Board of Directors Report

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3 Board of Directors Report was a year full of achievements and one in which Interceramic accomplished many of its goals, the Company closed the year with excellent financial results with record Sales and EBITDA figures, consistently generating sustainable growth and strengthening the Company's position in the markets within which it operates At US $406.0 million, consolidated sales for were 19.0 percent higher than sales in of US $341.2 million, putting the threshold of half a billion dollars of sales firmly in our sights. Despite having to pay US $4.9 million more for electricity and natural gas during than we did in, the Company was still able to achieve a key 33.0 percent growth in operating income during the year compared to. This is even more impressive taking into consideration the fact that since 2003 Interceramic s cost of energy has risen by a total of almost US $10.0 million, yet our EBITDA over that same period was up by US $16.1 million. A number of other developments occurred over the year, including the completion of our fourth production facility in Chihuahua, the opening of three new Companyowned stores in the United States markets of Sacramento and Manteca, California, and Denver, Colorado, as well as the opening of 20 new stores in Mexico, of which 11 are owned by the Company and nine are new independent franchise stores. The new plant in Mexico has boosted our production capacity by about 25 percent, and this stateoftheart facility is already operating at full capacity with very high efficiencies and our highestever levels of quality production. For the year, our gross income for at US $146.6 million was 20.5 percent better than that of US $121.6 for. Operating income of US $30.3 million was far better than we have ever achieved, and a good 33.0 percent ahead of operating income of US $22.8 million generated last year. The Company s operating margin continued to climb up as well, ending the year at 7.5 percent compared to 6.7 percent in. While overall EBITDA would be hard pressed to match the increase posted in the fourth quarter, for the year it still grew by 27.4 percent over, reaching US $52.3 million in compared to US $41.0 million in. The new production facility in Chihuahua resulted in an increased volume of manufactured product during of 11.6 percent up to 29.3 million square meters, while overall we sold 33.4 million square meters of products over the course of the year. Our yearend debt to EBITDA ratio reflected the excellent results for the year, ending at 2.3 compared to 2.8 at the end of. innovative products in the marketplace, such as our coloured body porcelain products. In Mexico, we have pursued an aggressive marketing campaign designed to bring consumers into our more than 200 showrooms nationwide, where we find that our product presentation in concert with the sophisticated array of Kohler bathroom and kitchen fixtures is very important in obtaining consumer commitment to the Interceramic brand. In the United States, where the market is less consumer driven than in Mexico, we work with building contractors, interior decorators and flooring distributors and professionals to learn about and select Interceramic products for their clients and customers. We also continue to focus on customer service in a number of areas, including our new comprehensive integrated information systems, extensive training of our sales staff from toptobottom, and the availability of consumer education seminars and programs designed to increase awareness of the many exciting and bold uses of our tile products. While we at Interceramic are thankful that the last several years have shown steady growth and constantly improving financial condition, the year was a truly defining achievement for the Company. We believe that in this year, all the Company has put in place over preceding periods has finally come together to allow Interceramic to post the kind of marked annual financial improvement that we have been working towards for some time. All trends continue to bode well for us, and with the tremendous boost from the fourth quarter of we have the greatest of expectations for As always, we thank our investors, customers and employees for their continued support. Oscar E. Almeida Chabre Chairman of the Board Víctor D. Almeida García Vicechairman / Chief Executive Officer Assessed domestically and Internationally, Interceramic showed impressive gains in each market, both for the quarter and the year. In, sales in Mexico of US $230.5 million grew by 21.1 percent over sales in Mexico for of US $190.4 million. The amount of product sold in Mexico during as compared to increased nicely too up by about 13 percent and we believe that we are gaining significant market share in Mexico, growing at a faster pace than our competitors. In the International markets, primarily the United States, for all of, Interceramic s International sales were US $175.5 million, an increase over last year s sales of US $150.8 million by 16.3 percent. The amount of product sold by the Company Internationally increased as well, up by almost ten percent to about 11.9 million square meters. Overall growth in sales affirms the Company s growth strategy, as we made considerable gains through our expanded Companyowned distribution in both the United States and Mexico, while at the same time making improvements through independent distribution in each market as well. The key feature of our strategy continues to be innovation, attracting more consumers and securing better pricing through the offering of the most technologically and stylistically 1

4 Report of the Audit Committee for the year ended December 31, The Management of Internacional de Cerámica, S.A. de C.V. is responsible for the internal controls of all of the internal processes of the company, including the preparation and finalization of all of the company s financial information. Mancera, S.C. (Member of Ernst & Young Global), as the external auditors of Internacional de Cerámica, S.A. de C.V., is responsible for the examination of the annual consolidated financial statements, in accordance with generally accepted accounting principles, and further must prepare a report as to said financial statements detailing the financial situation of the company, also in compliance with generally accepted accounting principles in Mexico, and, also, through a reconciliation note, with the generally accepted accounting principles in the Unites States. The Audit Committee watches over and supervises these processes and also recommends to the Board of Directors, for its approval, the office of independent accountants to be used as the external auditors for the Company. As part of this vigilance process, the Committee meets with the company s Management and with the external independent auditors, for the purpose of discussing the effectiveness of the internal controls which are applied to the operations and financial processes of the company, as well as to evaluate the accounting policies and practices and the results derived from the annual audits. Apart from meeting with Management and with the external, independent auditors, the Audit Committee undertook the following activities: It was in agreement with and ratified the selection of Mancera, S.C., as the external auditor for Internacional de Cerámica, S.A. de C.V., so it could examine the Company s consolidated financial statements and subsequently prepare and finalize a report, same which shall be presented for approval at the Annual Shareholders Meeting to take place on March 31, The consolidated financial statements for the year ended December 31, were reviewed and discussed with the Board of Directors and with the external auditors. Discussions were held with the independent auditors regarding the auditing of the consolidated financial statements of Internacional de Cerámica, S.A. de C.V., specifically as to the depth and reach of the audit, any observations to be made, and the results derived from the auditing process. The economic independence and related criteria for the independent auditors was reviewed and evaluated. All transactions which the company undertook with related parties were reviewed and evaluated, and a determination was made that said transactions were no more or less favorable to the company as if those transactions would have taken place with any other supplier or party. Based on the discussions which took place between Management and the independent auditors, the disclosures made on the financial statements report, the statements made by Management to this Auditors Committee, and the report of the independent auditors, this Audit Committee recommended to the Board of Directors that the consolidated financial statements for the year ended December 31, be presented for approval at the Annual Shareholders Meeting to take place on March 31, CP Humberto Valles Hernández President 2

5 Net Sales (Million of Nominal US Dollars) Gross Profit and Margin (Million of Nominal US Dollars) Mexico International Operating Income and Margin (Million of Nominal US Dollars) EBITDA (Million of Nominal US Dollars) Debt Service (Million of Nominal US Dollars) Net Debt to EBITDA (Million of Nominal US Dollars) 3

