. The fair value of plan assets is impacted by general market conditions. If actual returns on plan assets vary from the expected returns, actual results could differ. These plans accounted for approximately 30% of benefit obligations. The following table represents the asset mix of the investment portfolio as of December 31: Asset category: Equity securities 79% 61% Treasury bills % 100% 2007 $ to Total $ 57.1 For measurement purposes, a 2.5% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2006 and remain at that level thereafter. An increase in other benefit cost trend rates have a significant effect on the amount of the reported obligations as well as component cost of the other benefit plan. One percentage-point change in assumed other benefits cost trend rates would have the following effects: 16 GRUPO MEXICO

82 One Percentage Point (in millions) Increase Decrease Effect on total service and interest cost components $ 3.4 $ 2.7 Effect on the post-retirement benefit obligation $ 56.8 $ 45.6 The net projected benefit obligation in Ferromex related to the years ended December 31, 2006 and 2005 were not material. Foreign exchange - The Company s functional currency is the U.S. dollar. As required by local law, both the Peruvian Branch and MM maintain their books of accounts in Peruvian nuevos soles and Mexican pesos, respectively. Foreign currency assets and liabilities are remeasured into U.S. dollars at current exchange rates except for non-monetary items such as inventory, property, intangible assets and other assets which are remeasured at historical exchange rates. Revenues and expenses are generally translated at actual exchange rates in effect during the period, except for those items related to balance sheet amounts that are remeasured at historical exchange rates. Gains and losses from foreign currency remeasurement are included in earnings of the period. In mine division the gains and (losses) resulting from foreign currency transactions are included in Cost of sales (exclusive of depreciation, amortization and depletion) and amounted to ($5.8) million and ($8.8) million in 2006 and 2005, respectively. ITM and ITF, uses the current rate translation method to translate its financial statements into US dollars. The current rate method requires the translation of all assets and liabilities using the year-end exchange rate and the capital stock continues to be translated at historical exchange rates. Income statement components, including foreign exchange gains and losses recorded in Mexican pesos as a result of fluctuations in the rate of exchange between the Mexican pesos and the US dollars, are translated at the average exchange rate for the period. The effect of the exchange rate on the translation is reflected as a component of accumulated other comprehensive income within stockholders equity. The financial statements should not be construed as representations that Mexican pesos have been, could have been or may in the future be converted into US dollars at such rates or any other rates. ANNUAL REPORT 06 17

83 Relevant exchange rates used in the preparation of the financial statements were as follows: (Mexican pesos per one U.S. dollar) Current exchange rate at December 31 Ps Ps Weighted average exchange rate for the year ended Ps Ps Derivative instruments - The Company utilizes certain types of derivative financial instruments to enhance its ability to manage risks that exist as part of its ongoing business operations and to enhance its return on Company assets. Derivative contracts are reflected as assets or liabilities in the balance sheet at their fair value. The estimated fair value of the derivatives is based on market and/or dealer quotations and in certain cases valuation modeling. From time to time the Company has entered into copper and zinc swap contracts to protect a fixed copper and zinc price for portions of its metal sales, hedging contracts to fix power prices for a portion of its production costs, interest rate swap agreements to hedge the interest rate risk exposure on certain of its bank obligations with variable interest rates, currency swap arrangements to ensure Mexican peso/u.s. dollar conversion rates and certain barrier investment securities to enhance the return on its investments. Gains and losses related to copper and zinc hedges are included in net sales, gain and losses related to power costs are included in cost of sales, all other gains and losses on derivative contracts are included in Gain (loss) on derivative contracts in the statement of earnings. Asset Impairments - We evaluate our long-term mining and railway assets when events or changes in economic circumstances indicate that the carrying amount of such assets may not be recoverable. Our evaluations in case of mining segment are based on business plans that are prepared using a time horizon that is reflective of our expectations of metal prices over our business cycle. We are currently using a long-term average copper price of $2.00 per pound of copper and an average molybdenum price of $12.00 per pound, along with near-term price forecast, for 2007 through 2009, reflective of the current price environment, for our impairment tests. We use an estimate of the future undiscounted net cash flows of the related asset or asset group over the remaining life to measure whether the asses are recoverable and measure any impairment by reference to fair value. Should estimates of future copper and molybdenum prices decrease significantly, impairments could result. Investment in shares of associated and other unconsolidated companies - The Company owns 25% of the capital stock of FTVM (formerly Terminal Ferroviaria del Valle de México, S. A. de C. V.), the entity responsible for operating the Mexico City Terminal. The general guidelines for the opening of the investment of the Mexican railroad system stipulate that each of the companies associated with a terminal will own 25% of the capital of such terminal. The investment in shares of associated company is accounted for by the equity method. The financial position and results of operations of FTVM as of and for the years ended December 31, 2006 and 2005 are not material to the consolidated financial statements of the Company. On November 25, 2005, GMEXICO announced that the shareholders of its subsidiary ITM, agreed during the Regular General Annual Assembly to increase ITM s capital stock by $3,260 million pesos, through the emission of new Series C shares subscribed by companies GCarso and Sinca. Due to the said capital increase, ITM s new composition of shareholders consists of GMEXICO, with 75%, and GCarso and Sinca with the remaining 25%. The said transaction was previously notified to the Federal Antitrust Commission, in accordance with the applicable legislation. Likewise, on the same day GMexico reported that its ITM subsidiary, through its recently incorporated subsdiary ITF, acquired 100% of the capital stock of the company Ferrosur owned by Sinca and GCarso. In accordance with SFASB 141 Accounting Principle, it is necessary to have the Federal Antitrust Commission s final authorization before we can consolidated the accounting. Because of the aforementioned, and as long as the said authorization remains pending, investments in Ferrosur will be presented valued under the method of participation in GMEXICO s consolidated financial statements. Other comprehensive income - Comprehensive income represents changes in equity during a period, except those resulting 18 GRUPO MEXICO

84 from investments by owners and distributions to owners. During the fiscal years ended December 31, 2006 and 2005, the components of other comprehensive income (loss) was the additional minimum liability for employee benefit obligations and unrealized gain on equity securities and the adjustment necessary to adopt SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans. Related parties - The Company has entered into certain transactions in the ordinary course of business with parties that are controlling shareholders or their affiliates. These transactions include the lease of office space, air transportation and construction services and products and services relating to mining and refining. The Company lends and borrows funds among affiliates for acquisitions and other corporate purposes. These financial transactions bear interest. The Larrea family controls a majority of the capital stock of GMEXICO, and has extensive interests in other businesses, including oil drilling services, construction, aviation and real estate. The Company engages in certain transactions in the ordinary course of business with other entities controlled by the Larrea family relating to mining and refining services, the lease of office space, and air transportation and construction services. These transactions amounted to approximately $5.5 million and $3.7 million in 2006 and 2005, respectively. Additionally, in the third quarter of 2006 our Mexican subsidiary provided a short-term interest bearing loan of $10.6 million to Mexico Transportes Aereos, S.A. de C.V. ( MexTransport ) for the purchase of an airplane. MexTransport, a company controlled by the Larrea family, provides aviation services to our Mexican operations. Income per share - Basic income per ordinary share is calculated by dividing consolidated net loss of stockholders by the weighted average number of shares outstanding during the year. New accounting pronouncements - In September 2006, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No.108 (SAB 108) Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108 permits existing public companies to record the cumulative effect of initially applying this approach in the fiscal year ending after November 15, 2006 by recording necessary correcting adjustments to the carrying values of assets and liabilities as of the beginning of that year with the offsetting adjustment recorded to the opening balance of retained earnings. The adoption of this Staff Accounting Bulleting did not have a material impact on our financial reporting and disclosures. In September 2006 the FASB published SFAS No. 157 Fair Value Measurements, which provides enhanced guidance for using fair value to measure assets and liabilities. SFAS No. 157 establishes a common definition of fair value, provides a framework for measuring fair value under U.S. GAAP and expands disclosure requirements about fair value measurements. SFAS No. 157 is effective for financial statements issued in fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We are currently evaluating the impact, if any, the adoption of SFAS no. 157 will have on our financial reporting and disclosures. In June 2006, FASB issued FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes -an interpretation of FASB Statement No. 109 (FIN 48), which prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, We will adopt FIN 48 effective January 1, 2007 and we are currently evaluating the impact the adoption of FIN 48 will have on our financial reporting and disclosure requirements. In March 2006 the FASB published SFAS No. 156, Accounting for Servicing of Financial Assets an amendment of FASB Statement No This statement requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. The Board concluded that fair value is the most relevant measurement attribute for the initial recognition of all servicing assets and SFAS No. 156 permits, but does not require, the subsequent measurement of servicing assets and servicing liabilities at fair value. An entity that uses derivative instruments to mitigate the risks inherent in servicing assets and servicing liabilities is required to account for those derivative instruments at fair value. Under this statement, an entity can elect subsequent fair value measurement ANNUAL REPORT 06 19

85 of its servicing assets and servicing liabilities by class, thus simplifying its accounting and providing for income statement recognition of the potential offsetting changes in fair value of the servicing assets, servicing liabilities, and related derivative instruments. An entity that elects to subsequently measure servicing assets and servicing liabilities at fair value is expected to recognize declines in fair value of the servicing assets and servicing liabilities more consistently than by reporting otherthan-temporary impairments. The Board decided to require additional disclosures and separate presentation in the statement of financial position of the carrying amounts of servicing assets and servicing liabilities that an entity elects to subsequently measure at fair value to address concerns about comparability that may result from the use of elective measurement methods. SFAS No. 156 will be adopted by the Company as of the beginning of the fiscal year that begins after September 15, The Company believes that this statement will not have any material impact on its financial position or results of operations. In February 2006 the FASB published SFAS No. 155, Accounting for Certain Hybrid Financial Instruments an amendment of SFAS No. 133 and 140. This statement improves financial reporting by eliminating the exemption from applying statement 133 to interests in securitized financial assets so that similar instruments are accounted for similarly regardless of the form of the instruments. This statement also improves financial reporting by allowing a preparer to elect fair value measurement at acquisition, at issuance or when a previously recognized financial instrument is subject to a remeasurement (new basis) event, on an instrument-by-instrument basis, in cases in which a derivative would otherwise have to be bifurcated. Providing a fair value measurement election also results in more financial instruments being measured at what the Board regards as the most relevant attribute for financial instruments, fair value. SFAS 155 will be effective for all instruments acquired or issued after the beginning of an entity s first fiscal year that begins after September 15, The Company believes that this statement will not have any material impact on its financial position or results of operations. NOTE 2 - MARKETABLE SECURITIES: Commencing in 2006 the Company began making short term investments (90 days to 1 year). In 2006, the Company earned $9.3 million on these investments, which were recorded in interest income on the consolidated statement of earnings. The investments contain interest rates which are above the prevailing market rates. At December 31, 2006 the Company holds $290 million in investments of these types, as follows ($ in millions): (in millions) Investment Investment Book Value 3-month note, issued Dec. 12, 2006 with extensions every 3 months up to a maximum of 12 months, with an interest rate of 7%, a barrier range is established by a pool of Mexican and Peruvian bond issues. $ day note, maturing June 12, 2007 with an interest rate of 6%, with barrier range of $ and $ of SCC stock price, NYSE symbol PCU day note, maturing June 28, 2007 with an interest rate of 6%, with barrier range of $ and $ of SCC stock price, NYSE symbol PCU day note, maturing June 23, 2007 with an interest rate of 6%, with barrier range of $ and $ of SCC stock price, NYSE symbol PCU month note, issued Nov. 8, 2006 with an interest rate of 18%, with barrier range of $41.71 and $52.14 of SCC stock price, NYSE symbol PCU $ GRUPO MEXICO

86 Due to the short term nature of the investments, current value is deemed to approximate fair value. Certain of these investments are indexed to SCC common stock while others are indexed to certain bond pools. Both types of indexation clauses could cause the principal of the investment to be reduced if the established ranges are breached. These indexation clauses have been deemed to be bifurcated embedded derivatives and have been subject to valuation using a binomial model. At December 31, 2006, valuing the embedded derivatives at fair value resulted in a liability of $11.6 million. This liability has been included in other accounts payable, and is recorded as loss on derivative instruments in the income statement. NOTE 3 - INVENTORIES: December 31, (in millions) Metals Finished goods $ $ In process Subtotal Supplies Total $ $ NOTE 4 - INVESTMENTS: EThe amortized cost, gross unrealized gains and losses, and fair value of investment securities available-for-sale and other at cost investments are as follows: Gross unrealized Carrying (in millions) Cost holding gains value As of December 31, 2006 Available-for-sale: Equity securities $ 1.5 $ 1.5 Cost investments $ Total $ $ 1.5 $ As of December 31, 2005 Available-for-sale: Equity securities $ 22.8 $ 3.2 $ 26.0 Cost investments Total $ $ 3.2 $ ANNUAL REPORT 06 21

87 NOTE 5 - PROPERTY, PLANT AND EQUIPMENT: December 31, (in millions) Building and equipment $ 5,524.6 $ 5,756.8 Land, other than mineral Locomotives and freight cars Rails and structures Train yards and terminals Other railway equipment Construction in progress , ,471.6 Accumulated depreciation (3,444.0) (3,458.3) Property, plant and equipment - Net $ 4,405.8 $ 4,013.3 The average annual depreciation and amortization rates are as follows: December 31, 2006 and 2005 Buildings and improvements 4.0% Infrastructure 4.0% Automobiles and trucks 6.0% Mobile equipment 6.0% Depreciation expense for the years ended December 31, 2006 and 2005 amounted to $283.6 million and $263.7 million, respectively. NOTE 6 - CAPITALIZED MINE STRIPPING COSTS AND LEACHABLE MATERIAL: As of December 31, (in millions) Capitalized mine stripping cost $ $ Accumulated amortization (128.8) Capitalized mine stripping - Net $ $ As of December 31, (in millions) Capitalized leachable material $ $ Accumulated amortization (92.3) (41.9) Capitalized leachable material - Net $ $ GRUPO MEXICO

