## Management’s Discussion and Analysis 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payment.” SFAS No. 123 (revised 2004) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Through December 31, 2004, we have accounted for grants of employee stock options under the recognition principles of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, which require compensation costs for stock- based employee compensation plans to be recognized based on the difference on the date of grant, if any, between the quoted market price of the stock and the amount an employee must pay to acquire the stock. If we had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock- Based Compensation,” which requires compensation cost for all stock-based employee compensation plans to be recognized based on the use of a fair value method, our net income would have been reduced by $5.2 million, $0.05 per diluted share, for 2004, $4.7 million, $0.05 per diluted share, for 2003 and $6.5 million, $0.07 per diluted share, for 2002 (see Note 1 of “Notes to Consolidated Financial Statements”). We must adopt SFAS No. 123 (revised 2004) no later than July 1, 2005; however, we can elect to adopt SFAS No. 123 (revised 2004) as early as January 1, 2005. We are still reviewing the provisions of SFAS No. 123 (revised 2004) and have not yet determined if we will adopt SFAS No. 123 (revised 2004) before July 1, 2005. Also, stock options were granted to employees in February 2005, including multi-year grants to our senior executive officers. As a result, the annual charges for share-based payments will be higher than the pro forma annual amounts presented in Note 1 of “Notes to Consolidated Financial Statements.” Based on currently outstanding employee stock options, including those granted in February 2005, if we adopt SFAS No. 123 (revised 2004) on July 1, 2005, we estimate the charge to earnings before taxes and minority interest sharing in the second half of 2005 would total approximately $11 million, and the reduction in net income would be approximately $6.5 million, $0.04 per basic share using common shares outstanding at December 31, 2004. 

## PRODUCT REVENUES AND PRODUCTION COSTS PT Freeport Indonesia Product Revenues and Net Cash Production Costs 

Net cash production costs per pound of copper is a measure intended to provide investors with information about the cash generating capacity of our mining operations expressed on a basis relating to its primary metal product, copper. PT Freeport Indonesia uses this measure for the same purpose and for monitoring operating performance by its mining opera- tions. This information differs from measures of performance determined in accordance with generally accepted accounting principles and should not be considered in isolation or as a substitute for measures of performance determined in 

accordance with generally accepted accounting principles. This measure is presented by other copper and gold mining companies, although our measures may not be comparable to similarly titled measures reported by other companies. We calculate gross profit per pound of copper under a “by- product” method, while the copper, gold and silver contained within our concentrates are treated as co-products in our financial statements. We use the by-product method in our presentation of gross profit per pound of copper because (1) the majority of our revenues are copper revenues, (2) we produce and sell one product, concentrates, which contains all three metals and (3) it is not possible to specifically assign our costs to revenues from the copper, gold and silver we produce in concentrates. In the co-product method presentation below, costs are allocated to the different products based on their relative revenue values. In both the by-product and the co-product method calcu- lations below, we show adjustments to revenues for prior period open sales and for hedging as separate line items. Because the copper pricing adjustments do not result from current period sales, we have reflected these separately from revenues on current period sales. Hedging adjustments, which are attributed to our commodity-indexed preferred stock, are included with pricing adjustments because they result from transactions outside of our sales contracts. Noncash and other nonrecurring costs, which consist of items such as write-offs of equipment or unusual charges, have not been material. They are removed from site production and delivery costs in the calculation of net cash production costs (credits). As discussed above, gold and silver revenues are reflected as credits against site production and delivery costs in the by-product method. PT Freeport Indonesia’s gross profit totals are before considering the impact of the elimination of its share of profits on its sales to PT Smelting. Presentations under both methods are presented below together with a reconciliation to amounts reported in our consolidated financial statements. 