6 Manufacturing plants and Distribution network After almost 27 years of operations, today Interceramic has eight plants in four manufacturing complexes; three of them located in Chihuahua, México and a fourth in Garland, TX in the United States, with a total annual capacity of 33.0 million square meters of ceramic floor and wall tile. In the United States and Canada Interceramic products are distributed through more than 100 independent distributors, as well as 23 companyowned showrooms (International Tile and Stone Galleries) in the states of Texas, Georgia, Arizona, Nevada, New Mexico, California, Oklahoma and Colorado. In Mexico, Interceramic products are distributed through a unique franchise network with more than 200 stores located nationwide, offering consistency in quality of products and excellence of service. Interceramic showrooms display product in unique lifesize vignettes with different design ideas to accommodate every taste. 4

7 Technology In June of, Interceramic began operating its eighth manufacturing facility. The investment of this new plant was approximately 27.0 million dollars. This plant, which was designed by our engineers in collaboration with SACMI the manufacturing leader of machinery for the production of ceramic tile, is the most sophisticated in the world to date. It has the most advanced glazing equipment to accomplish the newest looks in demand in the market. Its highly productive electronic kilns are the largest in America. An electronic selection equipment with English and Italian technology guarantees world quality. Finished product is handled by automation and laser operated robots. Plant 8 has the largest mill in America; its oneofkind spray drier was designed to maximize production efficiency. A closedcircuit system in its presses provides great flexibility to make size changes according to market demand. 5

8 Service More than 3,900 employees have made the Interceramic name a synonym of Quality, Innovation and Service. Our unique franchise distribution network has made it possible for our service philosophy to reach the end consumer consistently throughout Mexico. 6

9 Mission Provide our customers with the most innovative, highquality ceramic tile and related products, and world class customer service by recruiting a highly qualified team, through the effective use of creative sales strategies and by using and efficient technologydriven distribution network. Vision Be the best manufacturer and distributor of ceramic tile and related products in the world, providing our customers with total satisfaction through commitment to our values of respect, loyalty, humility, and honesty. We will dedicate ourselves to working responsibly, communicating effectively, and working together as a team. We will create high value for our shareholders through effective leadership, strategic partnership, by recruiting the best people, and by using the best technology and distribution systems available worldwide.

10 Innovation Interceramic has its own Research & Development Center and a staff dedicated to the research for innovation in all fields of ceramic tile manufacturing, from the original concept to raw materials, machinery and manufacturing processes. This has enabled the company to offer the market aesthetically sophisticated products that constantly exceed customer s expectations. A commitment to constant renewal, quality, innovation and service make Interceramic a stateoftheart company competing in the world market with the finestquality products. 8

11 Social Responsability At Interceramic, the orderly and sustainable development of its day to day activities and operations is a top priority, same which has been strengthened with the implementation of the policies and standards set out for Socially Responsible Companies. This is why at Interceramic we carry out Social Responsibility not only in areas external to the Company, but also internally with all of the Company s collaborators with the firm goal of continuing to be a competitive and socially conscious Company. The main principles for Social Responsibility at Interceramic are as follows: 1). Quality of Life, providing a favorable, stimulating, creative and inclusive work environment, attaining professional and human development of all of the Company s collaborators and any person in any way related to the Company. 2). Corporate Ethics, with principles that guide and guarantee the transparent operation of the Company and its relationships with clients, suppliers, government authorities and the community at large. 3). Conservation and Care, of the environment through the application of practices and procedures which reflect respect towards the world that surrounds us, promoting the optimum use of resources and likewise promoting the minimization and recycling of waste products. 4). Community Ties, creating synergies for the solution of social problems, including direct participation with the Foundation Vida Digna, A.C., which seeks to improve the quality of life of children living in the Tarahumara Sierra by providing better education and health resources for those children. Being a Socially Responsible Company reflects the integration into our business strategies of a socially responsible vision based on policies and procedures which allow the Company to go above and beyond the minimum legal requirements so that in doing so it can contribute to the sustainable development of Mexico and of our Society. 9

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13 Consolidated Balance Sheets as of December 31, and (In thousands of Mexican pesos of purchasing power of December 31, ) December 31, Assets Current assets: Cash and cash equivalents Ps. 199,317 Ps. 132,890 Thousands of U.S. dollars US$ 12,449 Accounts receivable: Trade Due from related parties Other accounts receivable Less: allowance for doubtful accounts 375,102 43,450 22,038 ( 18,319) 422, ,688 50,271 58,671 ( 24,301) 495,329 38,472 4,709 5,496 ( 2,276) 46,401 Inventories, net Prepaid expenses and other current assets Total current assets 1,128,978 26,451 1,777,017 1,289,044 38,796 1,956, ,754 3, ,238 Investment in shares of associated companies 7,734 6, Property, plant and equipment Less: accumulated depreciation 4,359,326 ( 1,842,489) 2,516,837 4,267,756 ( 2,027,334) 2,240, ,790 ( 189,914) 209,876 Goodwill Other assets 52,078 93,723 52, ,996 4,964 11,616 Total assets Ps. 4,447,389 Ps. 4,379,802 US$ 410,288 See accompanying notes to consolidated financial statements 11

14 Consolidated Balance Sheets as of December 31, and (In thousands of Mexican pesos of purchasing power of December 31, ) December 31, Liabilities Current liabilities: Notes payable to financial institutions Current portion of longterm debt Trade accounts payable Due to related parties Accrued expenses and taxes other than income taxes Income tax payable and employee statutory profit sharing Total current liabilities Ps. 273, , ,499 21, ,992 6, ,586 Ps , ,713 23, ,640 8, ,975 Thousands of U.S. dollars US$ 47 7,304 29,762 2,214 17, ,328 Longterm debt Labor obligations Deferred income tax Total liabilities 821,357 48, ,438 2,367,605 1,217,049 53, ,817 2,286, ,009 5,057 37, ,222 Stockholders equity Common stock Premium on common stock Stock repurchase reserve Retained earnings Cumulative comprehensive loss Majority stockholders equity Minority stockholders equity Total stockholders equity 799,729 1,815, , ,590 ( 1,486,401) 1,785, ,024 2,079, ,729 1,815, , ,543 (1,731,289) 1,823, ,934 2,092,990 74, ,110 17,064 70,871 ( 162,182) 170,779 25, ,066 Total liabilities and stockholders equity Ps. 4,447,389 Ps. 4,379,802 US$ 410,288 See accompanying notes to consolidated financial statements 12