88 Effective January 1, 2006, SCC adopted EITF 04-6, ratified by the FASB, which states that stripping costs incurred during the production phase of a mine are variable production costs that should be included in the cost of inventory produced. Accordingly, SCC reversed $289.4 million of net cumulative capitalized stripping cost, recording a net charge of $166.6 million to retained earnings after recognition of workers participation and tax benefit of $122.8 million. Amortization of mine stripping is included in Depreciation, amortization and depletion and amounted to $67.5 million in Amortization of leachable material is included in Depreciation, amortization and depletion and amounted to $50.4 million and $5.7 million in 2006 and 2005, respectively. The Company s policy of deferring mine stripping costs (through 2005)and leachable material decreased operating costs by $19.3 million and $42.8 million in 2006 and 2005, respectively, as compared to what such amounts would have been if the Company expensed mine stripping costs and leachable material costs as incurred. NOTE 7 - CONCESSION TITLES: Ferromex has the following concession titles: Vía Troncal del Pacífico-Norte (North Pacific Railway), Vía Corta Ojinaga-Topolobampo and Vía Corta Nogales-Nacozari. Concessions are comprised of the following: (In millions) December 31, Concession: North-Pacific railroad track $ $ Nogales-Nacozari railroad track.2.2 Ojinaga-Topolobampo railroad track Overhauls Accumulated amortization (45.1) (40.7) Amortization charged to 2006 and 2005 income amounted to $5.2 million. $ $ The value of the North Pacific Railway concession title was determined by deducting the value of the tangible assets received, net of the liability from the Capital lease of 24 locomotives that Ferrocarriles Nacionales de México (FNM) had entered into with Arrendadora Internacional, S. A. de C. V., from the price paid for the Ferromex shares. The acquired assets and liabilities assumed include: - Tangible assets acquired under a purchase agreement executed for that purpose, which consist of locomotives, rolling stock and materials and accessories. - Rights of way, railway track, buildings and maintenance installations. - 25% of the shares of FTVM, the company in charge of operating the Mexico City Railway Terminal. The concession grants Ferromex the right to render freight transportation services for an initial 50-year term (beginning on February 19, 1998), on an exclusive basis for 30 years, renewable for an additional 50 years subject to certain conditions, using the general-purpose railway track and public use assets of the North Pacific and the Ojinaga-Topolobampo Railways. Ferromex is entitled to use, and has the obligation to maintain in good condition, the rights of way, railroad tracks, buildings and maintenance facilities. Title to those assets and facilities, however, lies with the Federal Mexican Government and all rights over those assets must be returned to the Federal Mexican Government upon termination of the concession term. On November 25, 2005, GMEXICO announced that the shareholders of its subsidiary ITM, agreed during the Regular General Annual Assembly to increase ITM s capital stock by $3,260 million pesos, through the emission of new Series C shares subscribed by companies GCarso and Sinca. Due to the said capital increase, ITM s new composition of shareholders consists of GMexico, with 75%, and GCarso and Sinca with the remaining 25%. The said transaction was previously notified to the Federal Antitrust Commission, in accordance with the applicable legislation. Likewise, on the same day GMEXICO reported that its ITM subsidiary, through its recently incorporated subsdiary Infraestructura y Transportes Ferroviarios, S. A. de C. V. (ITF), acquired 100% of the capital stock of the company Ferrosur owned by Sinca and GCarso. This settlement generated a net income of $84.9 million. GMEXICO believes such an acquisition will strengthen Mexico s transport system by pro- ANNUAL REPORT 06 23

89 moting competition in the load transport market in Mexico. In November 16, 2006, the Federal Antitrust Commission denied the merger between Ferrosur and ITF. As result ITM and ITF start a legal proceeding to revoke the above mentioned ruled proposed by the Federal Antitrust Commission. As of the date of these financial statement the outcome of this legal proceeding is uncertain. In accordance with SFASB 141 Accounting Principle, it is necessary to have the Federal Antitrust Commission s final authorization before we can consolidated the accounting. Because of the aforementioned, and as long as the said authorization remains pending, investments in Ferrosur will be presented valued under the method of participation in GMEXICO s consolidated financial statements. NOTE 8 - INTANGIBLE ASSETS: As of December 31, (in millions) Mining concessions $ $ Mine engineering and development studies Goodwill Amortization (26.1) (23.3) $ $ NOTE 9 - MAINTENANCE AND LEASING AGREEMENTS: GFM has executed four maintenance and repairs agreements with GE Transportation System México, S. A. de C. V. ( GETS ) and an agreement with Alstom Transporte, S. A. de C. V. ( AL- STOM ), and another with EMD Locomotive Company de México, S.A. de C.V. ( EMDL ) which includes major repairs to its locomotives, as follows: Number of Term Supplier locomotives Initial Date Expiration Date GETS 46 February 2006 February 2012 GETS 150 February 2006 February 2012 GETS 56 February 2006 February 2012 GETS 135 May 1999 June 2026 ALSTOM 120 November 2004 October 2009 EMDL 15 June 2006 June 2026 Total GRUPO MEXICO

90 GFM is entitled to cancel the maintenance agreements, in which case, it would assume the respective cost of early termination; with respect to GETS agreements that will expire in February 2012, it is not foreseen that GFM will decide an early termination thereof. Negotiations to define the terms of new maintenance contracts are under way. The GETS agreement expiring in June 2026 provides that GFM will not be able to cancel this agreement before June 30, 2009; it cannot be cancelled until July 1, 2009 and a penalty would have to be paid ranging from $2.0 million in 2009 to $0.1 million before June As regards to 60 EVO locomotives states that GFM shall not be able to cancel before June 30, 2010; it shall only be cancelled as of July 1, 2010 paying a penalty from $2.7 million in the year 2010 to $0.2 million in the year ALSTOM agreement specifies that in case of an early termination, the cost for GFM would be: (a) 100% of the maintenance services, extraordinary works and cleaning services, rendered and not settled; (b) starting from the second year of operation, a $80 charge for expenses incurred in the termination of agreements with personnel assigned to ALSTOM and the acquisition by GFM of materials. The EMDL agreement due on June, 2026 shall only be terminated in advance as of July 2011, paying in account of termination in advance the amount resulting from 15 months of invoice arising from maintenance fees, amount which shall be reduced in a month per year. Maintenance and repairs - With respect to the locomotives maintenance and repair work, pursuant to the agreements, GFM must make monthly payments based on certain fees that include mainly preventive and corrective maintenance. These fees are recorded in results of operations at the time such services are received. Overhauls - Overhauls are capitalized to property and equipment as incurred. NOTE 10 - LONG-TERM DEBT: At December 31, 2006 and 2005, the Company was in compliance with the guarantees and restrictions established by the debt agreements which include financial covenants and restrictions on contracting additional debt and on certain capital expenditures. The consolidated debt was as follows: Amount in (in millions) MM $ $ GFM/ITM SCC 1, Total notes and interest payable 2, ,617.6 Less - Current portion of long-term debt (188.0) (69.3) Long-term debt $ 1,878.5 $ 1,548.3 ANNUAL REPORT 06 25

91 The maturities of notes payable as of December 31, 2005 were as follows: Maturity Amount (in millions) 2007 $ and later 1,338.2 $ 2,066.5 SCC / Mining segment Long term debt: As of December 31, (in millions) SCC: 6.375% Notes due 2015 ($200 million face amount, less unamortized discount of $0.9 million and $1.0 million at December 31, 2006 and 2005, respectively) $ $ % Notes due 2035 ($1,000 million face amount, less unamortized discount of $16.0 million and $5.2 million at December 31,2006 and 2005, respectively) % Mitsui credit agreement due 2013 (5.92% at December 31, 2005) MM: 8.25% Yankee bonds - Series A due % Yankee bonds - Series B due Total debt 1, ,172.1 Less, current portion (10.0) (10.0) Total long-term debt $ 1,518.1 $ 1,162.1 In 1998, MM issued $500 million of unsecured debt, which are referred to as Yankee bonds. These bonds were offered in two series: Series A for $375 million, with an interest rate of 8.25% and a 2008 maturity, and Series B for $125 million, with an interest rate of 9.25% and a GRUPO MEXICO

92 maturity date. During 2006 and 2005, the Company repurchased $23.3 million and $143.0 million, respectively of the Series A bonds. In connection with this purchase the Company paid a premium of $1.1 million and $8.6 million, in 2006 and 2005, respectively, which is included in the consolidated statement of earnings on the line Loss on debt prepayments. The bonds contain a covenant requiring MM to maintain a ratio of EBITDA to interest expense of not less than 2.5 to 1.0 as such terms are defined by the facility. At December 31, 2006, MM is in compliance with this covenant. In 1999, SCC entered a $100 million, 15-year loan agreement with Mitsui. The interest rate for this loan is the Japanese LIBO rate plus 1.25% (Japanese LIBO for this loan at December 31, 2006 was 5.35%). The Mitsui credit agreement is collateralized by pledges of receivables on 31,000 tons of copper per year. The Mitsui agreement requires SCC to maintain a minimum stockholders equity of $750 million and a specific ratio of debt to equity. Reduction of Grupo Mexico s direct or indirect voting interest in SCC to less than a majority would constitute an event of default under the Mitsui agreement. At December 31, 2006, SCC is in compliance with these covenants. In 2005, SCC prepaid $600 million Citibank credit facility. In connection with the prepayment of this facility, SCC wrote off $10.2 million of deferred financing costs which is recorded in the consolidated statement of earning on the line Interest expense. In January 2005, SCC signed a $200 million credit facility with a group of banks led by Citibank, N.A. Proceeds of this credit facility were used to prepay $199 million the outstanding bonds of the Company s Peruvian bond program. SCC capitalized $2.8 million of costs associated with this facility. SCC paid a prepayment penalty of 1%, or $2.0 million, to the Peruvian bondholders. Additionally, SCC wrote off $2.3 million of previously capitalized bond issuance cost. The $2.0 million penalty and the $2.3 million amortization of bond issuance costs are included in the earnings statement under Loss or debt prepayments and Interest expense, respectively. On July 28, 2005 this credit facility was repaid and SCC wrote off $2.5 million of deferred financing cost. On July 27, 2005 SCC issued $200 million 6.375% Notes due 2015 at a discount of $1.1 million and $600 million 7.5% Notes due 2035, at a discount of $5.3 million. The notes are senior unsecured obligations of SCC. The Company capitalized $8.8 million of costs associated with this facility and are included in Other assets, net, non-current on the Consolidated balance sheet. The net proceeds from the issuance and sale of the notes were used to repay outstanding indebtedness of the Company s Peruvian and Mexican Operations, under its $200 million and $600 million ($480 million outstanding) credit facilities, respectively, and the balance was used for general corporate purposes. SCC filed a Registration Statement on Form S-4 with respect to these Notes on October 28, On January 3, 2006 the Company completed an exchange offer for $200 million, 6.375% Notes due 2015 and $600 million, 7.5% Notes due In the exchange offer, $197.4 million of the 6.375% old notes due 2015 were tendered in exchange for an equivalent amount of new notes and an aggregate of $590.5 million of the 7.5% old notes due 2035 were tendered in exchange for an equivalent amount of new notes. The new notes have been registered under U.S. securities law. The indentures relating to the notes contain certain covenants, including limitations on liens, limitations on sale and leaseback transactions, rights of the holders of the notes upon the occurrence of a change of control triggering event, limitations on subsidiary indebtedness and limitations on consolidations, mergers, sales or conveyances. All of these limitations and restrictions are subject to a number of significant exceptions, and some of these covenants will cease to be applicable before the notes mature if the notes attain an investment grade rating. At December 31, 2006 SCC is in compliance with these covenants. On May 9, 2006, SCC issued an additional $400 million 7.5% notes due These notes are in addition to the $600 million of existing 7.5% notes due 2035 that were issued in July The current transaction 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 +315 basis points over the 30-year U.S. Treasury bond. The notes are Investment Grade rated Baa2 by Moody s, BBB- by Standard & Poor s, and BBB- by Fitch. The notes were issued at a discount of $10.8 million. SCC capitalized $3.2 million of cost associated with this facility and is included in Other assets, net non-current on the consolidated balance sheet. SCC expect to use proceeds from the May 2006 issuance in its expansion programs, which includes construction of a new SX/EW plant at the Cananea mine, the initial cost to develop the Los Chancas and Tía María projects, the remaining investment to complete the Ilo smelter modernization and perhaps for a possible expansion of the productive capacity of the Ilo smelter and refinery. The notes issued in July 2005 and the new notes issued in May 2006 are treated as a single series of notes under the indenture, including for purposes of covenants, waivers and amendments. SCC has filed a registration statement with the Securities and Exchange Commission, which registration statement has become effective, to exchange the new notes for notes registered under the Securities Act of 1933, as amended. ANNUAL REPORT 06 27

