Table Of Content 2006 Report on Operations Business Outlook... Statement of Management s Responsibility...

Transcription

1

2 Table Of Content 2006 Report on Operations Business Outlook... 3 Statement of Management s Responsibility... 4 For Financial Statements Independent Auditors Report Balance Sheets 7 Statements of Income... 8 Statement of Changes in Stockholders Equity... 9 Statements of Cash Flows. 10 Notes to Financial Statements. 11 Board of Directors and Officers.. 35 CIP Management Support Services Group Corporate Directory... 37

3 KEMWATER PHIL. CORP Annual Report on Operations The year 2006 registered a new record for Kemwater Phil. Corp. (KPC) in Gross Sales Revenues at PhP million, a growth of 17% compared to Behind this growth in revenues were the 7% increase in volumes and the 5.6% improvement in average net selling prices. Net Income for 2006 was PhP 10.7 million; a 76% increase compared to the PhP 6.07 million Net Income of While the average direct cost per ton of product continued to rise, this was offset by the increases in sales volume and selling prices, as well as the significant reduction in overhead expenses. Manufacturing Efficiencies in plant operations improved further in 2006 as expenses continued to decline by 3% versus 2005, the year when expenses were already reduced by 8%. Better operating practices are now in place and performance standards are upgraded periodically. The Company continued to maintain a very lean labor complement in The significant improvements in plant reliability that include: (1) modifications of the plant, (2) better preventive maintenance, and, (3) more cost efficient sourcing for and management of supplies and third party services, gave the most contribution to savings. More specifically, plant downtimes and off-specs products declined. Given the improved output, the use of contractual services became more productive and more cost-efficient. Production related expenses alone declined by 22% that contributed three-fourths of the total overhead reduction. Part of this is the more effective preventive maintenance where total expenses declined by 16%, a significant part of which came from the 48% reduction in charges from third party contractors. Partly helping achieve the above were the continuous efforts done in improving and building the skills level of the plant organization. Even with a very lean organization, the people responded positively to having more responsibilities. Total Quality Management (TQM) & ISO 9000 Certification KPC is proud to state that the quality of the product it produces, particularly its alumina content, is now set at the international standard of 17%. From hereon, this will be the Company s standard for alum. The objective of KPC having its own capability in chemical analysis suffered some setbacks when its laboratory analyst decided to leave the Company. The loss of the analyst also stalled the on-going work on ISO certification that was started months earlier. KPC however, is committed to acquire ISO certification and the analytical capability in

4 Sales and Marketing Compared to last year, the total sales volume of KPC in 2006 increased by 7%, the growth coming solely from the high and unprecedented volume growth of one of the alum variants by 70%. One of the key clients for this alum variant started commercial operations of its second plant early in the year aside from increasing the capacity of its old plant. It should be noted that KPC won two major supply contracts for liquid alum in 2005: Manila Water in September and Maynilad Water in October. The total actual sales volume of liquid alum in 2006 however, decreased by 5% versus last year. The actual usage of Manila Water in 2006 was very low or only half of the contract volume due to two factors: overall good water turbidity and the maximized usage of raw water from La Mesa. KPC completed the deliveries to Maynilad in December 2006 although the contract quantity was smaller compared to Manila Water. The significant drop in sales volume of another alum variant by 32% however, pulled down total sales volume that could have been much higher than the actual of 7%. The drop was mainly due to three factors: first and with immediate impact was when KPC stopped selling to its biggest dealer of this alum which decided to put up its own alum plant; second, the increased volume of imports of low-priced alum mainly from China; and third, the entry of specialty chemicals intended for specific raw water conditions. These specialty chemicals are distributed by multinational companies. As mentioned earlier, competition from imported alums rose further in From a 104% increase in alum imports in 2004 and another 26% in 2005, the year 2006 saw another surge of 158% in alum imports: 1,070 MT and 2,760 MT of aluminum sulfate were imported in 2005 and 2006, respectively. It is important to note that 95% of imports in 2005 and 2006 came from China at very competitive prices. To broaden KPC s product range and reduce dependence on alum as the main business, the Company is now also focusing on traded specialty water treatment chemicals, particularly polymers. As a result, market development through laboratory tests have been conducted and KPC has gained client acceptance on products initially tested. Strategic Raw Material Purchasing The price of aluminum hydroxide, a major raw material used by KPC, remains high. Prices in 2006 increased slightly compared to As a result, KPC was pressed to look for alternative suppliers as KPC s sole supplier of aluminum hydroxide increased its prices during the second half of the year. With the objective of buying direct from the producers instead of a third party, KPC initiated the negotiations directly with foreign producers of alum hydroxide in the second half of To improve its leveraging position with the producers, KPC coordinated with Kemira, 2

5 one of KPC s major stockholders, to tie-in KPC s annual requirements with Kemira to take advantage of volume discounts on pricing. KPC expects to benefit from these successful negotiations in The forex rates started to improve in 2006 which softened the impact of the higher dollar prices on costs. The net effect, however, was still less than the effect of higher prices of the Company s raw material requirements. The availability of LMG sulfuric acid has continued to be a concern too in 2006 due partly to limited molten sulfur supply. In order to meet delivery requirements, KPC had to find alternative sources of acid, even at prices higher than LMG s BUSINESS OUTLOOK The year 2007 presents more challenges as well as opportunities for Kemwater Phil. Corp. In manufacturing operations, there is room for improvement both in terms of increasing production output and further reducing direct costs. Present implementation of projects will continue to achieve both output and cost objectives. A more pressing concern is the significant increase in imports of aluminum sulfate from China at very low US$ CIF prices which could affect KPC s market for both solid and liquid alum. Another is the entry in the market of specialty chemicals for water treatment that are able to compete with alum under certain raw water quality conditions. In addition, the recurring uncertainty of sulfuric acid supply from LMG remains to be a concern. Fortunately alternative suppliers have been identified and tested. These sources will just have to be further developed, if necessary, in The opportunities for growth in volumes and incomes in 2007 are expected to be better than any year since KPC started commercial operations in Demand for powdered alum is expected to at least maintain its 2006 levels. The possibility of getting a supply contract with major utilities is imminent given KPC s more competitive position. This will be further aided by the sustained peso and improvements in alum hydroxide prices. Initial results from steps taken to introduce polymers in the market have been encouraging. The market has become more competitive now with more players but KPC expects to start participating in biddings for these new and high value products in

6 Statement of Management s Responsibility for Financial Statement The Management of Kemwater Phil. Corp. is responsible for all information and representations contained in the financial statements as of December 31, 2006 and 2005 and for the years ended December 31, 2006 and The financial statements have been prepared in accordance with Philippine Financial Reporting Standards and reflect amounts that are based on the best estimates and informed judgment of Management with an appropriate consideration to materiality. In this regard, Management maintains a system of accounting and reporting which provides for the necessary internal controls to ensure that transactions are properly authorized and recorded, assets are safeguarded against unauthorized use or disposition, and liabilities are recognized. The Management likewise discloses to the Company s Audit Committee and to its external auditor: (1) all significant deficiencies in the design or operation of internal controls that could adversely affect its ability to record, process, and report financial data; (2) material weaknesses in the internal controls; and (3) any fraud that involves Management or other employees who exercise significant roles in internal controls. The Board of Directors reviews the financial statements before such statements are approved and submitted to the stockholders of the Company. SyCip, Gorres, Velayo & Co., the independent auditors appointed by the stockholders and the Board of Directors has examined the financial statements of the Company in accordance with Philippine Standards on Auditing and has expressed its opinion on the fairness of the presentation upon completion of such examination, in its report to the Board of Directors and Stockholders. ANA MARIA G. ORDOVEZA President and Chief Executive Officer JAIME Y. GONZALES Treasurer and Chief Financial Officer RAMON Y. NAVARRO General Manager 4