15 Consolidated Statements of Income For the years ended December 31, 2003, and (In thousands of Mexican pesos of purchasing power of December 31,, except per unit amounts) 2003 Years ended December 31, Thousands of U.S. dollars Net sales Cost of sales Gross profit Ps. 3,639,633 ( 2,376,574) 1,263,059 Ps. 3,996,175 ( 2,570,960) 1,425,215 Ps. 4,461,986 ( 2,850,928) 1,611,058 US$ 417,985 ( 267,066) 150,919 Operating expenses Operating income ( 1,019,532) 243,527 ( 1,157,468) 267,747 ( 1,279,245) 331,813 ( 119,836) 31,083 Comprehensive financing (cost) income: Interest income Interest expense Foreign exchange (loss) gain, net Monetary position gain 8,806 ( 84,860) ( 97,264) 54,378 ( 118,940) 13,749 ( 80,620) 19,884 60,471 13,484 14,258 ( 113,790) 53,940 46, ,336 ( 10,659) 5,053 4, Other income (expense), net Income before income taxes and employee statutory profit sharing ( 8,716) 115,871 ( 405) 280,826 ( 24,433) 308,163 ( 2,289) 28,868 Income tax expense Employee statutory profit sharing Consolidated net income Net income of minority stockholders Net income of majority stockholders ( 49,766) 66,105 31,869 Ps. 34,236 ( 56,710) ( 1,166) 222,950 39,534 Ps. 183,416 5, ,787 31,603 Ps. 282, ,395 2,960 US$ 26,435 Weighted average number of shares Ceramic B and Ceramic D outstanding (in thousands) Net income per unit 99,111 Ps ,746 Ps ,664 Ps ,664 US$ 0.16 See accompanying notes to consolidated financial statements 13

16 INTERNACIONAL DE CERAMICA, S.A. DE C.V.AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders Equity For the years ended December 31, 2003, and (In thousands of Mexican pesos of purchasing power of December 31, ) Balance at December 31, 2002 Repurchase of common stock Minority cash dividend Comprehensive income: Net income Minimum pension liability Result from holding non monetary assets Result from translation of foreign subsidiaries Comprehensive income Balance at December 31, 2003 Increase of stock repurchase reserve Paid in capital Unrealized profits by the acquisition of subsidiaries Minority cash dividend Comprehensive income: Net income Minimum pension liability Result from holding non monetary assets Result from translation of foreign subsidiaries Comprehensive income Balance at December 31, Decrease of stock repurchase reserve Minority cash dividend Comprehensive income: Net income Minimum pension liability Result from holding non monetary assets Result from translation of foreign subsidiaries Comprehensive income Balance at December 31, Thousands of U.S. dollars Common Stock Ps. 770,248 ( 4,910) Ps. 765,338 34,391 Ps. 799,729 Ps. 799,729 $ 74,916 Premium on common stock Ps. 1,338,865 Ps. 1,338, ,055 Ps. 1,815,920 Ps. 1,815,920 $ 170,110 Stock repurchase reserve Ps. 193,862 ( 51,724) Ps. 142,138 49,784 Ps. 191,922 ( 9,769) Ps. 182,153 $ 17,064 Retained earnings Ps. 311,612 34,236 Ps. 345,848 ( 49,784) ( 14,890) 183,416 Ps. 464,590 9, ,184 Ps. 756,543 $ 70,871 Cumulative comprehensive loss Ps. ( 1,606,242) ( 1,089) 55,479 19,972 Ps. ( 1,531,880) ( 441) 43,459 2,461 Ps. ( 1,486,401) ( 4,774) ( 206,950) ( 33,164) Ps. ( 1,731,289) $ ( 162,182) Comprehensive Income Ps. 34,236 ( 1,089) 55,479 19,972 Ps. 108, ,416 ( 441) 43,459 2,461 Ps. 228, ,184 ( 4,774) ( 206,950) ( 33,164) Ps. 37,296 Majority stockholders equity Ps. 1,008,345 ( 56,634) 34,236 ( 1,089) 55,479 19,972 Ps. 1,060, ,446 ( 14,890) 183,416 ( 441) 43,459 2,461 Ps. 1,785, ,184 ( 4,774) ( 206,950) ( 33,164) Ps. 1,823,056 $ 170,779 Minority stockholders equity Ps. 227,850 ( 17,163) 31,869 16,357 Ps. 258,913 ( 17,565) 39,534 13,142 Ps. 294,024 ( 32,348) 31,603 ( 23,345) Ps. 269,934 $ 25,287 Total stockholders equity Ps. 1,236,195 ( 56,634) ( 17,163) 66,105 ( 1,089) 71,836 19,972 Ps. 1,319, ,446 ( 14,890) ( 17,565) 222,950 ( 441) 56,601 2,461 Ps. 2,079,784 ( 32,348) 313,787 ( 4,774) ( 230,295) ( 33,164) Ps. 2,092,990 $ 196,066 See accompanying notes to consolidated financial statements 14

17 Consolidated Statements of Changes in Financial Position For the years ended December 31, 2003, and (In thousands of Mexican pesos of purchasing power of December 31, ) Years ended December 31, Operating activities Net income of majority stockholders Items that did not require (generate) resources: Depreciation Goodwill amortization Goodwill impairment Deferred income tax Minority net income Changes in operating assets and liabilities: Accounts receivable Inventories Other assets Trade accounts payable Other accounts payable Resources generated by operating activities 2003 Ps. 34, ,656 27,342 31, ,103 37,492 ( 114,010) ( 22,469) ( 48,498) ( 22,291) 110,327 Ps. 183, ,202 1,969 26,807 39, ,928 ( 38,848) ( 79,055) 70,024 ( 1,097) 17, ,647 Ps. 282, ,319 4,520 ( 44,300) 31, ,326 ( 67,104) ( 200,852) ( 40,097) 47,341 17, ,279 Thousands of U.S. dollars US$ 26,435 22, ( 4,150) 2,960 48,274 ( 6,286) ( 18,815) ( 3,756) 4,435 1,655 25,507 Financing activities Repurchase of capital stock Minority cash dividends Paid in capital Proceeds from longterm debt and financial institutions loans Repayment of longterm debt and financial institutions loans Monetary gain from financing activities Exchange (gain) loss generated by financing activities Resources provided (used in) financing activities ( 56,634) ( 27,376) 544,373 ( 498,307) ( 87,601) 112,507 ( 13,038) ( 17,565) 511, ,210 ( 470,061) ( 64,076) ( 2,773) 381,181 ( 32,348) 1,359,459 ( 1,306,847) ( 21,271) ( 66,662) ( 67,669) ( 3,030) 127,350 ( 122,421) ( 1,993) ( 6,245) ( 6,339) Investing activities Acquisition of shares on a permanent basis Increase of property, plant and equipment, net Resources used in investing activities Net (decrease) increase in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year ( 142,332) ( 142,332) ( 45,043) 99,292 Ps. 54,249 ( 193,118) ( 476,642) ( 669,760) 145,068 54,249 Ps. 199,317 ( 13,721) ( 257,316) ( 271,037) ( 66,427) 199,317 Ps. 132,890 ( 1,285) ( 24,105) ( 25,390) ( 6,222) 18,671 US$ 12,449 See accompanying notes to consolidated financial statements 15