93 Aggregate maturities of the outstanding borrowings at December 31, 2006, are as follows: GFM / Railway segment Long-term debt is comprised of the following: Year Principal Due (in millions) December 31, (in millions) $ Thereafter 1,345.0 Total $ 1,545.0 Total debt maturities do not include the debt discount valuation account of $16.9 million. At December 31, 2006 and 2005, other assets included $7.3 million and $7.4 million, respectively, held in escrow accounts as required by the Company s loan agreements. The funds are released from escrow as scheduled loan repayments are made. At December 31, 2006 and 2005, the balance of capitalized debt issuance costs was $12.3 million and $10.2 million, respectively. Amortization charged to interest expense was $1.6 million and $4.1 million in 2006 and 2005, respectively. Loan from BNP PARIBAS ( BNP ) and Export-Import Bank ( EXIM ), subject to an interest at the LIBOR rate for three months plus 0.09%, maturing on July 25, 2013 (1) $ 31.3 $ 35.9 Loan from Bank of America N.A. (BOFA), with the guarantee of EXIM, subject to an interest at the LIBOR rate for six months plus 0.1% maturing on August 2009 (2) Loan from HSBC Bank plc and Export Development Canada ( EDC ), subject to an interest at the LIBOR rate for six months plus 0.08% maturing on November 26, 2014 (3) 22.9 Direct loan HSBC subject to an interest at the LIBOR rate for six months plus 0.40% maturing on November 26, 2014 (3) 3.9 Loan from Banco Inbursa, S. A., at the TIIE rate for 28 days plus 0.91%, maturing in 2010 (4) Debt paper ( Certificados bursátiles ) (5) Loan from Banamex, S. A., at the TIIE rate for 28 days plus 0.15% to 0.60%, maturing on April 23, 2007 (6) Current portion of long-term debt (178.0) (59.3) Long - term debt $ $ GRUPO MEXICO

94 Long-term debt matures as follows: (in millions) Maturity $ $ and thereafter $ $ (1) In order to secure the loans from BNP and EXIM in December 30, 2004 and January 27, 2005 and irrevocable trust guarantee was set up, with Banco Nacional de México, S.A. as the trustee, GFM as the trustor, EXIM as the trust beneficiary in the first instance and BNP as trust beneficiary in the second instance, for which GFM yielded to the trust the rights to 25 acquired locomotives that gave rise to these loans, as well as the titles and interest on the guarantees provided to the trustee. (2) In order to secure the loans from BOFA EXIM, an irrevocable trust guarantee was set up, with Banco Nacional de México S.A. as the trustee, the Company as the trustor, EXIM as the trust beneficiary in the first instance and BOFA as trust beneficiary in the second instance, for which GFM yielded to the trust the rights to 50 acquired locomotives that gave rise to these loans, as well as the titles and interest on the guarantees provided to the trustee. (3) Direct loans from HSBC Bank pcl and EDC and HSBC, respectively hired for the purchase of fifteen SD70ACe locomotives, which are pledged for said loans. (4) Banco Inbursa S.A. loan. The outstanding balance shall be paid in two payments for same amounts equal to 50% each, being the first payment on December 31, 2009 and the following on December 31, ANNUAL REPORT 06 29

95 (5) Debt paper program ( certificados bursátiles ): GFM has a program authorized by the Mexican SEC to issue debt paper ( certificados bursátiles ) in the aggregated amount of $5 million (mexican pesos), during a period of four years, starting on December 10, As of December 31, 2006 and 2005, GFM had issued three debt papers ( certificados bursátiles ) under this program with the following features: (in millions) December 31, Issuance Transaction Maturity Date Date Rate First issuance Dec Dec CETES 91 days % $ 46.0 $ 46.7 Second issuance Dec Dec TIIE 28 days % 46.7 Third issuance Mar Sep TIIE 28 days+ 1.55% Reopening of first Issuance Mar Dec CETES 91 days % $ $ (6) Bridge loan with Banamex, S.A., for the purchase of 60 locomotives. The documents to turn it into long-term loan with approximately 85% of loan guarantee on Exim Bank are being prepared, and it is expected to be concluded for the first quarter of the year Acquired locomotives shall be pledged to secure said loans. The loans and the debt paper ( certificados bursátiles ) establish certain covenants for the Company, which at December 31, 2006 had been fulfilled. The average annual LIBOR rate that matured on December 31, 2006 and 2005 were: 6- month LIBOR: 5.27%, 3.76%; 3-month LIBOR: 5.19%, 3.56%; and 28-day TIIE: 7.51%, 9.61%, respectively. AMC and Asarco Interest paid by Asarco during 2005 were $19.7 million. NOTE 11 - STOCKHOLDERS EQUITY: At December 31, 2006 and 2005, paid common stock consists of 2,576,862,500 and 2,594,698,885, respectively, fully paid and subscribed shares, corresponding to fixed capital Series B Class I. At the April 27 and 29, 2005 Extraordinary Stockholders Meetings, the stockholders agreed; to a split of the 865,000,000 shares that compose the Series B, representing the company s capital 30 GRUPO MEXICO

96 at the rate of three new shares for each of the shares currently in circulation, after which, the capital stock is represented by 2,595,000,000 shares, Series B consists of ordinary voting stock always representing 100% of all Class I and Class II voting stock. At all times, at least 51% of the shares comprising this Series must be subscribed by private individuals or companies considered as Mexican investors, and established a repurchased owned shares reserve a mounting by $2,240 millions (Mexican pesos) which $112 millions are used to included as treasury stock of Grupo México for future sales to our employees. Variable capital is limited to ten times the amount of the minimum fixed capital. At an Extraordinary Stockholders Meeting it was agreed to change the social regime of Grupo México, S.A. de C.V. to Sociedad Anónima Bursatil de Capital Variable due to the amendments to the Securities Market Law, as result of which the Company now operates as Grupo México, S.A.B. de C.V. At an Ordinary Stockholders Meeting held on April 28, 2006 the stockholders decreed a dividend amounting to $563.9 million ($6,108.0 mexican million pesos). The paids were realized shown as follows: Amount in millions Mexican pesos Date of Mexican pesos per share January 27, 2006 $ 1,556.8 $ 0.60 April 28, , July 14, , October 27, , $ 6,108.0 At an Ordinary Stockholders Meeting held on April 29, 2005 the stockholders decreed a dividend amounting to $219.3 million ($2,387 mexican million pesos). Dividends paid are not subject to income tax if paid from the Net Tax Profit Account (CUFIN). Any dividends paid in excess of this account are subject to a tax equivalent to 40.84%, 38.89% or 37.50% depending on whether paid in 2006, 2007 or 2008, respectively. The tax is payable by the Company and may be credited against its income tax in the same year or the following two years. Dividends paid from previously taxed profits are not subject to tax withholding or additional tax payment. In the event of a capital reduction, any excess of stockholders equity over capital contributions, the latter restated in accordance with the provisions of the Income Tax Law, is accorded the same tax treatment as dividends. At December 31, 2006 and 2005, the CUFIN and capital contributions account amounted to $778.9 million and $304.4 million, respectively. Directors Stock Award Plan: SCC established a non-vested stock award compensation plan for certain directors who are not compensated as employees of the Company. Under this plan, participants will receive 400 shares of common stock upon election and 400 additional shares following each annual meeting of stockholders thereafter. 200,000 shares of Southern Copper common stock have been reserved for this plan. At December 31, 2006 and 2005, 67,500 and 62,400 shares, respectively, have been awarded under this plan. Stock Incentive Plan: The Company s Stock Incentive Plan expired on January 1,2006. There were no outstanding stock options under this plan as of December 31, 2006 and Employee Stock Purchase Plan: Grupo Mexico offers eligible employees a stock purchase plan (the Employee Stock Purchase Plan ) through a trust that acquires shares of Grupo Mexico for future sales to our employees, subsidiaries and certain affiliated companies. Sales are at the approximate fair market value. Every two years employees will be able to withdraw shares until 50% of the shares paid. The employees will pay for shares purchased through monthly payroll deductions over the eight year period of the plan. At the end of the 8 year period, Grupo Mexico will grant the participant a bonus of 1 share for every 10 shares purchased by the employee. If Grupo Mexico pays dividends on shares during the eight year period, the participant will be entitled to receive the dividend in cash for all shares that have been fully purchased and paid as of the date that the dividend is paid. If the participant has only partially paid for shares, the entitled dividends will be used to reduce the remaining liability owed for purchased shares. ANNUAL REPORT 06 31

97 Executive Stock Purchase Plan: Grupo Mexico also offers a stock purchase plan for certain members of executive management. Under this plan, participants will receive incentive cash bonuses which are used to purchase up to 250,000 shares of Grupo Mexico over an nine year period. In 2006 and 2005, participants received 100,000 and 150,000 shares, respectively, and pursuant to FAS 123R, the Company recorded, net of tax, $0.2 million, in compensation expense in both periods. Treasury Stock: Included in treasury stock are shares of SCC common stock carried at cost. In addition, included in treasury stock are shares of the Company s principal shareholder, Grupo Mexico. At December 31, 2006 and 2005 treasury stock holds 404,112 shares and 409,312 shares of Southern Copper Corporation common stock with a cost of $4.5 million for both periods. At December 31, 2006 and 2005 treasury stock holds 148,313,029 shares and 142,501,103 shares with a cost of $104.9 million and $87.5 million of Grupo Mexico, respectively. NOTE 12 - INCOME TAX, ASSET TAX AND WORKERS PARTICIPATIONS: The results of the Company s subsidiaries are consolidated for financial reporting purposes but are not includible in its tax filings on a consolidated basis. The following tables combine the separate provisions for income tax that have been determined for each company in accordance with SFAS No. 109 Accounting for Income Taxes. The components of the provision (benefit) for current and deferred income tax in 2006 and 2005 were as follows: FOR THE YEAR ENDED DECEMBER 31, 2006 (in millions) Mexico USA Peru Total Income tax: US Federal and state: Current $ ($ 4.0) $ Deferred $ $ 18.8 $ Income tax: Current $ $ $ 1,053.8 Deferred (30.4) (29.6) (60.0) Total income tax $ $ $ $ 1,134.1 Asset tax $ 1.2 $ 1.2 Total provision for income tax $ $ $ $ 1, GRUPO MEXICO

98 FOR THE YEAR ENDED DECEMBER 31, 2005 (in millions) Mexico USA Peru Total Income tax: US Federal and state: Current $ 1.5 $ 13.4 $ 14.9 Income tax: Current $ $ $ Deferred (20.3) (17.1) (37.4) $ $ $ Total income tax $ $ 1.5 $ $ Asset tax $ 2.6 $ 2.6 Total provision for income tax $ $ 1.5 $ $ Temporary differences and carry-forwards that give rise to deferred tax liabilities, assets and related valuation allowances at December 31, were: December 31, (in millions) Current: Reserves - Net $ $ 65.3 Inventories (4.2) (34.2) Other Net current deferred tax asset (liability) $ $ 32.4 Non-current: Alternative minimum tax credit carry-forward $ 29.2 $ 32.2 Foreign tax credit carry-forward Property, plant, equipment and concessions (441.7) (224.6) Deferred charges (77.4) (69.4) Tax loss carry-forwards 2.7 Recoverable asset tax 0.3 Reserves Other 95.7 (41.1) Valuation allowance for deferred tax assets (81.2) Net non-current deferred tax liability ($ 196.0) ($ 298.0) Total net deferred tax liability ($ 86.2) ($ 265.6) MEXICO In accordance with Mexican tax law, MM is subject to asset tax and income tax, which take into consideration the taxable and deductible effects of inflation. As a result of the amendments to the Income Tax Law approved on November 13, 2004, the income tax rate will be 28% as from Additionally starting 2005 there is a change on the tax treatment of the purchases of the year, as the cost of sales will be deductible and the purchases will not be deductible any longer. The deduction of the employees statutory profit sharing amount and the obligation to withhold taxes on dividends paid to individuals and foreign residents was also eliminated. Asset tax is calculated by applying 1.8% to the Company s asset position, as defined in the law, and is payable only to the extent that it exceeds the income tax payable for the same period. If in any year asset tax exceeds the income tax payable, the asset tax payment for such excess may be reduced by the amount by which the income tax exceeded asset tax in the three preceding years and any required payment of asset tax is creditable against the excess of the income tax over asset tax of the following 10 years. MM and its subsidiaries obtained authorization to file a consolidated income and asset tax return. Thus, the Company prepares a consolidated income tax return, including all of its subsidiaries. Additionally, MM subsidiaries file individual income tax returns. The Mexican Income Tax Law approves the tax consolidation to 100% starting 2005 as part of the amendments to the Income Tax Law of the parent s equity interest. Asset tax paid that is expected to be recoverable as an advance payment of income tax and is presented in the balance sheet together with deferred income tax. ANNUAL REPORT 06 33