7 SGV & CO SyCip Gorres Velayo & Co Ayala Avenue 1226 Makati City Philippines Phone: (632) Fax: (632) BOA/PRC Reg. No SEC Accreditation No FR-1 INDEPENDENT AUDITORS REPORT The Stockholders and the Board of Directors Kemwater Phil. Corp. Chemphil Building, 851 A. Arnaiz Avenue Legaspi Village, Makati City We have audited the accompanying financial statements of Kemwater Phil. Corp., (a subsidiary of LMG Chemicals Corp.) which comprise the balance sheets as at December 31, 2006 and 2005, and the statements of income, statements of changes in stockholders equity and statements of cash flows for the years then ended, and a summary of significant accounting policies and other explanatory notes. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with Philippine Financial Reporting Standards. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances. Auditors Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Philippine Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. SGV & Co is a member practice of Ernst & Young Global 5

8 - 2 - Opinion In our opinion, the financial statements present fairly, in all material respects, the financial position of Kemwater Phil. Corp. as of December 31, 2006 and 2005, and its financial performance and its cash flows for the years then ended in accordance with Philippine Financial Reporting Standards. SYCIP GORRES VELAYO & CO. Josephine H. Estomo Partner CPA Certificate No SEC Accreditation No AR-1 Tax Identification No PTR No , January 2, 2007, Makati City April 4,

9 KEMWATER PHIL. CORP. BALANCE SHEETS ASSETS December 31 Current Assets Cash and cash equivalents (Note 4) P=8,451,199 P=4,038,172 Receivables (Note 5) 19,225,722 16,345,591 Due from related parties (Note 10) 19,675,437 21,323,817 Inventories - net (Note 6) 24,933,540 23,656,518 Prepaid expenses and other current assets (Note 7) 1,910,731 3,040,182 Total Current Assets 74,196,629 68,404,280 Noncurrent Assets Property, plant and equipment (Note 8) At cost - net 15,883,545 17,944,774 At appraised value 32,069,000 32,069,000 Retirement asset (Note 14) 297, ,225 Other noncurrent assets - net (Note 18) 2,551,475 5,100,950 Total Noncurrent Assets 50,801,813 55,484,949 TOTAL ASSETS P=124,998,442 P=123,889,229 LIABILITIES AND STOCKHOLDERS EQUITY Current Liabilities Accounts payable and accrued expenses (Note 9) P=5,895,931 P=11,619,014 Due to related parties (Note 10) 475,380 5,911,547 Income tax payable 2,658, ,432 Total Current Liabilities 9,030,170 18,213,993 Noncurrent Liability Deferred tax liabilities - net (Note 15) 717,508 1,083,988 Total Liabilities 9,747,678 19,297,981 Stockholders Equity Capital stock - P=1 par value Authorized - 200,000,000 shares Issued and outstanding - 115,000,000 shares 115,000, ,000,000 Revaluation increment in land (Notes 8 and 15) 2,565,948 2,565,948 Deficit (2,315,184) (12,974,700) Total Stockholders Equity 115,250, ,591,248 TOTAL LIABILITIES AND STOCKHOLDERS EQUITY P=124,998,442 P=123,889,229 See accompanying Notes to Financial Statements. 7

10 KEMWATER PHIL. CORP. STATEMENTS OF INCOME Years Ended December 31 NET SALES P=153,517,943 P=131,415,809 COST OF GOODS SOLD (Note 11) 124,922, ,811,617 GROSS INCOME 28,595,126 19,604,192 Operating expenses (Note 12) (14,377,996) (13,349,044) Interest income (Note 10) 1,721,711 1,238,897 Interest expense (Note 10) (10,775) Others - net 442,181 1,459,804 (12,224,879) (10,650,343) INCOME BEFORE INCOME TAX 16,370,247 8,953,849 PROVISION FOR INCOME TAX (Note 15) Current 6,077,211 2,796,698 Deferred (366,480) 87,426 5,710,731 2,884,124 NET INCOME P=10,659,516 P=6,069,725 See accompanying Notes to Financial Statements. 8

11 KEMWATER PHIL. CORP. STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY FOR THE YEARS ENDED DECEMBER 31, 2006 AND 2005 Revaluation Increment in Land (Notes 8 Capital Stock and 15) Deficit Total BALANCES AT DECEMBER 31, 2004 P=115,000,000 P=2,684,376 (P=19,044,425) P=98,639,951 Net income for the year 6,069,725 6,069,725 Effect of change in income tax rate (118,428) (118,428) BALANCES AT DECEMBER 31, ,000,000 2,565,948 (12,974,700) 104,591,248 Net income for the year 10,659,516 10,659,516 BALANCES AT DECEMBER 31, 2006 P=115,000,000 P=2,565,948 (P=2,315,184) P=115,250,764 See accompanying Notes to Financial Statements. 9

12 KEMWATER PHIL. CORP. STATEMENTS OF CASH FLOWS Years Ended December 31 CASH FLOWS FROM OPERATING ACTIVITIES Income before income tax P=16,370,247 P=8,953,849 Adjustments for: Depreciation and amortization (Note 8) 2,846,693 2,831,439 Amortization of deferred license fee (Notes 12 and 18) 2,549,475 2,549,475 Interest income (1,721,711) (1,238,897) Interest expense 10,775 Unrealized foreign exchange gains - net 162,840 Operating income before working capital changes 20,055,479 13,258,706 Decrease (increase) in: Receivables (2,880,131) 10,087,784 Due from related parties 1,648,380 (4,704,365) Inventories (1,277,022) (7,098,887) Prepaid expenses and other current assets 1,299,486 (609,630) Increase (decrease) in: Accounts payable and accrued expenses (5,723,083) 3,689,684 Due to related parties (5,436,167) 1,135,237 Liabilities under letters of credit and trust receipts (8,892,070) Retirement benefits cost 72,432 57,277 Net cash generated from operations 7,759,374 6,923,736 Interest received 1,721,711 1,092,974 Interest paid (10,775) Income taxes paid, including creditable withholding tax and final tax (4,271,819) (2,113,266) Net cash from operating activities 5,198,491 5,903,444 CASH FLOWS FROM INVESTING ACTIVITIES Additions to property, plant and equipment (Note 8) (785,464) (4,829,788) Increase in other noncurrent assets (213,836) Net cash used in investing activities (785,464) (5,043,624) NET INCREASE IN CASH AND CASH EQUIVALENTS 4,413, ,820 CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 4,038,172 3,178,352 CASH AND CASH EQUIVALENTS AT END OF YEAR (Note 4) P=8,451,199 P=4,038,172 See accompanying Notes to Financial Statements. 10

13 KEMWATER PHIL. CORP. NOTES TO FINANCIAL STATEMENTS 1. Corporate Information Kemwater Phil. Corp. (the Company), a 60%-owned company of LMG Chemicals Corp. (LMG or the parent company), was incorporated in the Philippines and is primarily engaged in the manufacture and trade of chemicals such as water and sewage treatment chemicals, inorganic coagulants for the paper industry and ground alum for the detergent industry. LMG is 73.93%-owned by Chemical Industries of the Philippines, Inc. (CIP), the ultimate parent company. The registered office address of the Company is Chemphil Building, 851 A. Arnaiz Avenue, Legaspi Village, Makati City. The accompanying financial statements of the Company were authorized for issue by the Board of Directors (BOD) on April 4, Summary of Significant Accounting and Financial Reporting Policies Basis of Preparation and Statement of Compliance The financial statements of the Company have been prepared on the historical cost basis, except for land which is carried at appraised value and are presented in Philippine peso, which is the Company s functional currency. The accompanying financial statements have been prepared in compliance with Philippine Financial Reporting Standards (PFRS). Changes in Accounting Policies The accounting policies adopted are consistent with those of the previous year, except that the Company has made changes in accounting policies resulting from adoption of the following new and revised standards and Philippine Interpretation International Financial Reporting Interpretations Committee (IFRIC) effective January 1, 2006: Amendments to Philippine Accounting Standard (PAS 19), Employee Benefits Actuarial Gains and Losses, Group Plans and Disclosures, provides additional option to recognize all actuarial gains and losses immediately outside of profit or loss (i.e., in equity). If the new option is adopted, present actuarial gains and losses in a statement of changes in equity titled Statement of Recognized Income and Expenses. The Company chose not to apply the new option to recognize all actuarial gains and losses immediately outside of profit or loss. Amendments to PAS 39, Financial Instruments: Recognition and Measurement, restricts the use of the option to designate any financial asset or any financial liability to be measured at fair value through the income statement. Amendment for financial guarantee contracts requires financial guarantee contracts that are not considered to be insurance contracts to be recognized initially at fair value and to be remeasured at the higher of the amount determined in accordance with PAS 37, Provisions, Contingent Liabilities and Contingent Assets, and the amount initially recognized less, when appropriate, cumulative amortization recognized in accordance with PAS 18, Revenue. 11