18 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 1. Nature of business and significant accounting policies Nature of business Internacional de Ceramica, S.A. de C.V. ( Interceramic ) and its subsidiaries, Recubrimientos Interceramic, S.A. de C.V. ( Recubrimientos ) and Interceramic, Inc., which is located in Garland, Texas, are all engaged in the manufacture and marketing of ceramic floor and wall tiles, the extraction of clay for the manufacture of ceramic tiles and marketing of bathroom furniture. The other subsidiaries, which are listed below in the Basis of consolidation, are engaged primarily in the marketing of ceramic tiles and in the manufacture and marketing of adhesives in Mexico City, Guadalajara, Monterrey, Veracruz and Chihuahua. Interceramic and its subsidiaries are hereinafter referred to collectively as the Company. Significant accounting policies The consolidated financial statements of the Company have been prepared in Mexican pesos ( Ps. ) in conformity with accounting principles generally accepted in Mexico ( Mexican GAAP ). The significant accounting policies and practices followed in the preparation of the consolidated financial statements are described below: a) Basis of consolidation The consolidated financial statements include those of Internacional de Ceramica, S.A. de C.V. and its subsidiaries. Significant intercompany balances and transactions have been eliminated in these consolidated financial statements. The subsidiaries included in the consolidated financial statements are as follows, along with corresponding ownership: Adhesivos y Boquillas Interceramic, S. de R.L. de C.V. Holding de Franquicias Interceramic, S.A. de C.V. Holding de Servicios Interceramic, S.A. de C.V. Interceramic Holding, Inc. Interceramic de Occidente, S.A. de C.V. Interceramic Trading Co. Operadora Interceramic de México, S.A. de C.V. Recubrimientos Interceramic, S.A. de C.V. Ownership percentage as of December In September, Holding de Franquicias Interceramic, S.A. de C.V., acquired 80% of the shares of Mosaicos y Terrazos del Sureste, S.A de C.V. The cost of acquisition of these shares amounted Ps.15,075, which includes goodwill for Ps. 4,520 that was recorded in consolidated statements of income. In September, Holding de Franquicias Interceramic, S.A. de C.V., acquired 80% of the shares of Mosaicos y Terrazos del Sureste, S.A de C.V. The cost of acquisition of these shares amounted Ps.15,075, which includes goodwill for Ps. 4,520 that was recorded in consolidated statements of income. 16

19 Estados Financieros Consolidados (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 1. Nature of business and significant accounting policies (continued) a) Basis of consolidation (continued) In March, the Company acquired 100% of the shares of Holding de Franquicias Interceramic, S.A. de C.V., which currently owns 100% of the capital of Interacabados de Occidente, S.A. de C.V., Distribucion Interceramic, S.A. de C.V., Grupo Comercial Interceramic, S.A. de C. V. and Materiales Arquitectonicos y Decorativos, S.A. de C.V. The cost of acquisition of the shares totaled Ps. 185,363, amount that included paid goodwill for Ps. 54,047. In these transactions, main assets and liabilities are shown as follows: In Stockholders Extraordinary Meeting held on January 14,, the acquisition of Grupo Comercial Interceramic, S.A. de C.V., and Materiales Arquitectonicos y Decorativos, S.A. de C.V., was approved, by acquiring 100% of the shares of Holding de Franquicias Interceramic, S.A. de C.V. In March, Interacabados del Centro, S.A. de C.V., changes its name to Holding de Servicios Interceramic, S.A. de C.V. and it currently owns 100% of the capital of Servicios Minas Interceramic, S.A. de C.V., Servicios Administrativos Interceramic, S.A. de C.V., Servicios Tecnicos Interceramic, S.A. de C.V., Servicios Tecnicos Recubrimientos, S.A. de C.V., Servicios Operativos Franquicias Interceramic, S.A. de C.V., and Servicios Comerciales Franquicias Interceramic, S.A. de C.V. The caption Minority interest refers to the interest of the minority stockholders in the Company s subsidiaries. In conformity with Mexican Accounting Principles Bulletin B15, Transactions in Foreign Currency and Translation of Financial Statements of Foreign Operations, the Company translated the financial statements of its foreign subsidiaries to Mexican pesos as follows: Cash and shortterm investment Accounts receivable Inventory Other assets Fixed assets Trade accounts payable Other liabilities Total Ps. 7,135 23,400 70,983 46,734 63,955 ( 37,614) ( 43,277) Ps. 131,316 Ps. 1,355 5,954 9,312 10,330 ( 8,525) ( 7,871) Ps. 10,555 The financial information reported by the foreign subsidiaries was first adjusted to be presented on the basis of accounting principles generally accepted in Mexico. The financial statements were restated at December 31, and, based on the Consumer Price Index ( CPI ) of the United States. The monetary effects for the years ended December 31, 2003, and were determined based on the annual inflation factor derived from the CPI for the respective year. 17

20 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 1. Nature of business and significant accounting policies (continued) a) Basis of consolidation (conclude) Assets, liabilities and income statement accounts were translated into Mexican Pesos at the closing exchange rate and income statement accounts were translated at the weighted average exchange rate for the year. Translation adjustments are reflected in a separate component of stockholders equity entitled Translation effect of foreign subsidiaries. Consolidated financial statements as of December 31, 2003 and are presented in constant currency at December 31,, using a common restatement factor which is determinates based on the weighted average net sales. Such factors were and , respectively. b) Estimates in financial statements The accounting policies followed by the Company are in conformity with accounting principles generally accepted in Mexico, which require that management make certain estimates and use certain assumptions that affect the amounts reported of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the amounts of revenues and expenses during the reporting periods. Actual results may differ from these estimates. c) Concentration of risk In Mexico, the Company distributes its products through Companyowned and independent franchises. In the United States and Canada the Company distributes its products mainly through its network of whollyowned Interceramic Tile and Stone Galleries (ITS) stores and a network of 79 independent distributors with a combined total of 180 locations. On a regular basis, the Company assesses the credit worthiness of its customers and distributors and typically obtains personal guarantees or liens to secure amounts due from its customers and distributors. No single customer represented more than 5% of the Company s consolidated net sales. d) Recognition of the effects of inflation The Company recognizes the effects of inflation on financial information as required by Mexican Accounting Principles Bulletin B10, (Accounting Recognition of the Effects of Inflation on Financial Information). Consequently, the amounts shown in the accompanying financial statements and in these notes are expressed in thousands of constant pesos as of December 31,. Certain concepts and procedures required by the application of Bulletin B10 are explained below: The Company follows the specificcost method to restate its inventories. Machinery and equipment of foreign origin, was restated based on the rate of inflation in the country of origin and is converted into Mexican pesos at the market exchange rate in effect at the balance sheet date. Machinery and equipment of domestic origin was restated based on the Mexican National Consumer Price Index (NCPI). 18