99 SCC/USA AND PERÚ U.S. Tax Matters At December 31, 2006, the foreign tax credit carryforward available to reduce possible future U.S. income tax amounted to approximately $102.4 million, expiring in 2012 through No foreign tax credit carryforwards expired in 2006 or The minimum tax credit carryforward available to reduce possible future U.S. income tax, which was $29.2 million at December 31, 2006, is not subject to expiration. Peruvian Tax Matters- The Company obtains income tax credits in Peru for value-added taxes paid in connection with the purchase of capital equipment and other goods and services, employed in its operations and records these credits as a prepaid expense. Under current Peruvian law, the Company is entitled to use the credits against its Peruvian income tax liability or to receive a refund. The carrying value of these Peruvian tax credits approximates their net realizable value. In accordance with a 1996 agreement with the Peruvian government, income generated from the SX/EW operations is taxed at a fixed rate of 30% through the year Out of period adjustement - During 2006, SCC completed a comprehensive deferred tax analysis. This analysis was performed as of December 31, 2005, 2004 and The result of this analysis was an increase in deferred tax liabilities of $85.4 million and a release of valuation allowance of $81.2 million. The net effect of this analysis is $4.2 million. In this analysis, SCC trued up its Peru and U.S. gross temporary differences and then measured its U.S. deferred taxes by applying the regular statutory tax rate (35%). This recalculation exercise resulted in cumulative additional deferred tax liabilities equaling $85.4 million as of December 31, As a second component to the comprehensive deferred tax analysis, SCC undertook a scheduling exercise of certain carryforward credits relating to U.S. minimum tax and foreign tax credits. Prior to this scheduling exercise, SCC had created a valuation allowance related to US minimum tax and foreign tax credits. The scheduling exercise component of the comprehensive analysis resulted in SCC releasing the December 31, 2004 cumulative valuation allowance of $81.2 million. The combined net effect of the deferred tax analysis was an increase in the total income tax expense of $4.2 million. This adjustment is being recorded as part of income tax expense in SCC accounted for this adjustment as an out of period adjustment as it falls below the materiality levels established in the Company s SAB 108 analysis. Workers participation - The Company s operations in Peru and Mexico are subject to statutory workers participation. In Peru, the provision for workers participation is calculated at 8% of pre-tax earnings. The current portion of this participation, which is accrued during the year, is based on Branch s taxable income and is distributed to workers following determination of final results for the year. In Mexico, workers participation is determined using the guidelines established in the Mexican Income Tax Law at a rate of 10% of pre-tax earnings as adjusted by the tax law. The provision for workers participation is included in Cost of sales (exclusive of depreciation, amortization and depletion) in the consolidated statement of earnings. For the years ended December 31, 2006 and 2005, workers participation expense was $288.4 million and $231.5 million, respectively. In May 2005, the Mexican Supreme Court rendered a decision that changed the method of computing the amount of statutory workers profit sharing required to be paid by some Mexican companies, including the Company s Mexican subsidiary. The Supreme Court s ruling in effect prohibited the application of net operating loss carryforwards in computing the income used as the base for determining the workers profit sharing amounts. As a result MM recognized in its 2005 results of operations a charge of $36.3 million for workers profit sharing related to The deferred employees statutory profit sharing - Mexican law requires enterprises to pay their employees 10% of taxable profit each year. The profit sharing arrangement has deferred tax consequences to the extent that basis differences exist between financial reporting and income tax reporting. Prior years losses are not deductible in calculating profit sharing. Starting 2006 profit sharing expense is deductible in arriving at taxable income. 34 GRUPO MEXICO

100 The components of the net deferred employee s statutory profit sharing liability are as follows as of December 31: For the year ended December 31, (in millions) Current: Non-deductible reserves $ 44.7 $ 19.1 Inventories (8.6) (11.8) Other (7.4) Total current Long-term: Property, plant and equipment (53.2) (50.2) Deferred charges (27.5) (23.8) Other (23.3) 4.2 Total long-term (104.0) (69.8) Total deferred employees statutory profit sharing liability ($ 75.3) ($ 62.5) NOTE 13 - ASSET RETIREMENT OBLIGATION: On January 1, 2003, SCC adopted SFAS No. 143, Accounting for Asset Retirement Obligations, which established a uniform methodology of accounting for estimated reclamation and abandonment costs. The cumulative effect of the change of accounting principle, net of income tax was a charge to income of $1.5 million. As part of this change SCC recorded an asset retirement obligation of $4.9 million and increased net property $2.5 million. This adoption established the liability for a portion of the Company s long-lived assets in Peru, and includes a dam on the Torata River, close to the Cuajone mine and the SX/EW facility. In 2005 the SCC added an estimated asset retirement obligation for its mining properties in Peru, as required by the Mine Closure Law, enacted in 2003 and regulated in In accordance with the law a conceptual mine closure plan, without costs, was submitted to the Peruvian Ministry of Energy and Mines ( MEM ) in August The plan is subject to review by MEM in 45 days. After the MEM review SCC will have 90 days to prepare and resubmit the mine closure plan, including costs, which will then be subject to MEM approval and open to public discussion and comment in the area of the company operations. As of the end of February 2007, SCC is ANNUAL REPORT 06 35

101 still awaiting MEM s initial review. SCC has made an estimated provision for this liability in its financial statements, but believes that this estimate should be viewed with caution, pending final approval of the mine closure plan, expected later in The closure cost recognized for this liability includes the estimated cost required at the Peruvian operations, based on the Company s experience and includes cost at the Ilo smelter, the tailing disposal, dismantling of the Toquepala and Cuajone concentrators, shops and auxiliary services. In this connection we recorded an additional asset retirement liability in 2005 of $5.2 million for this new law and increased net property $4.6 million. The following is a reconciliation of the asset retirement obligation for the two years ended December 31, 2005 and 2006 (in millions): (in millions) Balance January 1, 2005 $ 5.6 Additions, changes in estimates 5.2 Accretion expense 0.4 Balance, December 31, Accretion expense 1.0 Balance, December 31, 2006 $ 12.2 NOTE 14 - BUSINESS SEGMENT: The Company applies SFAS No. 131, Disclosure About Segments of an Enterprise and Related Information. This statement establishes standards for reporting information about operating segments and related disclosures about products and services, geographic areas and major customers. The Company s segments are organized using the management approach by industry and geographical region, resulting in four primary reportable segments: MM, Asarco, SCC and ITM. The MM (open pit and underground operations), SCC and Asarco segments include integrated copper extraction, smelting and refining operations mainly in Mexico, Peru and the USA, respectively. The SCC segment includes integrated copper extraction, smelting and refining operations in Peru. ITM carries out railway transportation activities mainly in Mexico. 36 GRUPO MEXICO

102 Information by segments is shown in the same format used by management of the Company to evaluate each business. An operating segment is defined as a component of the Company dedicated to business activities from which the Company generates income and incurs costs and expenses, with respect to which information for decision-making is prepared and in respect of which management evaluates the allocation of resources periodically. The accounting policies of the segments are described in the summary of significant accounting policies. Some assets, costs and expenses, such as real estate, furniture and equipment and other assets, non-assignable corporate expenses, depreciation and amortization are not distributed to the segments and have been included in the column of non-operating companies. The Company assesses the performance by segment based on the operating income or loss (before these expenses). The more significant data by business segment in 2006 and 2005 (in millions) were as follows: Total Consolidation Total 2006 MM AMC SCC mining segment GFM eliminations consolidated Sales of product and services $ 2,651 ($ 395) $ 3,204 $ 5,460 $ 928 ($ 29) $ 6,359 Operating income (loss) $ 1,230 ($ 37) $ 1,855 $ 3,048 $ 227 $ 9 $ 3,284 Administrative expenses $ 52 $ 7 $ 36 $ 95 $ 43 $ 1 $ 139 Depreciation and amortization $ 189 $ 86 $ 275 $ 67 $ 1 $ 343 Comprehensive financing result $ 26 $ 13 $ 9 $ 48 $ 27 ($ 31) $ 44 Net income (loss) $ 872 ($ 1,531) $ 2,038 $ 1,379 $ 161 ($ 10) $ 1,530 Total assets, not including investment in shares of associated companies $ 3,334 ($ 284) $ 3,716 $ 6,766 $ 1,414 $ 456 $ 8,636 Total liabilities $ 995 $ 830 $ 2,335 $ 4,160 $ 742 ($ 1,299) $ 3,603 Net investment in property, plant and equipment $ 1,901 $ 1,637 $ 3,538 $ 852 $ 15 $ 4,405 Capital expenditures ($ 203) ($ 253) ($ 456) ($ 250) ($ 3) ($ 709) ANNUAL REPORT 06 37

103 Total Consolidation Total 2005 MM Asarco and AMC SCC mining segment GFM eliminations consolidated Sales of product and services $ 1,963 $ 311 $ 2,180 $ 4,454 $ 764 ($ 29) $ 5,189 Operating income (loss) $ 796 $ 7 $ 1,282 $ 2,085 $ 181 ($ 23) $ 2,243 Administrative expenses $ 47 $ 30 $ 34 $ 111 $ 41 $ 3 $ 155 Depreciation and amortization $ 201 $ 23 $ 77 $ 301 $ 68 $ 369 Comprehensive financing result $ 57 $ 27 ($ 6) $ 78 $ 39 ($ 3) $ 114 Net income (loss) $ 572 ($ 969) $ 1,400 $ 1,003 $ 110 ($ 50) $ 1,063 Total assets, not including investment in shares of associated companies $ 2,877 ($ 73) $ 3,199 $ 6,003 $ 1,179 ($ 17) $ 7,165 Total liabilities $ 1,000 ($ 9) $ 1,742 $ 2,733 $ 611 ($ 254) $ 3,090 Net investment in property, plant and equipment $ 1,857 $ 1,469 $ 3,326 $ 676 $ 11 $ 4,013 Capital expenditures ($ 149) ($ 322) ($ 471) ($ 91) $ 3 ($ 559) The Company made direct sales to customers and rendered railway transportation services in the following areas amounts in million: 2006 Country MM SCC GFM Eliminations TOTAL United States $ 1,225 $ 621 ($ 375) $ 1,471 Mexico $ 936 (69) 1,994 Europa 371 1,341 1,712 China and Asia Latin America, except Mexico and Peru Australia (2) 155 Grand total $ 2,651 $ 3,218 $ 936 ($ 446) $ 6, GRUPO MEXICO

104 2005 Country MM ASARCO SCC GFM Eliminations TOTAL United States $ 974 $ 354 $ 429 $ 1,757 Mexico $ 768 ($ 53) 1,653 Europa China and Asia Latin America, except Mexico and Peru Australia 3 3 Peru (23) 64 Bahamas 2 2 Grand total $ 1,963 $ 354 $ 2,180 $ 768 ($ 76) $ 5,189 NOTE 15 - DERIVATIVE INSTRUMENTS: The Company occasionally uses derivative instruments to manage its exposure to market risk from changes in commodity prices, interest rate and exchange rate risk exposures and to enhance return on assets. The Company generally does not enter into derivative contracts unless it anticipates a future activity that is likely to occur that will result in exposing the Company to market risk. Copper and zinc swaps: Transactions under these metal price protection programs are not accounted for as hedges under SFAS No. 133 and are adjusted to fair market value based on the metal prices as of the last day of the respective reporting period with the gain or loss recorded in net sales on the consolidated statement of earnings. In 2006, the Company changed its accounting classification policy to recognize gains or losses on metal price derivatives in net sales. The Company believes that this income statement classification reflects better the intention of this price protection program. Before 2006, the change in the fair market value of our derivative instruments was accounted for in a separate non-operating income statement line item. Prior-year gains and losses have been reclassified to conform to the 2006 presentation. During 2006 and 2005 the Company entered into short copper swap contracts to protect a portion of its copper production. In 2006 the Company entered into swap contracts for 384,500 metric tons of its copper production for future sales at a weighted average price of cents per pound and during 2005 the Company entered swap contracts for 299,457 metric tons of copper at a weighted average price of cents per pound. Related to the settlement of these copper swap contracts the Company recorded losses of $275.9 million and $23.5 million in 2006 and 2005, respectively. These losses were recorded in net sales on the consolidated statement of earnings. Also, these losses were recorded in net earnings in operating activities of the consolidated statement of cash flow. In addition, the Company entered into a long zinc swap contract to protect the cost of a portion of the zinc concentrates purchases during the recovery from a fire at the San Luis Potosí zinc refinery. Related to the settlement of this zinc swap contract the Company recorded a loss of $0.2 million in This loss was recorded in net sales on the consolidated statement of earnings. Also, this loss was recorded in net earnings in operating activities of the consolidated statement of cash flow. At December 31, 2006 the Company did not hold any open copper or zinc futures positions. Gas swaps: In 2006, the Company established long swap contracts for 3.7 million MMBTUs with a fixed price of $ per MMBTU. In this respect, the Company recorded a gain of $6.3 million which was credited to the production cost of At December 31, 2006, the Company held long fixed price swap contracts for 10,000 MMBTUs per day at a fixed price of $7.525 per MMBTU for the first three months of 2007 to protect the Company s production cost from the uncertainty and high volatility of energy prices during the 2007 winter season. ANNUAL REPORT 06 39

105 Interest Rate Swaps: During 2005 and 2004, the Company entered into short interest rate swap contracts to reduce its exposure to interest rate risk on certain of its floating rate bank obligations. As a result of these positions, the Company recorded a net gain of $1.2 million and a net loss of $1.4 million in 2005 and 2004, respectively. These gains and losses were recorded in loss on derivatives in the consolidated statement of earnings. The Company did not hold any interest rate swap contracts during 2006 and does not hold any open position as of December 31, Exchange Rate Derivatives, U.S. Dollar / Mexican Peso Contracts: Because more than 85% of our sales collections in Mexico are in US dollars and many of our costs are in Mexican pesos, during 2006 the Company entered into zero-cost derivatives contracts with the purpose of protecting, within a range, against an appreciation of the Mexican peso to the US dollar. In these contracts if the exchange rate settles at or below the barrier, the Company does not sell dollars, if the exchange rate settles above the barrier price established in the contract the Company sells dollars at the strike price established in the contract. In 2006, the exercise of these zero-cost derivative contracts resulted in a gain of $0.9 million, which was recorded as a gain on derivative instruments on the consolidated statement of earnings. At December 31, 2006 the Company held the following exchange rate derivative operations: Due Date, Weekly Strike Price Barrier Price Notional Amount (millions) expiration during (Mexican Pesos/Dollars) (Mexican Pesos/Dollars) $ st Quarter $ st Quarter $ rd Quarter $ rd Quarter $ th Quarter $ st Quarter At December 31, 2006, the fair value of the above listed exchange rate derivative contracts is $0.5 million. The notional amount are comprised on therein transactions that have the same strike and Barrier price. Additionally, the Company holds embedded derivatives which are described in Note 2 Marketable Securities. NOTE 16 - FINANCIAL INSTRUMENTS: For certain of the Company s financial instruments, including cash, and accrued liabilities, the carrying amounts approximate fair value due to their short maturities. Consequently, such financial instruments are not included in the following table that provides information about the carrying amounts and estimated fair values of other financial instruments of the Company at December 31, 2006 and 2005: 40 GRUPO MEXICO