14 - 2 - Amendment for cash flow hedges of forecast intragroup transactions permits the foreign currency risk of a highly probable forecast intragroup transaction to qualify as the hedged item in a cash flow hedge, provided that the transaction is denominated in a currency other than the functional currency of the entity entering into that transaction and that the foreign currency risk will affect the statement of income. Amendment for the fair value option restricts the use of the option to designate any financial asset or any financial liability to be measured at fair value through the statement of income. Philippine Interpretation IFRIC 4, Determining Whether an Arrangement Contains a Lease, provides guidance in determining whether arrangements contain a lease to which lease accounting must be applied. The adoption of this interpretation did not have any significant impact on the Company s financial statements. The adoption of the revised accounting standards and new interpretations did not result to restatement of prior year s financial statements. Additional disclosures required by these revised standards and interpretation were included in the financial statements, where applicable. Future Changes in Accounting Policies The following are the new and revised accounting standards and interpretations that will become effective subsequent to 2006: PFRS 7, Financial Instruments: Disclosures, and the complementary amendment to PAS 1, Presentation of Financial Statements: Capital Disclosures (effective for annual periods beginning on or after January 1, 2007), introduces new disclosures to improve the information about financial instruments. It requires the disclosure of qualitative and quantitative information about exposure to risks arising from financial instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk, as well as sensitivity analysis to market risk. The amendment to PAS 1 introduces disclosures about the level of an entity s capital and how it manages capital. PFRS 8, Operating Segments (effective for annual periods beginning on or after January 1, 2009), requires a management approach to reporting segment information. PFRS 8 will replace PAS 14, Segment Reporting, and is required to be adopted only by entities whose debt or equity instruments are publicly traded, or are in the process of filing with the Securities and Exchange Commission for purposes of issuing any class of instruments in a public market. Philippine Interpretation IFRIC 7, Applying the Restatement Approach under PAS 29, Financial Reporting in Hyperinflationary Economies (effective for annual periods beginning on or after March 1, 2006), provides guidance on how to apply PAS 29 when an economy first becomes hyperinflationary, in particular the accounting for deferred tax. Philippine Interpretation IFRIC 8, Scope of PFRS 2 (effective for annual periods beginning on or after May 1, 2006), requires PFRS 2 to be applied to any arrangements where equity instruments are issued for consideration which appears to be less than fair value. 12

15 - 3 - Philippine Interpretation IFRIC 9, Reassessment of Embedded Derivatives (effective for annual periods beginning on or after June 1, 2006), establishes that the date to assess the existence of an embedded derivative is the date an entity first becomes a party to the contract, with reassessment only if there is a change to the contract that significantly modifies the cash flows. Philippine Interpretation IFRIC 10, Interim Financial Reporting and Impairment (effective for annual periods beginning on or after November 1, 2006), prohibits the reversal of impairment losses on goodwill and available-for-sale equity investments recognized in the interim financial reports even if impairment is no longer present at the annual balance sheet date. Philippine Interpretation IFRIC 11, PFRS 2 - Group and Treasury Share Transactions (effective for annual periods beginning on or after March 1, 2007), requires arrangements whereby an employee is granted rights to an entity s equity instruments to be accounted for as an equity-settled scheme by the entity even if (a) the entity chooses or is required to buy those equity instruments (e.g., treasury shares) from another party, or (b) the shareholders of the entity provide the equity instruments needed. It also provides guidance on how subsidiaries, in their separate financial statements, account for such schemes when the subsidiary s employees receive rights to the equity instruments of the parent. Philippine Interpretation IFRIC 12, Service Concession Arrangements (effective for annual periods beginning on or after January 1, 2008), covers contractual arrangements arising from private entities providing public services. The effects and required disclosures of these standards and interpretations, if any, will be included in the Company s financial statements when the Company adopts them. Cash and Cash Equivalents Cash includes cash on hand and in banks. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash with original maturities of three months or less and that are subject to an insignificant risk of changes in value. Financial Assets and Financial Liabilities Financial assets are classified as either financial assets at fair value through profit or loss, loans and receivables, held-to-maturity investments, and available-for-sale financial assets, as appropriate. Financial liabilities, on the other hand, are classified as either financial liabilities at fair value through profit or loss or other liabilities, as appropriate. When financial assets and financial liabilities are recognized initially, they are measured at fair value, plus, in the case of investments not at fair value through profit or loss, directly attributable transaction costs. The Company determines the classification after initial recognition and, where allowed and appropriate, reevaluates this designation at each balance sheet date. All regular way purchases and sales of financial assets are recognized on the trade date, which is the date that the Company commits to purchase the asset. Regular way purchases or sales are purchases or sales of financial assets that require delivery of assets within the period generally established by regulation or convention in the marketplace. 13

16 - 4 - Financial assets or financial liabilities at fair value through profit or loss Financial assets or financial liabilities classified in this category are designated by management on initial recognition when the following criteria are met: The designation eliminates or significantly reduces the inconsistent treatment that would otherwise arise from measuring the assets or recognizing gains or losses on them on a different basis, or The assets and liabilities are part of a group of financial assets and financial liabilities, respectively, or both financial assets and financial liabilities, which are managed and their performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, or The financial instrument contains an embedded derivative, unless the embedded derivative does not significantly modify the cash flows or it is clear, with little or no analysis, that it would not be separately recorded. Financial assets or financial liabilities classified as held for trading are included in the category financial assets or financial liabilities at fair value through profit or loss. Financial assets or financial liabilities are classified as held for trading if they are acquired for the purpose of selling in the near term. Derivatives are also classified as held for trading unless they are designated as effective hedging instruments. Gains or losses on investments held for trading are recognized in the statement of income. The Company has not designated any financial assets or financial liabilities as financial assets or liabilities at fair value through profit or loss. Held-to-maturity investments Non-derivative financial assets with fixed or determinable payments and fixed maturities are classified as held-to-maturity when the Company has the positive intention and ability to hold until maturity. After initial measurement, held-to-maturity investments are measured at amortized cost in the balance sheet. Investments intended to be held for an undefined period are not included in this classification. Other long-term investments that are intended to be held-to-maturity, such as bonds, are subsequently measured at amortized cost. This cost is computed as the amount initially recognized minus principal repayments, plus or minus the cumulative amortization using the effective interest rate method of any difference between the initially recognized amount and the maturity amount less allowance for impairment. Assets under this category are classified as current assets if maturity is within 12 months from the balance sheet date and noncurrent assets if maturity is more than a year. This calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums and discounts. For investments carried at amortized cost, gains and losses are recognized in the statement of income when the investments are derecognized or impaired, as well as through the amortization process. The Company has not designated any financial assets as held-to-maturity investments. 14