21 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 1.Nature of business and significant accounting policies (continued) d) Recognition of the effects of inflation (conclude) As of December 31, and stockholder s equity accounts were restated by using a common restatement factor, which was determined based on NCPI. The gain or loss on monetary position represents the effects of inflation, as measured by the NCPI, on the Company s monetary assets and liabilities. During inflationary periods, losses are incurred by holding monetary assets, whereas gains are realized by holding monetary liabilities. The net monetary effect is included in the consolidated statements of income as part of the comprehensive financing cost. The insufficiency in restated stockholders equity consists principally of the initial cumulative monetary position result and the cumulative deficit from holding nonmonetary assets. The gain from holding nonmonetary assets represents the amount by which the increase in the specific value of assets was higher than the rate of inflation. f) Allowance for doubtful accounts The allowance for doubtful accounts is determined based on a seniority assessment and a qualitative review of accounts receivable. Total estimate also contemplates assessment of historic losses for bad credits, as well as the review of the economic environment in which the Company operates. In Mexico, a part of Company sales are made though a network of independent dealers where recovery of accounts receivable is assured and another part of sales is carried out though subsidiary franchises where most of the sales are in cash and, therefore, not giving way to significant doubtful accounts. In the U.S.A., the estimate for doubtful accounts is based on a number of factors that include, among others, the assessment of losses due to unrecoverable credits that occurred in prior years, experience, the review of specific balances of certain accounts and the economic conditions of the environment in which the Company operates. g) Inventories and cost of sales Inventories are recorded initially at acquisition or production cost and then restated to reflect replacement cost, which is not in excess of market value. Cost of sales represents the estimated replacement cost at the time sales were realized, expressed in constant pesos at the end of the year. e) Cash and shortterm investments Cash and shortterm investments are mainly represented by financial institutions deposits on immediately available cash instruments with maturities not exceeding 90 days, and they are presented valued at their acquisition cost plus outstanding accrued interest. Their amount is similar to their market value. 19

22 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 1. Nature of business and significant accounting policies (continued) g) Inventories and cost of sales (conclude) Allowance for obsolete and slowmoving inventories is determined based on an evaluation of the Company s inventories, an historical loss rate and a number of qualitative factors such as aging, discontinued lines of products and slow moving inventories. h) Investment in shares of associated companies Investments in Companies in which the Company has an ownership interest of between 10% and 50% and for which the Company exercises significant influence, are accounted for using the equity method. Investments in companies in which the Company has an ownership interest of less than 10% are recorded at acquisition cost and restated for changes in the NCPI. i) Property, plant and equipment Machinery and equipment of foreign origin, was restated based on the rate of inflation in the country of origin and is converted into Mexican pesos at the market exchange rate in effect at the balance sheet date. Machinery and equipment of domestic origin was restated based on the Mexican National Consumer Price Index (NCPI). At December 31, and, approximately 91% of machinery and equipment were restated based on specific factors and 9% were restated based on the NCPI. Depreciation is calculated on the restated values, using the straightline method based on the remaining useful lives of the assets, which is determined periodically by management based on technical studies. j) Financial Instruments On January 1,, the Company adopted the requirements of Mexican accounting Bulletin C2, Financial Instruments, as amended, issued by the Mexican Institute of Public Accountants. Bulletin C2. This document requires that changes in the fair value of instruments classified as available for sale be disclosed in stockholders equity until such time as the instruments are sold. Also, the Company follows the policy of determining at the balance sheet date whether there is objective evidence of impairment in the value of a financial asset or of a group of financial assets. Should there be objective and otherthantemporary evidence of impairment in the value of either its instruments available for sale or held to maturity, the Company is required to determine the amount of the related loss and recognize such loss as part of the comprehensive cost of financing. At December 31,, the Company has recorded no such impairment loss. The Company adopted, the requirements of Mexican accounting Bulletin C10, Accounting for Derivative Instruments and Hedging Activities. Said Bulletin establishes the features that financial instruments should include in order to be considered as derived, and it also sets the conditions for derived financial instruments to be considered as coverage. It defines the concept of effectiveness, pointing out the rules for assessment of coverage instruments and accounting treatment of changes in their value. 20

23 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 1. Nature of business and significant accounting policies (continued) j) Financial Instruments (conclude) Derivatives designated as and that qualify as hedges are classified as fair value, cash flow or foreign currency hedges, depending on the particular risk being mitigated. For fair value hedges, the gain or loss resulting from the valuation of the hedging instrument to its fair value is recognized immediately in earnings of the period of change, with the offsetting loss or gain resulting from valuing the hedged item attributable to the risk being hedged being adjusted to the carrying value of the hedged item. Any resulting hedge ineffectiveness is recorded in earnings. Through December 31,, the gain or loss from valuing derivatives was recognized in results of operations net of costs, expenses and revenues related to the assets and liabilities being hedged. Those instruments not qualifying as hedges were presented at market value and gains or losses arising from changes in such market value was charged or credited to operations. l) Intangible assets Bulletin C8 Intangible assets establishes, among other aspects, that only development costs of a project should be capitalized if they comply with the criteria defined for recognition as assets; preoperating costs not identified as development should be recorded as an expense of the year and intangible assets considered with an indefinite life are not amortized, but rather its fair value is subject to impairment tests. The effects of applying this Bulletin were not significant for the Company. The Company owns intangible assets to be amortized, such as deferred charges, intangible assets for labor obligations, and collateral deposits, which are listed in Note 5. Assets to be amortized and deferred charges are represented mostly by expenses for implementing software, showrooms, and expenses related to the acquisition of longterm debt. Amortization periods for these assets are 3, 2, and 5 years, respectively. Amortization periods were determined based on surveys carried out by the company, except for expenses due to acquisition of longterm debt, which were amortized during the effective period of the debt. k) Impairment of longlived assets Beginning January 1,, the Company adopted the dispositions of Bulletin C15 Impairment of long lived assets and their disposition, issued by the Mexican Institute of Public Accountants. Said Bulletin establishes that when impairment signs in the value of longstanding assets exist, recovery value of these assets should be determined by obtaining the sales price of said assets and the use value. When recovery value is lower than net book value, the difference is recognized as a loss due to impairment. 21

24 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 1. Nature of business and significant accounting policies (continued) m) Goodwill Goodwill represents the excess of cost over recorded value of subsidiaries as of the date of acquisition. Effective January 1,, the Company adopted the requirements of Mexican accounting Bulletin B7, Business Acquisitions, issued by the Mexican Institute of Public Accountants. Goodwill originated by the acquisition of shares at prices higher than their book value of the issuing company is subject to impairment tests at year end, thus eliminating the relevant amortization. Goodwill is recorded initially at acquisition cost and then restated based on the NCPI. n) Exchange differences Foreign currency transactions are recorded at the applicable exchange rate in effect at the transaction date. Exchange differences are determined from the date of the transactions to the time of settlement or valuation at the balance sheet date and are charged or credited to income. o) Labor obligations Beginning January, the Company implemented a pension plan in addition to that granted by the Mexican Social Security Institute. Otherwise, the Company decided to anticipate the effects of bulletin D3 referring to the new subject Remuneration at the end of the labor relationship. The effects of both the new pension plan and the effect of recognizing compensations are shown in Note 9. The costs of pensions, compensations, and seniority premiums are recognized periodically based on calculation performed by independent actuaries by means of the projected unit credit method, using net financial hypothesis net of inflation, in conformity with guidelines established in Bulletin D3 Labor Obligations, issued by the Mexican Institute of Public Accountants. Federal Labor Law establishes the obligation to make certain payments to personnel who no longer works for the Company under certain circumstances. At December 31, 2003, compensations to personnel were recorded under income of the year when payment occurs. p) Income taxes and employee statutory profit sharing Deferred income taxes are recognized for all temporary differences between balance sheet components for financial and tax reporting purposes, using enacted income tax rates. Current year income tax is charged to results of operations and represents the tax liability due and payable in less than one year. The Company periodically evaluates the possibility of recovering deferred tax assets and if necessary, adjusts the related valuation reserve. 22