106 Amounts in million of US dollars Mexico U.S. and Peru Mexico U.S. and Peru Market Carrying Market Carrying Market Carrying Market Carrying value value value value value value Value value Assets: Accounts receivables associated with provisionally priced sales ($ 13.5) ($ 13.5) ($ 45.3) ($ 45.3) Marketable securities $ 10.0 $ Other $ $ $ $ Share trust $ $ $ $ 92.0 Liabilities: Long-term debt (excluding financial leases and interest) $ $ $ 1,270.0 $ 1,374.0 $ $ $ $ The following methods and assumptions were used to estimate the fair value of each type of financial instrument: Accounts receivable associated with provisionally priced sales: fair value of copper is based on published forward prices and fair value of molybdenum is based on year-end market prices. Marketable securities: due to the short term nature of the investments, current value is deemed to approximate fair value. Long-term debt: fair value is based on quoted market prices. NOTE 17 - CONCENTRATION OF RISK: The Company operates four copper open-pit mines, five underground poly metal mines, three smelters and eight refineries in Peru and Mexico, and substantially all of its assets are located in these countries. There can be no assurances that the Company s operations and assets that are subject to the jurisdiction of the governments of Peru and Mexico will not be adversely affected by future actions of such governments. Much of the Company s products are exported from Peru and Mexico to customers principally in U.S., Europe, Asia and South America. Financial instruments, which potentially subject the Company to a concentration of credit risk, consist primarily of cash and cash equivalents, marketable securities and trade accounts receivable. The Company invests or maintains available cash with various banks, principally in the United States, Mexico, Europe and Peru, or in commercial paper of highly-rated companies. As part of its cash management process, the Company regularly monitors the relative credit standing of these institutions. At December 31, 2006, SCC had invested 25.14% of its cash equivalents and marketable securities with Peruvian banks, of which 9.13% was invested ANNUAL REPORT 06 41

107 with one institution. Likewise, SCC invested 40.72% of its cash equivalent and marketable securities with Mexican banks, of which 34.88% were invested in one institution. During the normal course of business, the Company provides credit to its customers. Although the receivables resulting from these transactions are not collateralized, the Company has not experienced significant problems with the collection of receivables. The Company is exposed to credit loss in cases where the financial institutions with which it has entered into derivative transactions (commodity, foreign exchange and currency/interest rate swaps) are unable to pay when they owe funds as a result of protection agreements with them. To minimize the risk of such losses, the Company only uses highlyrated financial institutions that meet certain requirements. The Company also periodically reviews the credit worthiness of these institutions to ensure that they are maintaining their ratings. The Company does not anticipate that any of the financial institutions will default on their obligations. The Company s five largest trade receivable balances accounted for 39.5% and 40.9% of the trade accounts receivable at December 31, 2006 and 2005, respectively, of which one customer represented approximately 10.9% and 14.6%, respectively, of our trade accounts receivable. In railway segment the revenues received from the top 25 customers for the years ended December 31, 2006 and 2005 represented 65% and 57% of the total revenues for those periods, respectively. NOTE 18 - COMMITMENTS: MEXICO Railway segment The Company s operations are subject to Mexican federal and state laws, and to regulations related to environmental protection. Under these laws, guidelines have been issued concerning air, soil and water pollution, and studies have been carried out concerning environmental impact, noise control and hazardous residues. The Environment and Natural Resources Ministry may impose administrative and criminal sanctions against companies that breach environmental laws and it has authority to partially or entirely close any facilities that fail to satisfy such regulations. The responsibility to regenerate soil, subsoil and phreatic layers as a result of any damage caused by the Company operations, through February 18, 1998, lies with FNM. The Company has taken certain measures to prevent the pollution indicated in environmental audits performed by FNM, which served as the basis for preparing 19 agreements with the Federal Attorney s Office for Environmental Protection (PROFEPA - acronym in Spanish), addressing 1,281 activities to be carried out within a three year term, starting from April 1999, 100% of which had been implemented as of December 31, Ferromex has received PROFEPA s official approval for the fulfillment of these activities for only nine locations and final approval of the remaining ten locations is still pending. Under the terms of the concession, the Federal Government has the right to receive payments from the Company equal to 0.5% of the gross revenue during the first 15 years of the concession and 1.25% during the remaining years of the concession. In the years ended December 31, 2006 and 2005, such payments amounted to $4.5 million and $3.8 million, respectively. GFM leases the building where their main offices are located. The lease agreement is for five years starting April 1, In addition, GFM leases certain equipment, such as hoppers, boxcars, flatcars and tanker cars. Commitments for minimum rental payments under non-cancelable operating leases are as follows: Millions 2007 $ and thereafter 4.2 Total minimum payments $ 78.9 In January 1998 GFM entered into a fuel purchase agreement with PEMEX, under which the Company is required to purchase, at market value, a minimum of 16,400 cubic meters and a maximum of 26,300 cubic meters of diesel per month, although this limit may be exceeded, as in 2006 and 2005 and there was no repercussion. The agreement is for an indefinite term; nevertheless, same may be terminated 42 GRUPO MEXICO

108 due to justified causes or with a previous written notice, by any of the parties thereto. On June GFM signed an agreement to buy 100 electric diesel Model ES44AC Evolution locomotives with General Electric Company including an option to buy 25 additional locomotives. During 2006, 56 locomotives were received and 4 locomotives were in transit; the remaining locomotives were received during the first days of January, The Company is committed to acquire the remaining 40 locomotives during the fourth quarter of 2007, and it holds the option to purchase 25 additional locomotives which must be exercised by May 8, In 2006, the GFM was granted a number of credits to fund the acquisition of 75 locomotives. As of December 31, 2006, the company received 71 locomotives and the remaining 4 locomotives were received in January The rights to certain locomotives were assigned to a trust in order to guarantee payment of certain long-term debt. (See Note 10). Mining segment PERU Power purchase agreement: In 1997 SCC sold its Ilo power plant to an independent power company, Enersur S.A. ( Enersur ). In connection with the sale, a power purchase agreement was also completed under which SCC agreed to purchase all of its power needs for its Peruvian operations from Enersur for twenty years, commencing in In 2003 the agreement was amended releasing Enersur from its obligation to construct additional capacity to meet the Company s increased electricity requirements. SCC believes it can satisfy the need for increased electricity requirements from other sources, including local power providers. NOTE 19 - CONTINGENCIES: The Company is involved in various legal proceedings derived from its normal operations. However, according to management, a reasonable amount has been reserved to cover any individual or collective court decisions in connection with these proceedings. The main contingencies and legal procedures are shown as follows: SCC & MM Peruvian Operations Peruvian Operations Extraordinary contribution: On December 28, 2006, the Company s Peruvian branch signed a contract with the Peruvian government that commits the company to make annual (five-year) contributions for the regional development of Peru. This has been in response to an appeal by the new president of Peru to the mining industry. SCC, as well as the mining industry, has responded positively to help with this cause. The programs envisioned will focus initially on nutrition for young children and expectant mothers, education and health services. SCC has a program of contributions, starting in 2007, with a contribution of about $16.1 million, calculated based on 2006 Peruvian earnings. This nontax deductible amount has been taken from 2006 earnings. The following four years contributions could increase or decrease depending on earnings and copper prices. Royalty charge: In June 2004, the Peruvian Congress enacted legislation imposing a royalty charge to be paid by mining companies in favor of the regional governments and communities where mining resources are located. Under this law, SCC is subject to a 1% to 3% royalty, based on sales, applicable to the value of the concentrates produced in our Toquepala and Cuajone mines. The Company made provisions of $67.2 million, $40.3 million and $17.6 million in 2006, 2005 and 2004, respectively, for this royalty. These provisions are included in Cost of sales (exclusive of depreciation, amortization and depletion) on the consolidated statement of earnings. In April 2005, a Constitutional Tribunal ruled the law constitutional and additionally stated that the royalty charge applies to all concessions held in the mining industry, implying that those entities with tax stability contracts are subject to this charge. In 1996, the Company entered into a tax stability contract with the Peruvian government (a Guarantee and Promotional Measures for Investment Contract ), relating to our solvent extraction and electrowinning ( SX/EW ) production, which agreement purports to, among other things, fix tax rates and other charges relating to such production. SCC believes that the ANNUAL REPORT 06 43

109 Constitutional Tribunal s interpretation relating to entities with tax stability contracts is incorrect and intends to protest the imposition of the royalty charge on SX/EW production, when and if assessed. Provisions made by the Company for the royalty charge do not include approximately $14.0 million of additional potential liability relating to its SX/EW production from June 30, 2004 through December 31, Environmental matters: The Company s operations are subject to applicable Peruvian environmental laws and regulations. The Peruvian government, through its MEM conducts annual audits of the Company s Peruvian mining and metallurgical operations. Through these environmental audits, matters related to environmental commitments, compliance with legal requirements, atmospheric emissions and effluent monitoring are reviewed. The Company believes that it is in material compliance with applicable Peruvian environmental laws and regulations. In accordance with Peruvian regulations, in 1996 SCC submitted its Programa de Adecuación y Manejo Ambiental (the Environmental Compliance and Management Program, known by its Spanish acronym, PAMA) to the MEM. A third-party environmental audit was conducted in order to elaborate the PAMA. The PAMA applied to all current operations that did not have an approved environmental impact study at the time. SCC s PAMA was approved in January 1997 and contained 34 mitigation measures and projects necessary to (1) bring the existing operations into compliance with the environmental standards established by the MEM and (2) identify areas impacted by operations that were no longer active and needed to be reclaimed. By the end of 2006, 32 of these projects were completed, including all PAMA commitments related to the Company s operations in Cuajone and Toquepala. The two pending PAMA projects were related to the Ilo smelter operations. The primary areas of environmental concern were the smelter reverberatory slag eroded from slag deposits up until 1994, and atmospheric emissions from the Ilo smelter. PAMA commitments related to the slag remediation program and the smelter modernization project were both completed by January 31, With the completion of these projects SCC fulfilled its environmental commitments under the PAMA. With the smelter modernization project, SCC increased sulfur recapture over the 92% requirement established by the PAMA. The new smelter is expected to maintain production at current levels and will use advanced technology to drastically reduce sulfur emissions, in order to achieve the main goal of the project. A new stationary 17-meter high smelting furnace (IsaSmelt), with a nominal capacity to treat 165 tons of copper concentrate per hour has been installed as part of the modernization project. The furnace uses Isa technology which is proven throughout the world. Additionally, two rotary holding furnaces (RHF) have been installed to separate the slag. The matte (62% copper) from the RHF is then sent to Peirce-Smith converters to produce 99.3% pure copper. Two 400-ton anode furnaces receive the copper from the converters and with the use of two casting wheels 99.7% pure copper anodes are produced. Since January 2006, when the anode furnaces entered operation, blister copper production has been basically replaced by anode copper. As part of the smelter modernization project a new 1000-ton per day oxygen plant as well as a new 800,000 tons per year sulfuric acid plant, two desalination plants, and two effluent treatment plants have been constructed. Spending on this project through December 31, 2006 was $549.4 million (which includes $56.1 million of capitalized interest). In 2003, the Peruvian Congress published a new law announcing future closure and remediation obligations for the mining industry. The law was amended in May 2004 and again in May The current modification establishes that mining companies submit their mine closure plans within one year of publication of final regulations. On August 16, 2005 final regulations were published and SCC initiated the preparation of the required mine closure plan. This plan, in its final form, will include the estimated cost required for the Peruvian operations, including cost at the Ilo smelter and refinery, tailings disposal, and the dismantling of the Toquepala and Cuajone concentrators, shops and auxiliary services. As the law requires that the mine closure plan be prepared by an independent consulting entity, SCC engaged Walsh Peru S.A., a Peruvian subsidiary of Walsh Environmental Scientists and Engineers, Inc. (Boulder, Colorado), and the Mines Group Inc (Reno, Nevada) independent consulting entities to prepare the mine closure plan. The conceptual plan, without costs, was submitted to MEM in August 2006 and is subject to review by MEM for 45 days. After the MEM review (as of the end of February 2007 this review is pending) SCC will have 90 days to prepare and resubmit the mine closure plan, including costs, which is then subject to approval by MEM and open to public discussion and comment in the area of Company operations. Additionally, the law requires companies to provide financial guarantees to insure that remediation programs are completed. SCC believes the liability for these asset retirement obligations cannot currently 44 GRUPO MEXICO