17 - 5 - Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments and fixed maturities that are not quoted in an active market. Such assets are carried at amortized cost using the effective interest rate method. Gains and losses are recognized in the statement of income when the loans and receivables are derecognized or impaired, as well as through the amortization process. Loans and receivables are included in current assets if maturity is within 12 months from the balance sheet date. Otherwise, these are classified as noncurrent assets. Classified as loans and receivables are the Company s trade receivables and due from related parties. Available-for-sale investments Available for sale investments are those non-derivative financial assets that are designated as available for sale or are not classified in any of the three preceding categories. After initial recognition, available-for-sale investments are measured at fair value with gains or losses being recognized as a separate component of equity until the investment is derecognized or until the investment is determined to be impaired at which time the cumulative gain or loss previously reported in equity is included in the statement of income. The Company has not designated any financial assets as available-for-sale financial assets. The fair value of investments that are actively traded in organized financial markets is determined by reference to quoted market bid prices at the close of business on the balance sheet date. For investments where there is no active market, fair value is determined using generally accepted valuation techniques. Such techniques include using recent arm s length market transactions; reference to the current market value of another instrument, which is substantially the same; discounted cash flow analysis and option pricing models. Other financial liabilities Other financial liabilities pertains to financial liabilities that are not held for trading or not designated as fair value through profit or loss upon the inception of the liability. These include liabilities arising from operations (e.g., payables, accruals). The liabilities are recognized initially at fair value and are subsequently carried at amortized cost, taking into account the impact of applying the effective interest method of amortization (or accretion) for any related premium, discount and any directly attributable transaction costs. Derecognition of Financial Assets and Financial Liabilities Financial Assets A financial asset (or, where applicable a part of a financial asset or part of a group of similar financial assets) is derecognized when: the rights to receive cash flows from the asset have expired; or the Company retains the right to receive cash flows from the asset, but has assumed an obligation to pay them in full without material delay to a third party under a pass-through arrangement; or 15

18 - 6 - the Company has transferred its rights to receive cash flows from the asset and either (a) has transferred substantially all the risks and rewards of the asset, or (b) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset. Where the Company has transferred its rights to receive cash flows from an asset and has neither transferred nor retained substantially all the risks and rewards of the asset nor transferred control of the asset, the asset is recognized to the extent of the Company s continuing involvement in the asset. Continuing involvement that takes the form of a guarantee over the transferred asset is measured at the lower of the original carrying amount of the asset and the maximum amount of consideration that the Company could be required to repay. Where continuing involvement takes the form of a written and/or purchased option (including a cash-settled option or similar provision) on the transferred asset, the extent of the Company s continuing involvement is the amount of the transferred asset that the Company may repurchase, except that in the case of a written put option (including a cash-settled option or similar provision) on an asset measured at fair value, the extent of the Company s continuing involvement is limited to the lower of the fair value of the transferred asset and the option exercise price. Financial Liabilities A financial liability is derecognized when the obligation under the liability was discharged, cancelled or expired. Where an existing financial liability is replaced by another financial liability from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability, and the difference in the respective carrying amounts is recognized in the statement of income. Impairment of Financial Assets The Company assesses at each balance sheet date whether or not a financial asset or group of financial assets is impaired. Assets Carried at Amortized Cost If there is objective evidence that an impairment loss on loans and receivables carried at amortized cost has been incurred, the amount of the loss is measured as the difference between the asset s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset s original effective interest rate (i.e. the effective interest rate computed at initial recognition). The carrying amount of the asset shall be reduced either directly or through the use of an allowance account. The amount of the loss shall be recognized in the statement of income. The Company first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If it is determined that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, the asset is included in a group of financial assets with similar credit risk characteristics and that group of financial assets is collectively assessed for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognized are not included in a collective assessment of impairment. 16

19 - 7 - If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized, the previously recognized impairment loss is reversed. Any subsequent reversal of an impairment loss is recognized in the statement of income to the extent that the carrying value of the asset does not exceed its amortized cost at the reversal date. In relation to trade receivables, a provision for impairment is made when there is objective evidence (such as the probability of insolvency or significant financial difficulties of the debtor) that the Company will not be able to collect all of the amounts due under the original terms of the invoice. The carrying amount of the receivable is reduced through the use of an allowance account. Impaired debts are derecognised when they are assessed as uncollectible. Assets Carried at Cost If there is objective evidence that an impairment loss on an unquoted equity instrument that is not carried at fair value because its fair value cannot be reliably measured, or on a derivative asset that is linked to and must be settled by delivery of such an unquoted equity instrument has been incurred, the amount of the loss is measured as the difference between the asset s carrying amount and the present value of estimated future cash flows discounted at the current market rate of return for a similar financial asset. Available-for-Sale Investments If an available-for-sale investments is impaired, an amount comprising the difference between its cost (net of any principal payment and amortization) and its current fair value, less any impairment loss previously recognized in statement of income, is transferred from equity to the statement of income. Reversals in respect of equity instruments classified as available-for-sale investments are not recognized in statement of income. Reversals of impairment losses on debt instruments are reversed through statement of income, if the increase in fair value of the instrument can be objectively related to an event occurring after the impairment loss was recognized in the statement of income. Offsetting of Financial Instruments Financial assets and financial liabilities are offset and the net amount reported in the balance sheet if, and only if, there is a currently enforceable legal right to offset the recognized amounts and there is an intention to settle on a net basis, or to realize the asset and settle the liability simultaneously. This is not generally the case with master netting agreements, and the related assets and liabilities are presented gross in the balance sheet. Inventories Inventories are valued at the lower of cost and net realizable value. Costs incurred in bringing each product to its present location and condition are accounted for as follows: Raw materials, spare parts and factory supplies Finished goods, work in process and merchandise inventories - cost is determined on a moving-average method - cost includes direct materials and labor and a proportion of manufacturing overhead costs Net realizable value of finished goods is the estimated selling price in the ordinary course of business, less estimated costs of completion, marketing and distribution. 17

20 - 8 - Cost of raw materials is the current replacement cost. Property, Plant and Equipment Property, plant and equipment, except land, are stated at cost, excluding the cost of day to day servicing less accumulated depreciation and amortization and any impairment in value. The initial cost of property, plant and equipment comprises its purchase price, including import duties, taxes and any other costs directly attributable to bringing the asset to its working condition and location for its intended use. Expenditures incurred after the property and equipment have been put into operation, such as repairs and maintenance, are normally charged to operations in the period such costs are incurred. In situations where it can be clearly demonstrated that the expenditures have resulted in an increase in the future economic benefits expected to be obtained from the use of an item of property, plant and equipment beyond its originally assessed standard of performance, the expenditures are capitalized as an additional cost of property, plant and equipment. Land are stated at revalued amounts based on a valuation performed by an independent firm of appraisers as of December 31, The increase in the valuation of these assets is credited to Revaluation increment in land net of related deferred tax liability, in the equity section of the balance sheets and in the statement of changes in stockholders equity. Revaluation is made with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. For subsequent revaluations, the land is restated to its revalued amount. Any resulting increase in the asset s carrying amount as a result of the revaluation is credited directly to Revaluation increment in land net of related deferred tax liability. Any resulting decrease is directly charged against any related revaluation increment to the extent that the decrease does not exceed the amount of the revaluation increment in respect of the same asset. Depreciation and amortization are calculated on a straight-line basis over the estimated useful life of the assets as follows: Years Land improvements 10 Plant, machinery and equipment 10 Buildings and structures 8 Transportation equipment 5 Office furniture and fixtures 2 The useful life, depreciation and amortization method and estimated residual values are reviewed periodically to ensure that these are consistent with the expected pattern of economic benefits from items of property and equipment. When assets are retired or otherwise disposed of, the cost and the related accumulated depreciation and amortization and impairment in value are removed from the accounts and any resulting gain or loss is credited to or charged against current operations. Impairment of Nonfinancial Assets The carrying values of non-financial assets are reviewed for impairment when events or changes in circumstances indicate that the carrying values may not be recoverable. If any such indication exists and where the carrying values exceed the estimated recoverable amounts, the assets are 18