25 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 1. Nature of business and significant accounting policies (conclude) p) Income taxes and employee statutory profit sharing (conclude) Employee statutory profit sharing is a statutory obligation payable to employees that is determined in accordance with the provisions of both Mexican labor and income tax laws. In conformity with Bulletin D4, deferred employee statutory profit sharing is recognized only on temporary differences determined in the reconciliation of current year net income for financial and tax reporting purposes, provided there is no indication that the related liability or asset will not be realized in the future. Current year employee statutory profit sharing is charged to results of operations and represents a current liability due and payable in a period of less than one year. s) Comprehensive income Comprehensive income consists of net income or loss for the year plus those items that are reflected directly in stockholders equity and that do not constitute capital contributions, reductions or distributions, such as insufficiency from restatement of stockholders equity, translation effect of foreign subsidiaries and deferred taxes allocated to stockholders equity. t) Convenience translation Solely for the convenience of the reader, the consolidated financial statements as of and for the year ended December 31, have been translated into United States dollars ( US$ or dollars ) at the exchange rate of Ps per US $ 1.00, the rate of exchange at December 31,. The translation should not be construed as a representation that the Peso amounts have been or could be converted into dollars at this or any other rate. u) Reclassifications Certain amounts in the 2003 and consolidated financial statements have been reclassified to conform to the presentation. q) Revenue recognition The Company recognizes revenue when goods are shipped and invoiced. Revenue from retail operations is recognized, generally, at the point of sale. Returns and allowances are estimated and accrued based on historical results. r) Net income per unit Net income per share is determined on the basis of the weighted average number of shares B and shares D issued and outstanding. 23

26 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 2. Related parties In the normal course of business, the Company has transactions with related parties and affiliated companies. Affiliated companies are those in which the Company s principal stockholders have significant equity interests or control of management. The main transactions with these companies consist of ceramic tile purchases for resale in Mexico and in the United States. Such transactions are negotiated on terms and prices that management believes are comparable to similar transactions with nonrelated customers. Transactions with related parties, carried out in the ordinary course of business, were as follows: 2003 Sales of ceramic tile: Affiliated companies Grupo Comercial Interceramic, S.A. de C.V. Materiales Arquitectónicos y Decorativos, S.A. de C.V. Ps. 184,939 88,462 Ps. Ps. Joint venture: DalTile International, Inc. Inventory purchases: Stockholders: Kohler, Co. 90,135 Ps. 363,536 Ps. 102, ,014 Ps. 110,014 Ps. 92, ,621 Ps. 148,621 Ps. 144,462 Joint venture: Custom Building Products, Inc. Compañía en Coinversión: Custom Building Products, Inc. 17,634 Ps. 120,622 6,283 Ps. 99,254 11,469 Ps. 155,931 Fees paid for administrative services and other expenses Affiliated companies: Arquitectura Habitacional e Industrial, S.A. de C.V. (Construction Industry) Corporación Administrativa y Técnica, S.A. de C.V. Corporación Aérea Cencor, S.A. de C.V. Ps. 37,167 10,354 Ps. 47,521 Ps. 58,376 38,138 10,658 Ps. 107,172 Ps. 60,578 23,944 10,400 Ps. 94,922 Sales to join venture partners consist of ceramic tiles sold in the United States. Purchases from stockholders and joint ventures consist of bathroom fixtures and adhesives related products to be resold in Mexico, respectively. Fees paid are related to management consulting, use of computer systems, maintenance of equipment, air taxi services and construction of a new plant, which started operations on June. All these services were provided by related parties. 24

27 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 2. Related parties (conclude) Balances receivable and payable with related parties at December 31, and are as follows: Trade receivables: DalTile International, Inc. Officers and employees Other Accounts payable: Custom Building Products, Inc Kohler, Co. Other Ps. 28,358 14, Ps. 43,450 Ps. 1,441 20, Ps. 21,978 Ps. 34,744 15, Ps. 50,271 Ps. 1,063 22, Ps. 23, Inventories Inventories at December 31, and consisted of the following: Finished goods Production in process Raw materials and supplies Merchandise in transit Ps. 912,136 42, ,367 66,320 Ps. 1,128,978 Ps. 1,039,838 70,981 84,166 94,059 Ps. 1,289,044 The allowance for obsolete and slowmoving inventories is Ps. 91,451 and Ps. 96,388 at December 31, and, respectively, and has been deducted from finished goods and raw materials and supplies. 4. Property, plant and equipment Details of property, plant and equipment at December 31, and was as follows: Buildings Machinery and equipment Furniture and fixtures Vehicles Investment Ps. 959,080 2,540, , ,492 3,894,634 Accumulated depreciation Ps. 345,065 1,218, ,027 75,854 Ps. 1,842,489 Investment Ps. 1,129,562 2,490, , ,883 4,052,242 Accumulated Depreciation Ps. 388,299 1,335, ,010 81,357 Ps. 2,027,334 Land Projects in progress Net carrying value 172, ,190 Ps. 4,359, ,992 35,522 Ps. 4,267,756 25

28 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 4. Property, plant and equipment (conclude) At December 31,, projects in progress correspond to investments on construction and machinery acquisition for a new plant, which started operations in June and is engaged in the production of ceramic tile. Depreciation expense for the years ended December 31, 2003, and was Ps. 186,656, Ps. 213,202 and Ps. 241,319, respectively. Average depreciation rates used during the year ended December 31, are shown below: Buildings 5% Machinery and equipment 8% Furniture and fixtures 23% Automotive equipment 30% 5. Other assets At December 31, and, other assets are comprised as follows: Assets to be amortized Intangible assets due to labor obligations Deferred charges Collateral deposits Ps. 28,717 34,757 26,314 3,935 Ps. 93,723 Ps. 59,960 33,581 25,885 4,570 Ps. 123, Bank loans and notes payable Notes payable to banks and outstanding longterm debt at December 31, and were as follows: December 31, M a t u r i t i e s Secured Syndicated loan Total bank loans Type of loan Total Ps. 281, ,874 Ps. 1,057,140 Current portion Ps. 1, ,171 Ps. 235,783 Long term Ps. 279, ,703 Ps. 821,357 Interest rates 4.24%7.15% 4.52% December 31, M a t u r i t i e s Secured Syndicated loan Total bank loans Type of loan Total Ps ,294,729 Ps. 1,295,022 Current portion Ps ,842 Ps. 77,973 Long term Ps. 99 1,216,950 Ps. 1,217,049 Interest rates 7.10% 6.47% 26