110 be precisely measured, or estimated, until SCC has completed its final mine closure plan and is reasonably confident that it will be approved by MEM in most material respects. However, SCC has made a preliminary estimate of this liability and has recorded such amount in its financial statements. As of December 31, 2006, SCC has recorded $5.8 million for this liability. SCC believes that this estimate should be viewed with caution, pending final approval of its mine closure plan, expected in For the Company s Peruvian operations, environmental capital expenditures were $160.9 million and $234.6 million in 2006 and 2005, respectively. SCC expects to spend approximately $40.5 million for environmental capital expenditures in 2007, for completion of the Ilo smelter modernization project. Mexican operations: Environmental matters: The Company s operations are subject to applicable Mexican federal, state and municipal environmental laws, to Mexican official standards, and to regulations for the protection of the environment, including regulations relating to water supply, water quality, air quality, noise levels and hazardous and solid waste. Some of these laws and regulations are relevant to legal proceedings pertaining to the Company s San Luis Potosí copper facilities. The principal legislation applicable 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 the Environmental Law), which is enforced by the Federal Bureau of Environmental Protection or the PROFEPA. The PROFEPA monitors compliance with environmental legislation and enforces Mexican environmental laws, regulations and official standards and, if warranted, the PROFEPA may initiate administrative proceedings against companies that violate environmental laws, which in the most egregious cases may result in the temporary or permanent closing of non-complying facilities, the revocation of operating licenses and/ or other sanctions or fines. Also, according to the Código Penal Federal (Federal Criminal Code), the PROFEPA must inform corresponding authorities regarding environmental noncompliance. Mexican environmental regulations have become increasingly stringent over the last decade, and this trend is likely to continue and has been influenced by the environmental treaty entered into by Mexico, U.S. and Canada in connection with NAFTA in February However, the Company s management does not believe that continued compliance with the Environmental Law or Mexican State environmental laws will have a material adverse effect on the Company s business, properties, result of operations, financial condition or prospects or will result in material capital expenditures. Although MM believes that all of its facilities are in material compliance with applicable environmental, mining and other laws and regulations, MM cannot assure that stricter enforcement of existing laws and regulations or the adoption of additional laws and regulations would not have a material adverse effect on the Company s business, properties, results of operations, financial condition or prospects. Due to the proximity of certain facilities of MM to urban centers, the authorities may implement certain measures that may impact or restrain the operation of such facilities. Any enforcement action may have an adverse effect on the operating results of the relevant subsidiary. For the Company s Mexican operations, environmental capital expenditures were $10.5 million, $7.5 million in 2006 and 2005, respectively. Approximately $3.9 million has been budgeted for environmental capital expenditures in SCC and MM has instituted extensive environmental conservation programs at its mining facilities in Peru and Mexico. The Company s environmental programs include water recovery systems to conserve water and minimize impact on nearby streams, reforestation programs to stabilize the surfaces of the tailings dams and the implementation of scrubbing technology in the mines to reduce dust emissions. Litigation matters: Peruvian operations: Garcia-Ataucuri and Others vs. SCC: in April 1996, SCC was served with a complaint filed in Peru by approximately 800 former employees seeking the delivery of a substantial number of labor shares (acciones laborales) of its Peruvian Branch plus dividends on such shares, to be issued in a proportional way to each former employee in accordance with their time of work with SCC s Branch in Peru. SCC conducts its operations in Peru through a registered Branch. Although the Branch has neither capital nor liability separate from that of SCC, under Peruvian law it is deemed to have an equity capital for purposes of determining the economic interest of the holders of the labor shares. The labor share litigation is based on claims of former employees for ownership of labor shares issued during the 1970s until 1989 under a former Peruvian mandated profit sharing system. In 1971, the Peruvian Government enacted legislation providing that workers in the mining industry would participate in the pre-tax profits of the enterprises for which they worked at a rate of 10%. This participation was distributed 40% in cash and 60% as an equity interest in the enterprise. Under the law, the equity ANNUAL REPORT 06 45

111 participation was originally delivered to the Mining Community, an organization representing all workers. The cash portion was distributed to the workers after the close of the year. The accrual for this participation was (and continues to be) a current liability of the Company, until paid. In 1978, the law was amended and the equity distribution was calculated at 5.5% of pre-tax profits and was made to individual workers of the enterprise in the form of labor shares to be issued in Peru by the Peruvian Branch of SCC. These labor shares represented an equity interest in the enterprise. In addition, according to the 1978 law, the equity participations previously distributed to the Mining Community were returned to SCC and redistributed in the form 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 the close of the year. Effective in 1992, the law was amended to its present status, and the workers participation in pre-tax profits was set at 8%, with 100% payable in cash. The equity participation component was eliminated from the law. In 1995, SCC offered to exchange new common shares of SCC for the labor shares issued under the prior Peruvian law. Approximately 80.8% of the issued labor shares were exchanged for the Company s common shares, greatly reducing the minority interest on the Company s balance sheet. What remains of the workers equity participation is now included in the consolidated balance sheet under the caption Minority Interest. In relation to the issuance of labor shares by the Branch in Peru, the company is a defendant in the following lawsuits: 1) As stated above, in April 1996, SCC was served with a complaint filed in Peru by approximately 800 former employees, (García Ataucuri and others vs. SCC), seeking the delivery of 38,763, labor shares (acciones laborales) (or S/. 3,876,380,679.56), as required by Law # 22333, to be issued in a proportional way to each former employee or worker in accordance with their time of work with SCC s Branch in Peru, plus dividends on such shares. This amount corresponds to the total number of labor shares for all of the Company s Peruvian workers, and the complaint is seeking to have labor shares issued to the plaintiffs proportionally to each in accordance with their time of work with SCC, plus dividends on such labor shares. In December 1999, a civil court of first instance of Lima decided against SCC, ordering the delivery of the labor shares and dividends to the plaintiffs. SCC appealed this decision in January On October 10, 2000, the Superior Court of Lima affirmed the lower court s decision, which had been adverse to SCC. On appeal by SCC, the Peruvian Supreme Court annulled the proceeding noting that the civil courts lacked jurisdiction and that the matter had to be decided by a labor court. On March 8, 2002, Mr. García Ataucuri restated the claim to comply with Peruvian labor law and procedure requirements, and increased the number of plaintiffs to approximately 958 ex-workers. The lower labor judge dismissed the lawsuit in January In March 2005, the plaintiffs appealed to the Lima Labor superior court which has dismissed the lawsuit due to the plaintiffs not following the proper appeal procedures. 2) Additionally, on May 10, 2006, SCC was served with a new complaint filed in Peru, this time by 44 former employees, (Cornejo Flores and others vs. SCC), of SCC seeking delivery of: (1) labor shares (or shares of whatever other current legal denomination) corresponding to years 1971 to December 31,1977 (we understand the plaintiffs are seeking the same 38,763, labor shares mentioned in the prior lawsuit), that should have been issued in accordance with Law # 22333, plus interest, and (2) labor shares resulting from capital increases made by the Branch in 1980 for the amount of the workers participation of S/. 17,246,009,907.20, equivalent to 172,460, labor shares, plus dividends. On May 23, 2006, SCC answered this new complaint, denying the validity of the claim. Previous Case: The two above mentioned cases, are similar to a concluded lawsuit filed by 127 former employees on July 15, 1996, also represented by Mr. Garcia Ataucuri, which sought the issuance and delivery of 38,763, labor shares plus dividends and S/. 1,118,439, representing labor share capital increases made by the Branch. In December 1999, the lower court dismissed the complaint against the Company. Plaintiffs appealed this decision in January 2000 before the Superior Court. In August 2000 the Superior Court affirmed the lower court decision and the plaintiffs filed an appeal before the Supreme Court. In June 2002 the Supreme Court dismissed the appeal and as a consequence the Superior Court decision became final. It should be noted that these two (2) lawsuits refer to a prior Peruvian currency called sol de oro, which was later changed to the new sol. One billion of soles de oro is equivalent to today s one new sol. The labor shares are currently called investment shares. SCC asserts that the claims are meritless and that the labor shares were distributed to the former employees in accordance with the profit sharing law then in effect. We do not believe 46 GRUPO MEXICO

112 that an unfavorable outcome is reasonably possible. SCC has not made a provision for these lawsuits because it believes that it has meritorious defenses to the claims asserted in the complaints. Class actions Three purported class action derivative lawsuits have been filed in the Delaware Court of Chancery (New Castle County) late in December 2004 and early January 2005 relating to the acquisition of MM by SCC. On January 31, 2005, the three actions Lemon Bay, LLP v. Americas Mining Corporation, et al., Civil Action No. 961-N, Therault Trust v. Luis Palomino Bonilla, 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 Copper Corporation Shareholder Derivative Litigation, Consol, C. A. No. 961-N and the complaint filed in Lemon Bay was designated as the operative complaint in the consolidated lawsuit. The consolidated action purports to be brought on behalf of the Company s common stockholders. The consolidated complaint alleges, among other things, that the acquisition of MM is the result of breaches of fiduciary duties by the SCC s directors and is not entirely fair to the SCC and its minority stockholders. The consolidated complaint seeks, among other things, a preliminary and permanent injunction to enjoin the acquisition, the award of damages to the class, the award of damages to the SCC and such other relief that the court deems equitable, including interest, attorneys and experts fees and costs. SCC believes that this lawsuit is without merit and is vigorously defending itself against this action. The Company s management believes that the outcome of the aforementioned legal proceeding will not have a material adverse effect on the Company s financial position or results of operations. Mexican operations The Mexican Geological Services (MGS) Royalties: In August 2002, MGS (formerly named Council of Mineral Resources ( COREMI )) filed with the Third Federal District Judge in Civil Matters, an action demanding from Mexicana de Cobre, S. A. de C. V. (Mexcobre) the payment of royalties since Mexcobre [subsidiary of MM] answered and denied MGS s claims in October In December 2005, Mexcobre signed an agreement with MGS. Under the terms of this agreement the parties established a new procedure to calculate the royalty payments applicable for 2005 and the following years, and Mexcobre paid in January 2006, $6.9 million of royalties for 2005 and $8.5 million as payment on account of royalties from the third quarter 1997 through the last quarter of We estimate that the payment made on January 11 will cover 100% of the royalty payments required for past periods. The residual payments will be determined based on a recent ruling of the Third Federal District Judge issued on January 22, On an ongoing basis Mexcobre will be required to pay a 1% royalty on La Caridad s copper production value after deduction of treatment and refining charges and certain other carrying costs. San Luis Potosí Facilities: The municipality of San Luis Potosí has granted Desarrolladora Intersaba, S.A. de C.V., licenses for use of land and construction for housing and/or commercial zones in the former Ejido Capulines, where the residential project Villa Magna is expected to be developed in the near future. The Villa Magna residential project will be developed within an area that IMMSA s approved Risk Analysis by SEMARNAT (the federal environmental authority) has secured as a safeguard and buffer zone due to the use by Industrial Minera México, S. A. de C. V. (IMMSA - subsidiary of MM) of Anhydrous Ammonia Gas. Based on the foregoing, IMMSA has initiated two different actions regarding this matter: (1) First, against the municipality of San Luis Potosí, requesting the annulment of the authorization and licenses granted to Desarrolladora Intersaba S.A. de C.V. to develop Villa Magna within the zinc plant s safeguard and buffer zone; and (2) Second, filed before SEMARNAT a request for a declaration of a safeguard and buffer zone surrounding IMMSA s zinc plant. The first action was resolved by denying IMMSA s interest on August 23, 2006 by a Federal Court. IMMSA submitted on September 21, 2006 its last appeal before the Supreme Court of Justice. Based on the foregoing IMMSA is expecting that in the near future Desarrolladora Intersaba, S.A. de C.V. will file a lawsuit against IMMSA, requesting payment of certain damages supposedly caused by IMMSA, during the procedure of annulment requested. These actions are awaiting final resolutions. IMMSA believes that, should the outcome of the above mentioned legal proceedings be adverse to IMMSA s interests, the construction of the Villa Magna housing and commercial development would not, in itself, affect the operations of IMMSA s zinc plant. In addition to the foregoing, IMMSA has initiated a series of legal and administrative procedures against the Municipality of San Luis Potosi due to its refusal to issue IMMSA s use ANNUAL REPORT 06 47