21 - 9 - written down to their recoverable amounts. An asset s recoverable amount is the greater of net selling price and value-in-use. In assessing value-in-use, the estimated future cash flows are discounted to their present values using a pre-tax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. Any impairment loss is recognized in the statement of income. An assessment is made at each balance sheet date as to whether there is any indication that previously recognized impairment losses may no longer exist or may have decreased. If such indication exists, the recoverable amount is estimated. A previously recognized impairment loss is reviewed only if there has been a change in the estimates used to determine the asset s recoverable amount since the last impairment loss was recognized. If this is the case, the carrying amount of the asset is increased to its recoverable amount. The increased amount cannot exceed the carrying amount that would have been determined net of depreciation, had no impairment loss been recognized for the asset in prior years. Such reversal is recognized in the statement of income unless the asset is carried at a revalued amount, in which case the reversal is treated as a revaluation increase. After such a reversal, the depreciation expense is adjusted in future years to allocate the asset s revised carrying amount, less any residual value, on a systematic basis over its remaining life. License Fee License fee, presented as part of Other noncurrent assets in the balance sheet, is accounted for under the cost model. Costs incurred for the license agreement until November 2007 (see Note 18) have been capitalized and are amortized over the period covered by the agreement of 10 years until November The carrying value of the license fee is reviewed for impairment and any impairment loss is recognized in the statement of income. Retirement Benefits Cost Retirement benefits cost is actuarially determined using the projected unit credit method. This method reflects services rendered by employees up to the date of valuation and incorporates assumptions concerning employee s projected salaries. Actuarial valuations are conducted with sufficient regularity, with options to accelerate when significant changes to underlying assumptions occur. Retirement benefits cost include current service cost, interest cost, expected return on any plan assets, actuarial gains and losses, past service cost and the effect of any curtailment or settlement. Actuarial gains and losses are recognized as income or expense when the net cumulative unrecognized actuarial gains and losses of the defined benefit plan at the end of the previous reporting year exceeded 10% of the higher of the defined benefit obligation and the fair value of plan assets at that date. These gains and losses are recognized over the expected average remaining working lives of the employees participating in the defined benefit retirement plan. The net retirement asset recognized by the Company in respect of the defined benefit retirement plan is the lower of: (a) the present value of the defined benefit obligation at the balance sheet date less the fair value of the plan assets, together with adjustments for unrecognized actuarial gains or losses and past service costs that shall be recognized in later periods or (b) the total of any net cumulative unrecognized actuarial losses and past service cost and the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan. The defined benefit obligation is calculated annually by an independent 19

22 actuary using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting the estimated future cash outflows using risk-free interest rates of government bonds that have terms to maturity approximating to the terms of the related pension liability. On the initial adoption of PAS 19, the effect of change in accounting policy includes all actuarial gains and losses that arose in earlier periods that fall inside the 10% corridor limit. In subsequent periods, portion of actuarial gains and losses is recognized as income or expense if the net cumulative unrecognized actuarial gains and losses at the end of the previous reporting period exceeded the greater of the 10% of the present value of defined benefit obligation or 10% of the fair value of the plan assets. These gains and losses are recognized over the expected average remaining working life of the employees participating in the plans. Operating Lease The determination of whether the arrangement is, or contains a lease is based on the substance of the arrangement at inception date of whether the fulfillment of the arrangement is dependent on the use of a specific asset or assets or the arrangement conveys a right to use the asset. A reassessment is made after inception on the lease only if one of the following applies: (a) there is a change in contractual terms, other than a renewal or extension of the arrangement; (b) a renewal option is exercised or extension granted, unless the term of the renewal or extension was initially included in the lease term; (c) there is a change in the determination of whether fulfillment is dependent on a specified asset; or (d) there is substantial change to the asset. Where a reassessment is made, lease accounting shall commence or cease from the date when the change in circumstances gave rise to reassessment for scenarios (a), (c), or (d) and at the date of renewal or extension period for scenario (b). For arrangements entered prior to January 1, 2005, the date of inception is deemed to be January 1, 2005 in accordance with the transitional requirements of Philippine Interpretation IFRIC 4. Leases where the lessor retains substantially all the risks and benefits of ownership of the asset are classified as operating leases. Operating lease proceeds are recognized as income in the statement of income on a straight-line basis over the lease term. Provisions and Contingencies Provisions are recognized when the Company has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. If the effect of the time value of money is material, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability. Contingent liabilities are not recognized in the financial statements. These are disclosed unless the possibility of an outflow of resources embodying economic benefits is remote. A contingent asset is not recognized in the consolidated financial statements but disclosed when an inflow of economic benefit is probable. 20

23 Revenue Revenue is recognized to the extent that it is probable that the economic benefits will flow to the Company and the revenue can be reliably measured. The following specific recognition criteria must also be met before revenue is recognized: Sale of goods Revenue is recognized when the significant risks and rewards of ownership of the goods have passed to the buyer. Interest income Interest is recognized as interest accrues (using the effective interest rate method that is the rate that exactly discounts estimated future cash receipts through the expected life of the financial instrument to the net carrying amount of the financial asset). Foreign Currency Transactions and Translations Transactions denominated in foreign currencies are recorded in Philippine peso based on the exchange rates prevailing at the transaction dates. Foreign currency denominated monetary assets and liabilities are translated to Philippine peso at closing rates prevailing at the balance sheet date. Foreign exchange differentials between rate at transaction date, and rate at settlement date or balance sheet date of foreign currency-denominated monetary assets or liabilities are credited to or charged against current operations. Income Taxes Current Tax Current tax assets and liabilities for the current and prior periods are measured at the amount expected to be recovered from or paid to the taxation authorities. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted by the balance sheet date. Deferred Tax Deferred tax is provided using the balance sheet liability method, on temporary differences at the balance sheet date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax assets are recognized for all deductible temporary differences, carryforward benefits of unused tax credits from the excess of the minimum corporate income tax (MCIT) over the regular corporate income tax (RCIT) and net operating loss carryover (NOLCO) but only to the extent that it is probable that taxable profit will be available against which the deductible temporary differences and the carryforward benefits of unused tax credits from MCIT and NOLCO can be utilized. The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred tax assets to be utilized. Deferred tax assets are reassessed at each balance sheet date and are recognized to the extent that it has become probable that future taxable profit will allow the deferred tax assets to be recovered. 21

24 Deferred tax assets and liabilities are measured at the tax rates that are expected to apply in the year when the asset is realized or the liability is settled based on the tax rates that have been enacted or substantively enacted at the balance sheet date. Income tax relating to items recognized directly in equity is recognized in equity and not in the statement of income. Deferred tax assets and deferred tax liabilities are offset, if a legally enforceable right exists to set off current tax assets against current tax liabilities and the deferred taxes relate to the same taxable entity and the same taxation authority. Events After the Balance Sheet Date Post year-end events up to the date of the approval of the BOD that provide additional information about the Company s position at the balance sheet date (adjusting events) are reflected in the financial statements. Post year-end events that are not adjusting events are disclosed in the notes to the financial statements when material. 3. Significant Accounting Judgments and Estimates The preparation of the accompanying financial statements in conformity with PFRS requires management to make judgments, estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. The judgments, estimates and assumptions used in the accompanying financial statements are based upon management s evaluation of relevant facts and circumstances that are believed to be reasonable as of the date of the financial statements. While the Company believes that the assumptions are reasonable and appropriate, differences in the actual experience or changes in the assumptions may materially affect the estimated amounts. Actual results could differ from such estimates. The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods. Determination of the Company s functional currency The Company, based on the relevant economic substance of the underlying circumstances, has determined its functional currency to be the Philippine peso. It is the currency of the primary economic environment in which it operates. Classification of financial instruments The Company classifies a financial instrument, or its components, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset or an equity instrument. The substance of a financial instrument, rather than its legal form, governs its classification in the Company s balance sheet. 22