29 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 6. Bank loans and notes payable (conclude) At December 31, and, all bank loans were denominated in U.S. dollars. All secured and syndicated bank loans are pledged by property, plant and equipment, accounts receivable and inventory amounting to Ps.2,231,291 and Ps. 1,797,308 at December 31, and, respectively. The Company entered into a line of credit with Wells Fargo for US $ 25,000 (Ps. 266,875) available through May At December 31,, the Company has not used any amount from the abovementioned credit line. The Company has contracted an unsecured credit line with Santander Serfin for the amount of Ps.3,000, available through June The annual interest rate set for this credit line is TIIE plus 3 points, equivalent to 11.49% per year. At December 31,, the Company has used the amount of Ps This amount was paid off during January 2006, and on that same date cancellation of said credit line was requested to the Bank. On January 20,, the Company obtained a new syndicated loan, whose administrative agent is BBVA Bancomer for the amount of US$ 120,000. The principal will be payable until January 20, 2010, on a quarterly basis beginning on July 31, Said loan was used mainly to prepay the previous syndicated loan. This loan is pledged by land, buildings and equipment, accounts receivable, inventory and shares owned by the Company in a joint venture. The Company s subsidiaries Distribución Interceramic, S.A. de C.V., Interacabados de Occidente, S.A. de C.V., Interceramic, Inc., Grupo Comercial Interceramic, S.A. de C.V., Materiales Arquitectónicos y Decorativos, S.A. de C.V., Interceramic Holding Co., Holding de Franquicias Interceramic, S.A. de C.V. and Holding de Servicios Interceramic, S.A. de C.V., also provided certain guarantees. During, the Company contracted four revolving credit lines with Bancomer, Banorte, Banamex and Scotiabank Inverlat for the amount of US $ 7,000, US $ 8,000, US $ 6,000 and US $ 5,000, respectively. At December 31, the Company had used US $24,000. This amount was paid off during January. The unused portion of the line of credit is US$ 24,000 ($256,200) at December 31,. As of December 31,, long term debt, excluding labor obligations, matures as follows: Maturities Amount Ps. 192, , , ,150 Ps. 1,217,049 The Syndicated loan and outstanding bank loan agreements establish certain obligations and restrictive covenants with respect to certain transactions including, the payment of cash dividends, mergers and combinations, the disposal of fixed assets, information reporting requirements and others. In addition, the Company is required to maintain certain financial ratios. At December 31,, the Company was in compliance with all of its obligations and restrictions established by these agreements. 27

30 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 7. Hedge Instruments On April 20,, the Company enters into interest rate swap agreement with BBVA Bancomer, to manage its interest rate risk on its syndicated loan of US $120,000. The effective term of said agreement is three years, setting a LIBOR interest rate of 4.13%, stating that amounts computed based on set interest rates are to be paid and amounts computed based on variable interest rates are to be received. During, the Company had a loss of Ps. 4,929, which was recorded in the comprehensive financing cost due to fluctuation of the LIBOR rate. The swap is recorded at its market value. At December 31,, the swap reflected a valuation in favor of the Company for the amount of US $ 1,506. At December 31,, the Company had not entered into this type of agreements. 8. Foreign currency position At December 31, the foreign currency monetary position denominated in U.S. dollars is as follows: Current assets Current liabilities Longterm liabilities Total liabilities Net short position US 41,158 65,758 72,022 US 137,780 US ( 96,622) US 2,920 20, ,009 US 134,274 US ( 131,354) Assets and liabilities denominated in U.S. dollars were translated to Mexican pesos using the interbank exchange rates at December 31, and of Ps and Ps per U.S. dollar, respectively. The exchange rate in effect at February 7, 2006, date of issuance of the consolidated financial statements was Ps per U.S.dollar. Foreign currency denominated sales during the years ended December 31, 2003, and were Ps. 1,598,710 (US $134,647), Ps. 1,767,801 (US $ 150,844) and Ps. 1,929,606 (US $ 175,465), respectively (calculated using the Interbank exchange rate at the end of each month), and represented 43.93%, 44.24% and % of total net sales, respectively. Most of the Company s machinery and equipment is imported, primarily from Italy and Spain. During the years ended December 31, 2003, and, the Company imported inventory and machinery and equipment into Mexico totaling US$ 47,788, US$ 52,429, and US $85,307 respectively. 28

31 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 9. Labor obligations The Company records liabilities for seniority premium, pension plan and compensations as it is earned according to computation performed by independent actuaries by means of the projected unit credit method. Beginning January 1,, the Company established a pension plan with defined benefits covering all employees upon their 65th. anniversary, provided they are still working at the plant and whose working shift is full time. Benefits of said plan consist in granting them a compensation equivalent to a onetime only payment of three months salary plus twenty days of their last monthly base salary for each one of the years of service, counted from the date the worker joined the Company to the date he/she stopped working for the Company. This plan also includes compensations covering employees who are considered as full time workers and whose work shift is considered as full time. It applies whenever an employee is laid off without justified cause or when the cause is not clearly proved in accordance with the effective Mexican labor law. Benefits of said plan consist in granting them a compensation equivalent to a onetime only payment of three months salary, plus twenty days of their last monthly base salary for each year of service. Following is a summary including consolidated data showing actuarial studies at December 31, and : Accumulated benefit obligation (ABO) Projected benefit obligation (PBO) Unrecognized transition obligations Unrecognized net gain ( loss ) Net projected liability Additional liability Accrued liability Intangible asset Minimum pension liability Ps. 47,830 Ps. 52,433 ( 39,013) ( 1,483) 11,937 36,287 Ps. 48,224 Ps. 34,757 Ps. 1,530 Ps. 53,971 Ps. 59,156 ( 36,297) ( 8,773) 14,086 39,885 Ps. 53,971 Ps. 33,581 Ps. 6,304 29

32 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 9. Labor obligations (conclude) The components of the net periodic pension cost during the years ended December 31, 2003, and were as follows: 2003 Change in benefit obligation: Net liabilities projected to January 1st. Liabilitites at January 1st. subsidiary franchises acquired: Seniority premium obligations Ps. 3,668 Total labor obligations Ps. 3, Total labor obligations Ps. 11,937 Cost of pension: Service cost Interest cost Expected fund return Amortization of transition liability Amortization of actuarial losses Inflation effects Net periodic pension cost ( 9) ( 135) 994 4,659 2,064 ( 6) 1, ,813 3,876 2,695 ( 3) 1, ,437 Adjustment for actual amount expensed Net liabilities projected to December 31st. Adjustment for actual amount expensed ( 1,344) 32 Ps. 3,350 ( 611) ( 173) Ps. 11,937 ( 7,103) ( 185) Ps. 14,086 The transition liability is being amortized over a period of 21 years. The significant assumptions considered in determining the net periodic pension cost during the years ended December 2003, and were as follows: Discount rate Rate of pay increases Effect of inflation % 2.50% 5.00% 5.50% 1.50% 5.00% 5.50% 1.00% 4.00% The Company s subsidiary located in the United States has a defined contribution savings plan covering substantially all its employees. Total contributions for the years ended December 31, 2003, and were approximately Ps. 2,927 (US $249), Ps. 3,099 (US $276) and Ps. 3,544 (US $ 332), respectively. 30