113 of land permit in respect to its zinc plant. The Municipality has refused to grant such license based on the argument that IMMSA has failed to submit, as part of the application process, a manifestación de impacto ambiental (environmental impact assessment). IMMSA believes that the environmental impact assessment is not required because IMMSA will not undertake construction activities. The trial judge has ordered the Municipality to continue the analysis of IMMSA s request to issue the licencia de uso de suelo (land use permit). The municipality has refused to issue the land use permit. IMMSA has filed a request for relief against such resolution to compel the court to issue the land use permit. Tax contingency matters- U.S. Internal Revenue Service (IRS) SCC is regularly audited by the federal, state and foreign tax authorities both in the U.S. and internationally. These audits can result in proposed assessments. In 2002, IRS issued a preliminary Notice of Proposed Adjustment for the years 1994 through In 2003, SCC settled these differences with the IRS and made a payment of $4.4 million, including interest. Generally, the years 1994 through 1996 are now closed to further adjustment. The IRS completed field audit work for all years preceding 2003 and currently is auditing 2003 and During the audit of the tax years 1997 through 1999, the IRS questioned the Company s accounting policy for determination of useful lives for depreciable property, the calculation of deductible and creditable Peruvian taxes, the methodology of capitalizing interest and the capitalizing of certain costs (drilling, blasting and hauling) into inventory value as items for possible adjustment. In the fourth quarter of 2003, SCC and the IRS had jointly requested technical advice from the IRS National Office to help resolve the inventory value dispute. In August 2005 the National Office of the IRS responded to the IRS field audit group s request for technical advice. The issuance of this technical advice memorandum (TAM) allowed the IRS to close the field audit work for the audit cycles 1997 through 1999 and 2000 through The TAM accepts the position of the IRS field office and concludes that SCC is required to capitalize the drilling, blasting and hauling costs of material transported to its leach dumps based on the weight of material moved, without regard to metal content or recoverability. On October 5, 2005 SCC filed a formal protest with the IRS to appeal the proposed changes with respect to the TAM conclusion, as well as other items of adjustment proposed by the IRS field audit group. These other adjustments include the methodology of capitalizing interest, the determination of useful lives for depreciable property, the calculation of deductible and creditable Peruvian taxes and the established service fee between SCC and related parties. SCC believes that the positions that it is reporting to the IRS are correct and appropriate. SCC believes that it has substantial defenses to the proposed IRS adjustments and that adequate provisions have been made so that resolution of any issues raised by the IRS will not have a material adverse effect on its financial condition or results of operations. Discussions with the Appeals Office representatives have begun and the parties have agreed to working through the protested issues and concluding the appeals process by December 31, Peruvian operations: In Peru the Superintendencia Nacional de Administración Tributaria ( SUNAT ), the Peruvian Tax Administration, regularly audits SCC. These audits can result in proposed assessments. In 2002, SCC received assessments and penalties from SUNAT for fiscal years 1996 through 1999, in which several deductions taken were disallowed. After appeal, SCC settled many of the issues with SUNAT in However, the portion of the assessment related to the disallowance of financial expenses is still pending resolution. In addition, SCC has not recognized a liability for penalties and interest related to the portion of the assessments settled in 2003 or for the pending assessment related to financial expenses, as it considers that they are not applicable. The status of these pending issues as well as other tax contingencies is as follows: a) Year 1996: With regard to the appeal of the penalty related to fiscal year 1996, SCC was required to issue a letter of credit to SUNAT of $3.4 million, which was issued in July This deposit is recorded in other assets on the consolidated balance sheet. SCC was not required to issue a deposit for appeal of assessments and rulings with respect to any other years. In February 2004, the Peruvian tax court denied the Company s appeal. Consequently, in April 2004, SCC filed a lawsuit against the Peruvian tax court and SUNAT in the superior court of Peru. In September 2005, the Superior Court declared the Company s claim valid. SUNAT appealed this decision to the Peruvian Supreme Court in Lima. In December 2006, the Peruvian Supreme Court confirmed the opinion of the lower court that declared valid SPCC s claim. As SUNAT has not appealed this decision within the legal timeline, SCC considers this case closed and will file for a refund of the funds related to the letter of credit in the first quarter of b) Year 1997: With regard to the penalty issued by SUNAT related to fiscal year 1997, in November 2002 the Peruvian tax court indicated that the penalty needed to be modified and declared the previously issued penalty null. Consequently, SUNAT 48 GRUPO MEXICO

114 issued a new penalty in December This penalty had been protested before SUNAT. The Company s appeal before the Peruvian tax court related to the assessments (pertaining to the deduction of certain financial expense) for fiscal year 1997 was denied. In May 2003, SCC filed a lawsuit before the superior court against SUNAT and the Peruvian tax court, seeking the reversal of the ruling of the tax court. In July 2005 the Superior Court decided in favor of SCC and remanded the case to SUNAT for a new pronouncement. SUNAT has appealed the court s decision to the Peruvian Supreme Court in Lima. In December 2006, the Supreme Court declared null the lower court s opinion and remanded the case back to the lower court for final resolution. c) Years 1998 and 1999: SUNAT has not ruled on the portion of the 1998 and 1999 assessment related to the financial deductions. However, in August 2006, SUNAT ruled on other 1998/1999 issues related to payment of commissions to certain financial institutions. The ruling resolved one issue in favor of SCC and other issues against the company. SCC has appealed before the Peruvian tax court the portion of the claim decided against the Company. d) Years 2000 and 2001: In December 2004 and January 2005, SCC received assessments and penalties from SUNAT for the fiscal years 2000 and 2001, in which certain deductions taken by SCC were disallowed. SUNAT has objected to the Company s method of deducting vacation pay accruals in 2000, a deduction in 2000 for a fixed asset write-off, as well as certain other deductions in both years. SCC has appealed these assessments and resolution is still pending. Additionally, SCC received penalties and assessments from SUNAT relating to treatment of foreign exchange differences for 2000 and SCC has appealed these assessments and resolution is still pending. In June 2006, a fiscal court resolution was published with regards to another company, which states that profits related to foreign exchange differences need not be included in calculations for monthly advance tax payments. The fiscal court has indicated that this resolution is applicable to all future cases that are similar. As such, SCC expects that the portion of the 2000/2001 tax assessment related to foreign exchange difference will be removed from the assessment. In September 2006, SUNAT declared not valid the Company s claim related to the income tax rate applied to commissions paid to certain financial institutions. SCC has appealed SUNAT s decision before the Peruvian tax court. e) Year 2002: In December 2006, SCC received assessments and penalties from SUNAT for the fiscal years 2002 in which income tax rate applied to services received by SCC and deductions taken by the company were disallowed. In February SCC appealed these SUNAT assessments. Mexican Operations: MM is regularly examined by the Servicios de Administración Tributaria ( SAT ), the Mexican tax administration. These examinations can result in proposed assessments. a) Year 1995: In March 2001, SAT issued an assessment, related to 1995 tax year, disallowing certain deductions related to MM housing and local travel expenses. MM has appealed these assessment. The tax courts have ruled against the company. MM believes that final resolution of this issue will not be material to company financial results. b) Year 1999: In May 2005 SAT issued an assessment against MM claiming that MM understated asset value used in the determination of asset tax. In addition, SAT claimed that MM improperly reduced their consolidated results through the consolidation of two subsidiaries. MM believes that the SAT assessment is not legal. Accordingly, in July 2005, MM filed a Nullity Motion with the Metropolitan Regional Tax Court, Exchequer division, against the assessment, which is currently at the stage of submittal and admission of expert and documentary evidence. Significant management judgment is required in determining the provision for tax contingencies in Mexico, Peru and the U.S. The estimate of the probable cost for resolution of the tax contingencies has been developed in consultation with legal and tax counsel. The Company does not believe that there is a reasonable likelihood that there is an exposure to loss in excess of the amounts accrued. Labor matters During 2006, there were a number of work stoppages at some of the Company s Mexican operations. While some of these work stoppages were of a short-term nature with little or no production loss, others have been more disruptive. A strike at the La Caridad copper mine in Sonora began in the first quarter of 2006 and ended in July A strike at the San Martin polymetallic complex in Zacatecas commenced in the first quarter of 2006 and ended in May Workers at the Cananea copper mine went on a strike on June 1, 2006 returning to work six weeks later on July 17, ANNUAL REPORT 06 49

115 2006. These work stoppages were declared illegal by the Mexican authorities. On June 9, 2006, the Company announced the closing of the La Caridad mine as picketing workers made it impossible to continue operations. As a result of these strikes, the Company declared force majeure on certain of its June and July copper contracts. On July 14, 2006, with the approval of a Labor Court, MM dismissed the La Caridad workers. Individual work agreements, and the collective union contract, were terminated in compliance with the provisions of the ruling rendered by federal labor authorities. On July 26, 2006, the installations were returned to the company and the company commenced to hire workers to resume operations. In July 2006, MM reopened the La Caridad mine and in the fourth quarter of 2006 restored production to 100% capacity. In recent years the SCC has experienced a number of strikes or other labor disruptions that have had an adverse impact on its operations and operating results. Collective bargaining agreements with the Company s nine Peruvian labor unions expire in It is believed that certain of the unions in common locations are exploring the possibility of merging. In addition, SCC has received initial proposals from certain unions. It is too early to assess the outcome of this years labor negotiations, SCC, however, is hopeful that new agreements can be reached without disruptions to the operations. SCC cannot give assurances that they will not experience strikes or other labor-related work stoppages in the future that could have a material adverse effect on its financial condition and results of operations. Mine accident: On February 19, 2006 an explosion occurred at the IMMSA unit s Pasta de Conchos coal mine, located in San Juan de Sabinas, Coahuila, Mexico. Immediately, IMMSA along with neighboring industry initiated a rescue effort. Federal and local governmental help and support was received. As a result of the accident eight miners were injured and 65 perished. Both the Coahuila Public District Attorney (Procurador de Justicia) and the Federal Attorney Office (Procuraduría Federal de la República) initiated investigations to establish: (1) the causes of the accident and (2) the responsible party. The investigation is underway; however, it will be necessary for the investigation team to have access to the site where the explosion occurred, which at present is blocked. Recovery efforts are also continuing, however progress is very slow as access is blocked by debris and rocks. It may still take several more months to complete this effort. The underground mine has been closed since the accident and will remain closed until we complete efforts to recover the remains of our workers lost in the accident. Other legal matters: The Company is involved in various other legal proceedings incidental to its operations, but the Company does not believe that decisions adverse to it in any such proceedings individually or in the aggregate would have a material adverse effect on its financial position or results of operations. GMEXICO and its direct and indirect subsidiaries, have from time to time been named parties in various litigations involving Asarco. In August 2002 the U.S. Department of Justice brought a claim alleging fraudulent conveyance in connection with AMC s then-proposed purchase of SCC from Asarco. That action was settled pursuant to a Consent Decree dated February 2, The consent decree is binding solely on the U.S. government. In March 2003, AMC purchased its interest in SCC from Asarco. In October 2004, AMC, Grupo Mexico, Mexcobre and other parties, not including SCC, were named in a lawsuit filed in New York State court in connection with alleged asbestos liabilities, which lawsuit claims, among other matters, that AMC s purchase of SCC from Asarco should be voided as a fraudulent conveyance. The lawsuit filed in New York State court was stayed as a result of the August 9, 2005 Chapter 11 bankruptcy filing by Asarco, as described below. On February 2, 2007 a complaint was filed by Asarco, the debtor in possession, alleging many of the matters previously claimed in the New York State lawsuit, including that AMC s purchase of SCC from Asarco should be voided as a fraudulent conveyance. While Grupo Mexico and its affiliates believe that these claims are without merit, we cannot assure you that these or future claims, if successful, will not have an adverse effect on the Company or its subsidiaries. Any increase in the financial obligations of the Company result of matters related to Asarco or otherwise could, among other effects, result in rescission of the transfer of the stock, the return of the stock to Asarco LLC, and money damages in the amount of dividends paid since the transfer of the shares. In 2005, certain subsidiaries of Asarco filed bankruptcy petitions in connection with alleged asbestos liabilities. In July 2005, the unionized workers of Asarco commenced a work stoppage. As a result of various factors, including the above-mentioned work stoppage, on August 9, 2005 Asarco filed a voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code before the U.S. Bankruptcy Court in Corpus Christi, Texas. Asarco s bankruptcy case is jointly administered with the bankruptcy cases of its subsidiaries. Asarco s bankruptcy could result in additional claims being filed against Grupo Mexico and its subsidiaries, including AMC, SCC, MM or its subsidiaries. On February 5, 2007, Asarco LLC filed a complaint in the Bankruptcy Proceeding against AMC alleging that the Asarco LLC, rather 50 GRUPO MEXICO

116 than AMC, is entitled to an income tax refund as a result of certain losses incurred by its corporate predecessor, Asarco Incorporated. Asarco LLC claims that AMC caused a corporate reorganization to shift the ownership of the tax refund from Asarco LLC to AMC and the post - reorganization Asarco Incorporated. AMC believe that Asarco LLC s claims are without merit and are vigorously defending the action. Grupo Mexico and its subsidiary, Americas Mining Corporation ( AMC ) served with the original complaint, are defendants in a suit filed in New York State Supreme Court, New York County, by plaintiffs with alleged personal injury asbestos claims against Asarco LLC. Plaintiffs allege that the march 2003 transfer of certain of the stock held by Asarco LLC in Southern Copper Corporation ( SCC ) to AMC was fraudulent and that the Company facilitated the transfer. Plaintiffs allege that Asarco LLC was insolvent at the time of the transfer, that the transfer was made for less than fair value, and that the transfer resulted in Asarco LLC being left with insufficient assets to pay asbestos - exposure - related damages to plaintiffs. The case is currently stayed due to Asarco LLC s bankruptcy. The Company and AMC believe that plaintiffs claims are without merit and are vigorously defending the action. Asarco - Environmental litigation and related matters. In connection with the matters referred to below, as well as the other closed plants and sites where the Asarco is working with federal and state agencies to resolve environmental issues, the Asarco accrues for losses when such losses are probable and reasonably estimable. Such accruals are adjusted as new information comes to the Company s attention or circumstances change. In August 2002, the United States Department of Justice and Environmental Protection Agency (EPA) filed a lawsuit in federal district court in Tacoma Washington against Asarco, seeking to enjoin the transfer of the Company s 54% stockholder interest in SCC to AMC, alleging fraudulent conveyance. Asarco agreed to a stipulation staying the transfer pending settlement discussions. On the Company s motion, the case was transferred to Phoenix, Arizona. In January 2003, Asarco reached a settlement with the government, which was entered as a consent decree by the court in February The consent decree allowed Asarco to finalize the SCC transaction and required the establishment of an environmental trust to be funded by AMC (through the assignment by Asarco of a promissory note receivable from AMC having an original face value of $100 million plus interest at 7% per annum) over the next eight years at a total of approximately $125.0 million (includes principal and interest). The trust is dedicated to remediation work at most of the sites where Asarco still has environmental liability, offsetting that liability dollar for dollar. The government agreed to: (1) stay enforcement of certain environmental obligations against Asarco for the next three years; (2) waive the obligation for three years to meet certain financial assurance requirements, and (3) release Asarco of certain environmental liabilities, including approximately $100.0 million for accrued civil and stipulated penalties and approximately $4.5 million for environmental response costs at certain sites. The consent decree does not limit the Asarco s liability for future environment response costs. The consent decree also includes not to exceed limits of $2.0 million, $2.5 million and $3.0 million during 2003, 2004 and 2005, respectively, on Asarco s environmental response costs outside of the consent decree but not exclusive of those designated for funding. The note receivable from AMC at December 31, 2006 and 2005 totaled $38.6 millions and $62.5 million, respectively. Asarco and certain of its subsidiaries have been notified by the EPA that it is a Potentially Responsible Party (PRP) for multiple sites under Superfund Legislation. Asarco has accrued its best estimate of its obligations with respect to each of the sites. Asarco could incur additional obligations for which Asarco has no estimate at this time. It is reasonably possible that the Asarco s recorded estimates for these obligations may change in the near term. Also, Asarco and certain of its subsidiaries have received notices from the EPA and other federal and state agencies that they, and in some cases numerous other parties, are potentially responsible for damages and remediation occasioned by alleged hazardous substance releases at certain sites under CERCLA or similar state laws. In addition, Asarco and certain of its subsidiaries are defendants in lawsuits brought under CERCLA or state laws that seek substantial damages and remediation. Remedial action is being undertaken by Asarco at, and in some instances nearby, some of the sites. - Asbestos product and premises litigation Asarco and two subsidiaries, Capco Pipe Company, Inc. (Capco), and Lac d Amiante du Quebec, LTEE (LAQ) as of December 31, 2004, are defendants against claims seeking substantial actual and punitive damages for personal injury or death allegedly caused by exposure to asbestos. Asarco never produced asbestos or manufactured asbestos products. Claims against it arise as claims of alleged alter ego or other derivative liability from Capco and/or LAQ or by reason ANNUAL REPORT 06 51