25 The Company determines the classification at initial recognition and reevaluates this classification, where allowed and appropriate, at every reporting date. Operating Lease - the Company as lessee The Company has entered into property leases, where it has determined that the risks and rewards related to those properties are retained with the lessors. As such, these lease agreements are accounted for as operating leases. Estimation of allowance for doubtful accounts Allowance for doubtful accounts is provided for accounts that are specifically identified to be doubtful as to collection. The level of allowance is evaluated by management on the basis of factors that affect the collectibility of the accounts. Receivables, net of allowance for doubtful accounts of P=303,520 in 2006 and P=165,776 in 2005, amounted to P=19,225,722 and P=16,345,591 as of December 31, 2006 and 2005, respectively (see Note 5). Determination of net realizable value of inventories The Group s estimates of the net realizable values of inventories are based on the most reliable evidence available at the time the estimates are made, of the amount that the inventories are expected to be realized. These estimates consider the fluctuations of price or cost directly relating to events occurring after the end of the period to the extent that such events confirm conditions existing at the end of the period. A new assessment is made of net realizable value in each subsequent period. When the circumstances that previously caused inventories to be written down below cost no longer exist or when there is a clear evidence of an increase in net realizable value because of change in economic circumstances, the amount of the write-down is reversed so that the new carrying amount is the lower of the cost and the revised net realizable value. The Company s inventories as of December 31, 2006 and 2005 amounted to P=24,933,540 and P=23,656,518, respectively (see Note 6). Valuation of land under revaluation basis The Group s land is carried at revalued amounts, which approximate their fair values at the date of the revaluation, less any subsequent accumulated impairment losses. The valuations of land are performed by professionally qualified appraisers. Revaluations are made every two to three years to ensure that the carrying amounts do not differ materially from those which would be determined using fair values at balance sheet date. Land at appraised value amounted to P=32,069,000 as of December 31, 2006 and Estimation of useful life and residual values of property, plant and equipment The Company estimates the useful life of its property, plant and equipment based on the period over which the assets are expected to be available for use. The Company reviews annually the estimated useful lives and residual values of property, plant and equipment based on factors that include asset utilization, internal technical evaluation, technological changes, environmental and anticipated use of the assets tempered by related industry benchmark information. It is possible that future results of operation could be materially affected by changes in these estimates brought about by changes in factors mentioned. A reduction in the estimated useful lives of property and equipment would increase depreciation expense and decrease noncurrent assets. 23

26 Recognition of deferred tax assets The Company reviews the carrying amounts at each balance sheet date and adjusts the balance of deferred tax assets to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred tax assets to be utilized. The Company s deferred tax assets amounted to P=768,384 and P=484,249 as of December 31, 2006 and 2005, respectively (see Note 15). Impairment of assets Internal and external sources of information are reviewed at each balance sheet date to identify indications that the following assets may be impaired or an impairment loss previously recognized no longer exists or may be decreased: Investments and other financial assets and Property, plant and equipment. If any such indication exists, the recoverable amount of the asset is estimated. An impairment loss is recognized whenever the carrying amount of an asset exceeds its recoverable amount. The Company assesses the impairment of assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The factors that the Company considers important which could trigger an impairment review include the following: Significant underperformance relative to expected historical or projected future operating results; and Significant negative industry or economic trends. The carrying value of the Company s property, plant and equipment amounted to P=15,883,545 and P=17,944,774 as of December 31, 2006 and 2005, respectively (see Note 8). Retirement benefits The determination of the obligation and cost of retirement benefits is dependent on the selection of certain assumptions used by independent actuary in calculating such amounts. Those assumptions are described in Note 14 and include among others, discount rates, expected returns on plan asset and salary increase rates. Actual results that differ from the Company s assumptions are accumulated and amortized over future periods and thereafter, generally affect the recognized expense and recorded obligation in such future periods. While the Company believes that the assumptions are reasonable and appropriate, significant differences in the actual experience or significant changes in the assumptions may materially affect the retirement obligations. The Company s retirement expense charged to operations amounted to P=72,432 in 2006 and P=57,277 in Net retirement assets as of December 31, 2006 and 2005 amounted to P=297,793 and P=370,225, respectively (see Note 14). 24

27 Provisions The Company provides for present obligations (legal or constructive) where it is probable that there will be an outflow of resources embodying economic benefits, that will be required to settle said obligations. An estimate of the provision is based on known information at balance sheet date, net of any estimated amount that may be reimbursed to the Company. If the effect of the time value of money is material, provisions are discounted using a current pre-tax rate that reflects the risks specific to the liability. The amount of provision is being re-assessed at least on an annual basis to consider new relevant information. No provision was made as of December 31, 2006 and Cash and Cash Equivalents Cash on hand and in banks P=2,451,199 P=4,038,172 Short term investments 6,000,000 P=8,451,199 P=4,038,172 Cash in banks earn interest at the respective bank deposit rates. Short-term investments are made for varying periods of up to three months depending on the immediate cash requirements of the Company, and earn interest at the respective short-term investment rates. 5. Receivables Trade P=17,342,458 P=15,964,917 Others 2,186, ,450 19,529,242 16,511,367 Less allowance for doubtful accounts (Note 12) 303, ,776 P=19,225,722 P=16,345, Inventories At cost: Merchandise on hand (Note 10) P=1,523,269 P=1,397,085 Work in process 1,023,144 At net realizable value: Finished goods 968,094 6,077,020 Raw materials: On hand (Note 10) 18,252,234 12,163,812 In transit 1,657,621 17,295 Spare parts and factory supplies in transit 2,532,322 2,978,162 P=24,933,540 P=23,656,518 25

28 Prepaid Expenses and Other Current Assets Input value-added taxes P=1,110,578 P=1,112,508 Prepaid expenses 738,444 1,886,687 Others 61,709 40,987 P=1,910,731 P=3,040, Property, Plant and Equipment 2006 Office Plant, Buildings Furniture Land Machinery and and Transportation and Construction Improvements Equipment Structures Equipment Fixtures In progress Total At Cost: Costs Beginning balances P=2,893,879 P=24,202,149 P=4,395,788 P=3,135,973 P=750,268 P=2,811,134 P=38,189,191 Additions 88,229 5, , ,464 Ending Balances 2,893,879 24,290,378 4,395,788 3,135, ,893 3,502,744 38,974,655 Accumulated Depreciation and Amortization Beginning balances 1,119,274 13,195,958 3,598,530 1,793, ,243 20,244,417 Depreciation and 289,389 1,783, , ,227 67,597 2,846,693 amortization Ending Balances 1,408,663 14,979,244 3,816,724 2,281, ,840 23,091,110 Net Book Values P=1,485,216 P=9,311,134 P=579,064 P=854,334 P=151,053 P=3,502,744 P=15,883, Office Plant, Buildings Furniture Land Machinery and and Transportation And Construction Improvements Equipment Structures Equipment Fixtures In progress Total At Costs Costs Beginning balances P=2,893,879 P=22,709,877 P=4,395,788 P=2,080,701 P=578,597 P=700,561 P=33,359,403 Additions 791,711 1,055, ,671 2,811,134 4,829,788 Reclassification 700,561 (700,561) Ending Balances 2,893,879 24,202,149 4,395,788 3,135, ,268 2,811,134 38,189,191 Accumulated Depreciation and Amortization Beginning balances 829,886 11,473,203 3,341,828 1,285, ,303 17,412,978 Depreciation and 289,388 1,722, , ,654 54,940 2,831,439 amortization Ending Balances 1,119,274 13,195,958 3,598,530 1,793, ,243 20,244,417 Net Book Values P=1,774,605 P=11,006,191 P=797,258 P=1,342,561 P=213,025 P=2,811,134 P=17,944,774 Land: At Appraised value P=32,069,000 P=32,069,000 Cost P=28,121,388 P=28,121,388 Plant, machinery and equipment with an aggregate cost of P=11,047,050 and P=9,251,630 were fully depreciated as of December 31, 2006 and 2005, respectively. These property and equipment are still being used in the Company s operations. 9. Accounts Payable and Accrued Expenses Trade (Note 10) P=3,476,231 P=9,024,789 Accrued operating expenses 1,354,424 1,209,573 Others 1,065,276 1,384,652 P=5,895,931 P=11,619,014 26

29 Related Party Transactions Significant transactions with related parties consist of: a. Purchase of merchandise inventories and raw materials in the ordinary course of business from its stockholders, Kemira Chemicals Oy of Finland (Kemira) and LMG, respectively. Total purchases from LMG amounted to P=25,457,446 in 2006 and P=20,148,400 in Total purchases from Kemira amounted to P=2,399,644 in 2006 and P=4,237,463 in b. Share in common costs and expenses under a plant support services agreement with LMG and a management support services agreement with CIP. The shared services fees are billed by LMG and CIP using activity-based costing, under which services rendered are based on manhours spent or number of items processed or output produced as applicable. The Company s share in common services, included under Cost of goods sold in the statements of income, under the agreement with LMG amounted to P=952,888 in 2006 and P=1,134,861 in The Company s share in common services, included under Operating expenses in the statements of income, under the agreement with CIP amounted to P=5,999,487 in 2006 and P=6,213,312 in c. Lease of its warehouse space from LMG for one year renewable at the option of both parties. Rental expense amounted to P=1,920,193 in 2006 and P=1,713,620 in 2005 (Note 11). d. Lease of its office space from CIP for one year renewable at the option of both parties. Rental expense amounted to P=223,072 in 2006 and P=216,254 in 2005 (Note 12). e. Noninterest-bearing and interest-bearing cash advances and reimbursable expenses with the parent company and affiliates. The interest-bearing cash advances bear interest of 8% in 2006 and 8% to 9.75% in Related interest income amounted to P=1,573,017 in 2006 and P=1,133,907 in Related interest expense amounted to P=922 in There were no interest expense in f. Compensation of key management personnel consists of short-term employee benefits and termination benefits amounting to P=2,771,934 and P=47,077, respectively, in 2006 and P=2,065,075 and P=30,152 in 2005, respectively. g. Outstanding balances of the related party accounts in the balance sheets are as follows: Advances Noninterest-bearing Interest-bearing Interest Receivable Total Total Due from: CAWC, Inc. (CAWC) P=18,347 P= P=18,650,000 P=14,426,616 P=194,685 P=437,633 P=18,863,032 P=14,864,249 CIP 464,148 8,390 6,130, , ,148 6,450,162 LMG 348, ,257 Vision Insurance Consultants, Inc. (VIC) 9,406 9,406 P=830,752 P=17,796 P=18,650,000 P=20,556,858 P=194,685 P=749,163 P=19,675,437 P=21,323,817 27

30 Noninterest-bearing Advances Due to : VIC P=456,214 P= LMG 5,911,547 Perfumeria Española Corp. (PEC) 19,166 P=475,380 P=5,911, Cost of Goods Sold Raw materials used (Note 10) P=94,402,229 P=92,051,513 Direct labor (Note 13) 2,888,397 2,440,716 Manufacturing overhead: Personnel expenses (Note 13) 3,190,712 2,910,681 Depreciation and amortization (Note 8) 2,676,379 2,689,422 Rent (Note 10) 2,633,921 2,678,817 Communication, light and water 2,592,046 2,313,840 Repairs and maintenance 1,999,176 2,406,613 Share in common services (Note 10) 952,888 1,134,861 Insurance 490, ,279 Others 4,386,945 4,789,238 Changes in finished goods and semi-processed inventories 6,090,966 (5,289,148) Cost of merchandise inventories sold 2,619,125 3,134,785 P=124,922,817 P=111,811, Operating Expenses Share in common services (Note 10) P=5,999,487 P=6,213,312 Amortization of deferred license fee (Note 18) 2,549,475 2,549,475 Personnel expenses (Note 13) 2,009,358 1,997,587 Outside services 1,389,010 1,292,490 Insurance 713, ,411 Communication, light and water 286, ,437 Taxes and licenses 286, ,217 Rent (Note 10) 223, ,254 Depreciation and amortization (Note 8) 170, ,017 Provision for doubtful accounts (Note 5) 137,744 Entertainment, amusement and recreation 37,124 66,780 Others 575, ,064 P=14,377,996 P=13,349,044 28

31 Personnel Expenses Salaries and other compensation P=7,825,433 P=7,176,853 Retirement benefits cost (Note 14) 72,432 57,277 Other employee benefits 190, ,854 P=8,088,467 P=7,348, Retirement Benefits Cost The Company, together with its affiliated companies, is participating in a funded and noncontributory defined benefit retirement plan covering substantially all its regular employees. The benefits are based on the years of service and latest monthly compensation of the employees. Net retirement benefits cost recognized in the statements of income are as follows: Current service cost P=78,965 P=78,630 Interest cost 168, ,116 Expected return on plan assets (174,887) (164,469) Net retirement benefits cost for the year P=72,432 P=57,277 Actuarial return on plan assets P=1,184,280 P=164,469 Net retirement assets recognized by the Company as of December 31, 2006 and 2005 are as follows: Fair value of plan assets P=564,593 P=1,748,873 Present value of retirement liabilities 789,324 1,414,379 (224,731) 334,494 Net cumulative unrecognized actuarial loss 522,524 35,731 Net retirement assets P=297,793 P=370,225 Movements in the retirement assets for during the years ended December 31, 2006 and 2005 are as follows: Balance at beginning of year P=370,225 P=213,670 Retirement benefits cost (72,432) (57,277) Actual contributions 213,832 Balance at end of year P=297,793 P=370,225 29

32 Changes in the present value of retirement liabilities are as follows: Balance at beginning of year P=1,414,379 P=1,192,633 Interest cost 168, ,116 Current service cost 78,965 78,630 Actuarial gain for the year (872,374) Balance at end of year P=789,324 P=1,414,379 Changes in fair value of plan assets are as follows: Balance at beginning of year P=1,748,873 P=1,370,572 Expected return on plan assets 174, ,469 Actual contributions 213,832 Actuarial loss for the year (1,359,167) Balance at end of year P=564,593 P=1,748,873 The major categories of plan assets of the Company as a percentage of the fair value of the plan assets as of December 21, 2006 are as follows: Investment in government securities 58% Investment in stocks 12% Other investments 25% Other assets 5% The overall expected return on the plan assets is determined based on the market prices prevailing on the date applicable to the period over which the obligation is to be settled. There has been no change in the expected rate of return on plan assets. The principal assumptions used in determining retirement benefits costs for the Company s plans are as follows as of January 1 of each year: Number of employees Discount rate per annum 12% 12% Expected annual rate of return on plan assets 12% 12% Future annual increase in salary 6% 6% As of December 31, 2006, the following are the assumptions: discount rate of 8%, expected annual rate of return on plan assets of 10% and future annual increase in salary of 6%. Amount for the current and previous years are as follows: Defined benefit obligations P=789,324 P=1,414,379 Fair value of plan assets 564,593 1,748,873 Unfunded (funded) retirement obligation 224,731 (334,494) Experience adjustment on plan liabilities 263,421 Experience adjustment on plan assets (1,359,167) 30