117 of alleged past exposure to asbestos on the premises of Asarco facilities in Texas. Capco produced cement asbestos pipe in Alabama and Arkansas in the mid-1960s to the early 1980s. LAQ mined raw asbestos fiber from the Black Lake region of Quebec from the early 1950s to the mid-1980s. Both Capco and LAQ are non-operating entities. In mid 2004, Asarco undertook to resolve its asbestos liabilities by negotiating prepackaged bankruptcy plans for LAQ and Capco under Section 524(g) of the U.S. Bankruptcy Code. To that purpose during 2004 representatives of Asarco met in person or in rare instances by telephone with a group of plaintiffs law firms representing approximately 75% of the estimated number (based on the best currently available information) claimants against the Asarco, and invited the claimants (or their designated representatives) to form an informal committee of asbestos claimants for the purpose of negotiating a prepackaged plan of reorganization for Capco and LAQ. In response to that invitation, representatives of a substantial majority in number of asbestos claimants met in September 2004 and formed an informal committee of asbestos claimants (ACC), retained professionals and is engaged in due diligence regarding Asarco and a potential prepackaged plan of reorganization. Asarco agreed to fund and has funded the ACC s professionals, has cooperated in connection with and is responding to the ACC s due diligence requests, and on October 14, 2004, met with the ACC and its professionals to provide the ACC with certain information about Asarco and the prepackaged process. Asarco, after considering a number of possible candidates to serve as the representative of holders of future demands (FCR), proposed Robert C. Tate of Corpus Christi, Texas to the ACC, and is proceeding to engage Mr. Tate as the FCR for Capco and LAQ. Asarco has engaged LECG LLC (LECG) to combine and reconcile its asbestos claims data and to otherwise perform such operations as it deems necessary to establish that Asarco has a reliable and accurate asbestos claims database upon which its professionals may estimate its present and future asbestos liability for the purposes of negotiating and confirming a prepackaged plan of reorganization for Capco and LAQ. Currently, LECG is in the process of obtaining listings of active and outstanding claimants and reconciling those lists to the Asarco database. The scope of this exercise is information in the possession of the plaintiffs firms that comprise 80% of the claims against Asarco and its subsidiaries. This process is only partially complete at present due to a lack of cooperation from the plaintiffs firms and incomplete and inconsistent information received from the plaintiffs firms to date. Asarco has settled with some of its insurers and has received insurance recovery settlements in connection with its alleged asbestos liability. These settlements are reported as reserves, primarily in other long-term liabilities, and totaled $102.5 million and $105.7 million at December 31, 2004 and 2003, respectively. Asarco believes that these reserves represent at least a minimum in a range of possible outcomes of its prepackaged bankruptcy plan negotiation process for LAQ and Capco as to the amount of the total liability for asbestos-related claims. Asarco will continue to review its asbestos reserve on a periodic basis and make such adjustments as may be appropriate. However, it is possible that Asarco will not be in a position to conclude that a further adjustment to the reserve is appropriate until additional significant developments occur during the course of its negotiations toward a prepackaged bankruptcy plan, including resolution by negotiation or the Bankruptcy Court, if required. Any such adjustment could, however, be material to Asarco s consolidated financial position and results of operations in any given period. Other litigation Asarco is a defendant in lawsuits in Arizona, the earliest of which commenced in 1975, involving the U.S., Native Americans, and other Arizona water users contesting the right of Asarco and numerous other individuals and entities to use water and, in some cases, seeking damages for water usage and alleged contamination of ground water. The lawsuits could affect Asarco s use of water at its Ray Complex, Mission Complex, and other Arizona operations. In November 1999, an action by Cyprus Amax, (Cyprus) a subsidiary of Phelps Dodge Corporation, was commenced against Asarco in federal court in the Southern District of New York. The action sought damages of not less than $90.0 million for the alleged breaches of a merger agreement between Asarco and Cyprus. This case was dismissed in Cyprus took no appeal of this decision. Asarco is involved in multiple breach of contract suits alleging damages approximating $17.4 million. Asarco has reported these obligations in accounts payable and other liabilities in the accompanying financial statements. Asarco settled and paid $13.5 million of these obligations in January GRUPO MEXICO

118 Asarco is also involved in multiple suits and claims against it arising from such matters as workers compensation claims and employment related claims among other matters. Asarco does not believe any of these matters will have a material adverse effect on the Company s financial position, results of operations or cash flows. Future environmental related expenditures cannot be reliably determined in many circumstances due to the early stages of investigation, the uncertainties relating to specific remediation methods and costs, the possible participation of other potentially responsible parties, and changing environmental laws and interpretations. Similarly, due to the uncertainty of the outcome of court proceedings, future expenditures related to litigation cannot be reliably determined. The financial viability of other potentially responsible parties has been considered when relevant and no credit has been assumed for any potential insurance recovery when not deemed probable. It is the opinion of management that the outcome of the legal proceedings, environmental contingencies and asbestos litigation mentioned, and other miscellaneous litigation and proceedings now pending, could be material to the financial position of Asarco at December 31, Asarco can make no assurances as to the materiality of the future financial statement impact. This opinion is based on considerations including experience related to previous court judgments and settlements and remediation costs and term. GFM/Railway segment Negotiations with a Mexican railway system operator - GFM has net balances receivable from a Mexican railway system operator generated from 1998 through Negotiations are currently underway to determine the amounts to be recovered and paid per segment (interline traffic, trackage rights, and haulages) as the terms of these arrangements are not clearly defined in the concession agreements. At December 31, 2006 and 2005, the net balances receivable amounted to $29.6 million and $38.2 million, respectively. At December 31, 2006, GFM considers that it has estimated adequately these balances and had recorded no additional reserves to cover the possible adverse or favorable results of the negotiations and legal procedures referred to in subparagraphs below. a. Legal and administrative procedures.- GFM is involved in several legal actions in the normal course of its business. However, the Company s management believes that any individual or collective decisions related to these procedures would not have an adverse material effect on its financial position or results of operations. The main lawsuits in which GFM is involved are as follows: a.1. Mercantile lawsuits filed against Kansas City Southern Mexico, S.A. de C.V. ( KCSM before TFM, S. A. de C. V., TFM ) - Ferromex has filed three lawsuits against KCSM requesting a court resolution to determine the amount of principal and interest to be paid to Ferromex by TFM for trackage rights, interline traffic, and haulages: (1) For the period starting on February 19, 1998 and ending on August 31, 2001, the balance claimed by Ferromex at the inception date of this demand, amount to $792.7 million Mexican Pesos and $20.6 million. After a lawsuit where all possible instances have been resorted to, including an appeal, Ferromex was denied this appeal, as a result of which Ferromex reserved its right to file a new demand and was required to cover legal costs and fees. KCSM filed the required to cover legal costs, interlocutory decree was sentenced and it was denied due to procedures were not filed correctly and; therefore, the calculation was not correct. As KCSM was not satisfied, interlocutory sentence was then confirmed, denying constitutional protection, a revision appeal was filed, which was sustained and the legal procedures continued. Appeal was denied on November 29, 2006 and revision appeal was filed. GFM is looking forward to hearing the corresponding resolutions. (2) For the period of time from September 1 to December 31, 2001, in which the amount claimed (nominal value) amounts to $21.0 million Mexican Pesos. On October 18, 2006, trial court judgment was pronounced that the parties shall reserve the rights to make the valuable in accordance to their interests. Against this judgment, Ferromex filed an appeal accepted to proceed on November 13, 2006, whereby, the counter party was summoned to provide response to damages. (3) On September 19, 2006, Ferromex filed a mercantile lawsuit against KCSM, claiming accountability for the period of time from January 2001 to December 2004, as well as the amounts arising from said accountability. In the month of December 2006, the first higher civil court for the Federal District issued resolutions stating: (i) it pronounced well founded the appeal for the payment of damages of Ferromex against the appeal filed by Kansas City, against the court order ad- ANNUAL REPORT 06 53

119 mitted the legal procedures considering that said appeal was not lawful; (ii) incompetence was declared related to the Kansas City s decline, stating to continue hearing procedures in the common courts for the Federal District and not in the federal courts as alleged by Kansas City. a.2. Nullity trial against several rulings issued by the Secretary of Communications and Transports (SCT) on haulages rights, interconnection and terminal services. Nowadays, there are seven lawsuits which are processed in the Federal Court of Taxes and Administrations, in the Supreme Court of Justice, Collegiate Courts and SCT. Now, GFM is looking forward to hearing the corresponding resolutions. a.3. Ordinary Mercantile Action - There is a lawsuit filed by the company Suacero, S. A. de C. V. ( SUACERO ) against Ferromex, claiming the fulfillment of the barter agreement executed by and between the parties, consisting of the delivery of 4,924 tons of railway material, or otherwise, the payment of same in the approximate amount of $14.0 million Mexican Pesos. On February 11, 2005, Ferromex serves response upon the lawsuit arguing that the railroad material has not been delivered since SUACERO has not demonstrated to be the legal owner of said material, Ferromex files defense due to judge incompetence, which was already resolved being the Judge from San Luis Potosí competent; and there is a defense filed related to the lack of personality of the legal representative of Suacero, which was overruled, and by means of a writ dated on October 11, 2006, Ferromex filed an appeal which on October 23, 2006 was admitted, ordering review to said appeal and serve testimony of the appeal upon the corresponding instance. a. 4. Indirect lawsuits - These lawsuits are those in which Ferromex is included in labor claims filed against FNM. These indirect lawsuits cannot be quantified, but the possible economic impact would be absorbed by the Federal Government, in accordance with the terms previously agreed. a. 5. Direct lawsuits - These lawsuits are those in which Ferromex is sued directly. The related amount will be liable in the case that the Company losses the lawsuits and there will not be possibility of negotiation. Indemnifications paid in 2006 and 2005, in connection with labor claims amounted to $1.8 million and $2.4 million, respectively. At December 31, 2006, GFM considers that it has estimated adequately the accounts to receive and to pay and therefore has not recorded an additional reserve to cover the possible adverse or favorable results of the negotiations and lawsuits mentioned above. 54 GRUPO MEXICO

120 NOTE 20 - SUBSEQUENT EVENTS: Dividends announced On January 26, 2007 a dividend of $213.2 million ($2,319 mexican million pesos) was announced by GMEXICO and was paid on February 15, On January 25, 2007 a divided of $500.5 million was announced and was paid by SCC on March 2, 2007 to shareholders of record as of February 13, Our dividend policy continues to be reviewed at Board of Directors meetings, taking into consideration the current intensive capital investment program and expected future cash flow generated from operations. Other matters: AMC was recently sued by Asarco, LLC., a 100% subsidiary of AMC, which is currently controlled by independent board members who have autonomy and independent responsibility, and were appointed by a bankruptcy court in the USA. The lawsuit is related to the acquisition of SCC by AMC, during the first quarter of 2003, supposedly damaging the creditors of Asarco, LLC. AMC considers that this lawsuit has no merits since among other facts the acquisition was made at the fair market value determined by prestigious independent financial firms and the transaction also obtained the approval of the U.S. Department of Justice as creditor of Asarco, LLC. Additionally, the terms of the transaction were approved by a Federal US Court. The funds obtained were applied exclusively to the payment of financial and environmental liabilities of Asarco, LLC. AMC presented its response to the mentioned lawsuit in which the company highlighted that the supposed detriment is based on the difference of SCC s value at that time, March 2003, date of the acquisition, and its current value, four years later, without considering the important positive variation of the copper commodity price, main metal produced by SCC, due to the strong demand that has been registered during the last two years. Asarco LLC, is currently undergoing Chapter 11 process in the USA with the purpose of achieving a financial reorganization, once its environmental liabilities are defined by the corresponding judge. Likewise, is pending the definition of Asarco s responsibility in the asbestos operation of its subsidiaries LAQ and CAPCO. AMC considers that the asbestos responsibility of those subsidiaries should not be assumed by Asarco, LLC. ANNUAL REPORT 06 55

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