33 Income Taxes a. The Company s net deferred tax assets and liabilities are as follows: Deferred tax assets on: Allowance for doubtful accounts P=106,232 P=58,021 Allowance for probable inventory losses 192, ,371 Accrued expenses 275,521 Unamortized past service cost 194, , , ,249 Deferred tax liabilities on: Revaluation increment in land 1,381,664 1,381,664 Retirement asset 104, ,579 Unrealized foreign exchange gain - net 56,994 1,485,892 1,568,237 P=717,508 P=1,083,988 Management, however, believes that it is improbable that any deferred tax liability will arise from revaluation of land since it is unlikely that the revalued property will be sold, exclusive of the business, in the foreseeable future. b. The reconciliation of the statutory income tax, computed by multiplying income before income tax by the statutory tax rate, and the provision for income tax shown in the statements of income is as follows: Statutory income tax P=5,729,586 P=2,910,001 Adjustments for: Interest income already subjected to final tax at lower rates (22,304) (16,406) Nondeductible portion of interest expense 3,449 Effect of change in income tax rate (9,471) Provision for income tax P=5,710,731 P=2,884,124 c. The components of the Company s provision for income tax-current are as follows: RCIT P=6,047,473 P=2,770,451 Final tax on interest income 29,738 26,247 P=6,077,211 P=2,796,698 d. On May 24, 2005, the new Expanded-Value Added Tax (E-VAT) law was signed as Republic Act (RA) No or the E-VAT Act of The E-VAT law took effect on November 1, 2005 following the approval on October 19, 2005 of Revenue Regulations (RR) No which provides for the implementation of the rules and regulations of the new E-VAT law. Among the relevant provisions of the new E-VAT law are: 31

34 i. change in RCIT rate from 32% to 35% for the next three years effective on November 1, 2005, and 30% starting on January 1, 2009 and thereafter; ii. a 70% cap on the input VAT that can be claimed against output VAT; iii. increase in the VAT rate imposed on goods and services from 10% to 12% effective January 1, 2006 provided that the VAT collection as a percentage of Gross Domestic Product (GDP) of the previous year exceeds 2.8% or the Philippine national government deficit as a percentage of GDP of the previous year exceeds 1.5%; and iv. The amount of interest paid or incurred within a taxable year on indebtedness in connection with the taxpayer s profession, trade or business shall be allowed as a deductible from gross income, provided that, the taxpayer s otherwise unallowable deduction for interest expense shall be reduced by 42% of the interest income subject to final tax, provided that, effective January 1, 2009, the rate shall be 33%. On January 31, 2006, the President, upon recommendation of the Secretary of Finance, approved the 2% increase in VAT rate effective on February 1, On November 21, 2006, the President signed into law RA No which amends Section 110 (B) of the Tax Code. This law, which became effective on December 13, 2006, provides that if the input tax, inclusive of the input tax carried over from the previous quarter exceeds the output tax, the excess input tax shall be carried over to the succeeding quarter or quarters. The Department of Finance through the Bureau of Internal Revenue, issued RR No to implement the provisions of the said law. Based on the regulation, the amendment shall apply to the quarterly VAT returns to be filed after the effectivity of RA No except VAT returns covering taxable quarters ending earlier than December Financial Risk Management Objectives and Policies The Company s principal financial instruments comprise of cash and cash equivalents and due to/from related parties. The Company has various other financial assets and financial liabilities such as trade receivables and trade payables, which arise directly from its operations. The main risks arising from the Company s financial instruments are cash flow interest rate risk, foreign currency risk, credit price risk and liquidity risk. The BOD reviews and approves the policies for managing each of these risks and they are summarized below: Cash flow interest rate risk The Company s exposure to the risk for changes in market interest rates relates primary to the Company s due to related parties. The interest rate risk is somehow mitigated since the annual interest rate is still subject to mutual agreement by both parties. The other financial instruments are not subject, to interest rate risk as they are noninterest-bearing. Foreign currency risk The Company has transactional currency exposures. Such exposure arises from purchases in currencies other than the Company s functional currency. Approximately 10.65% of the Company s purchases are denominated in currencies other than the functional currency. 32

35 Credit price risk The Company trades only with recognized, creditworthy third parties. It is the Company s policy that all customers that wish to trade on credit terms are subject to credit verification procedures. In addition, receivable balances are monitored on an on-going basis with the result that the Company s exposure to bad debts is not significant. For transactions that are not denominated in the functional currency, the Company does not offer credit terms without the specific approval of the Head of Credit Control. Since the Company trades only with recognized third parties, there is no requirement for collateral. Liquidity risk The Company s objective is to maintain a balance between continuity of funding and flexibility. The Company avails credit facilities from related parties and maximizes the net cash inflows from operations to finance its working capital requirements. 17. Financial Assets and Financial Liabilities Set out below is a comparison by category of carrying amounts and fair values of all of the Company s financial instruments that are carried in the financial statements: Carrying Amount Fair Value Financial assets: Cash and cash equivalents P=8,451,199 P=4,038,172 P=8,451,199 P=4,038,172 Trade receivables 17,342,458 15,964,917 17,342,458 15,964,917 Due from related parties 19,675,437 21,323,817 19,675,437 21,323,817 P=45,469,094 P=41,326,906 P=45,469,094 P=41,326,906 Financial liabilities: Trade payables P=3,476,231 P=9,024,789 P=3,476,231 P=9,024,789 Due to related parties 475,380 5,911, ,380 5,911,547 P=3,951,611 P=14,936,336 P=3,951,611 P=14,936,336 The carrying amounts of cash and cash equivalents, trade receivables and payables and due to/from related parties approximate their fair values either because of their short-term nature or the interest rates that they carry which approximate the interest rate for comparable instruments in the market. 18. License Agreement with Kemira The Company has a license agreement (the Agreement) with Kemira for 10 years until November 2007, to manufacture and sell water treatment chemicals by using product technology developed and to be developed by Kemira. Under the Agreement, the Company will pay US$550,000 covering license fees, basic designs, commissioning and start-up of a new aluminum sulfate plant; management and marketing; technical support; and production know-how. The license fee amount in the Agreement was later reduced to US$400,

36 Total license fee payments made by the Company amounting to US$300,000 or P=11,331,000 (net of taxes), as of December 31, 2003, were deferred and shown as Other noncurrent assets account in the balance sheets. Amortization of deferred license fee charged to operations presented under Operating Expenses amounted to P=2,549,475 in 2006 and Registration with the Board of Investments (BOI) The Company is registered with the BOI as a preferred nonpioneer enterprise for the Aluminum Sulfate Modernization Project. Under the terms of the registration, the Company is entitled to tax and nontax incentives and is subject to certain requirements. There were no incentives availed of in 2006 and Number of employees Discount rate per annum 12% 12% 12% Expected annual rate of return on plan assets 12% 12% 12% Future annual increase in salary 6% 6% 6% As of December 31, 2006, the following are the assumptions: discount rate of 8%, expected annual rate of return on plan assets of 10% and future annual increase in salary of 6%. Amount for the current and previous years are as follows: 2004 Defined benefit obligations P=789,324 P=1,414,379 P=1,192,633 Fair value of plan assets 564,593 1,748,873 1,370,572 Unfunded retirement obligation 224,731 (334,494) (177,939) Experience adjustment on plan liabilities 263,421 Experience adjustment on plan assets (1,359,167) 34

37 Board of Directors Alexandra G. Garcia Jaime Y. Gonzales Antonio M. Garcia Chairman of the Board Jesus N. Alcordo Juha Kuikka Ana Maria G. Ordoveza President & Chief Executive Officer Per Andersson Gunnar S. Smith Ramon Y. Navarro Executive Officers Antonio M. Garcia - Chairman of the Board Ana Maria G. Ordoveza - President and Chief Executive Officer Alexandra G. Garcia - Chief Operating Officer Jaime Y. Gonzales - Treasurer & Chief Financial Officer Ramon Y. Navarro - General Manager Dennis S. Dumanat - Managing Consultant, Operations Division Head Reynaldo C. Rafael - Secretary 35