33 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 10. Stockholders equity a) The Company s capital stock is variable with a fixed minimum of Ps. 231,488 (Ps. 8,000 nominal). The Company s capital stock consists of two series of shares (Serie B and Serie D ). Series B shares are common, registered shares, with no par value and full voting rights (traded as Ceramic B ). Series D shares are nominative, preferred, registered shares, with limited voting rights, without par value and have no owner ship limitations. The Series D shares are entitled to a minimum annual preferred dividend of Ps per share. In any given period in which no minimum preferred dividend is declared or it is paid only partially, such dividend or the unpaid amount shall accumulate for future periods. The accumulated minimum preferred dividends at December 31, and is Ps. 5,070 and Ps. 5,892, respectively. (Traded as Ceramic D ). Up to December, ULD Series units were units with limited vote, nominative, without par value, and have no ownership limitations, convertible into regular Series B and D series over a tenyear term (December ); they were represented by linked titles, each of them representing a Series D share and a Series L share. (traded as Ceramic ULD ). In December, the Series L shares were converted to Series B shares, and thereafter, the Series L shares ceased to exist as a class of Company s capital stock, and all voting and other rights previously applicable to holders of Series L shares no longer exist as a serie of capital stock and ceasing voting rights and other rights linked to this serie of shares. An analysis of the authorized and outstanding capital stock as of December 31, and is as follows: Series "B" "D" Number of outstanding shares Number of authorized shares Number of shares 129,785,378 32,878, ,664, ,800,072 Number of shares 129,785,378 32,878, ,664, ,800,072 b) Until before December, the Company had established a Stock Option Plan, according to which some employees and executives of the Company could receive options from time to time during their term, to buy a number of Limited Vote Units for the eligible employee as established by the Board Committee. All shares distributed under this plan were issued and acquired by a trust expressly established for that purpose. Acquisitions made by the Trust were funded by contributions made by the Company. 31

34 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 10. Stockholders equity (conclude) During, all employees and executives decided to buy from the Trust all the units to which they were entitled, according to the plan. At the time of the acquisition, all employees had earned said right. At December 31,, therefore, the Trust was cancelled, the total amount of acquisitions made from the Trust totaled 1,154,700 Series B shares and 1,154,700 Series D shares, limited vote units, for the amount of Ps.14,697. c) Pursuant to a resolution of the general ordinary stockholders meeting on April 26,, it was agreed that the amount of Ps.182,153 was to be used as a top amount in the fund to acquire Company shares, carrying forward the difference against retained earnings. d) The General Corporate Law requires that at least 5% of net income of the year be transferred to the legal reserve until the reserve equals 20% of capital stock. At December 31, and, the legal reserve was Ps. 38,267 and Ps. 49,339 respectively, which is included in retained earnings Cumulative effect of deferred income taxes Insufficiency in labor obligations Insufficiency in restated stockholders equity Cumulative translation effects of foreign subsidiaries Cumulative comprehensive loss Ps. ( 340,046) ( 1,089) ( 1,293,120) 102,375 Ps.( 1,531,880) Ps. ( 340,046) ( 1,530) ( 1,249,661) 104,836 Ps.( 1,486,401) Ps.( 340,046) ( 6,304) ( 1,456,611) 71,672 Ps.( 1,731,289) 11. Income taxes, tax on assets and employee statutory profit sharing a) Internacional de Cerámica, S.A. de C.V., and each of its subsidiaries in Mexico are individually subject to payment of income tax (ISR) and tax on assets (IMPAC). IMPAC is payable only to the extent that it exceeds ISR payable for the same period. The Company files ISR and IMPAC tax returns on an individual entity basis and the related tax results are combined in the consolidated financial statements. 32

35 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 11. Income taxes, tax on assets and employee statutory profit sharing (continued) ISR expense for the years ended December 31, 2003, and consist of the following: 2003 Current income tax and tax on assets Deferred income tax expense (benefit) Ps. 22,424 27,342 Ps. 49,766 Ps. 29,903 26,807 Ps. 56,710 Ps. 38,676 ( 44,300) Ps.( 5,624) b) The main items comprising the liability balance of deferred ISR are: Deferred ISR liability Inventories Fixed assets Foreign subsidiaries deferred tax liabilities and translation effect Other net Deferred ISR asset Allowance for doubtful accounts Accrued liabilities Advances from customers Effect of tax loss carryforwards Recoverable tax on assets paid Less: valuation allowance Net deferred income tax liability Ps. 190, ,675 22,089 2, ,596 1,097 21, ,845 42,248 ( 363,180) 296,022 Ps. 536,438 Ps. 25, ,482 13,452 4, ,884 1,256 19,662 1, ,153 39,275 ( 236,212) 204,145 Ps. 403,817 A valuation allowance has been recorded due to the uncertainly of recovering a portion of tax on assets paid and tax loss carryforwards, primarily from its operations in the United States. In accordance with tax regulations in effect as of, the Company s management elected to amortize the tax inventory, giving way to an accelerated amortization of tax loss carryfowards and a release of the applicable reserve. c) The portion of deferred income taxes attributable to the excess of indexed costs over replacement cost and the translation effect of foreign subsidiaries, have an effect on deferred income taxes charged to income for the years ended December 31, 2003, and as follows: 33

36 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 11. Income taxes, tax on assets and employee statutory profit sharing (continued) 2003 Change in deferred income tax liability Add: Effects of inflation Less: Opening balance of deferred tax by acquired franchises Deferred income tax recorded in insufficiency from restatement of stockholders equity Deferred income tax of translation effect foreign subsidiaries Deferred income tax expense (benefit) included in statements of income Ps. 102,495 19,135 ( 70,963) ( 23,325) Ps. 27,342 Ps. 66,068 30,387 ( 30,443) ( 16,912) ( 22,293) Ps. 26,807 Ps.( 132,621) ( 1,836) 79,971 10,186 Ps.( 44,300) (1) Since current tax legislation recognizes partially the effects of inflation on certain items that give rise to deferred taxes, the current year net monetary effect on such items has been reclassified in the statement of income from result from the monetary position result to deferred income tax expense of the year. d) A review of main items that in 2003,, and originated a difference between income tax computed at the current tax rate of 34%, 33%, and 30%, respectively, and the provision recorded by the Company for income tax and tax on assets is as follows: 2003 Income before provision for income tax and employee statutory profit sharing Tax computed over income before income tax and employees profit sharing (34%, 33% and 30%, respectively) Ps. 115,871 Ps. 39,397 Ps. 280,826 Ps. 92,672 Ps. 308,163 Ps. 92,449 Effects of inflation Nondeductible expenses Other Cost of income tax at current rate Change in valuation allowance Effect of reduction in statutory rate on deferred ISR Net income tax expense Effective rate ( 604) 3,876 1,737 44,406 5,967 ( 607) Ps. 49,766 43% ( 3,270) 8,797 15, ,415 5,101 ( 61,806) Ps. 56,710 42% 6,118 12, ,457 ( 116,809) ( 272) Ps. ( 5,624) 36% 34

37 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 11. Income taxes, tax on assets and employee statutory profit sharing (continued) In December, the ISR rate was reduced to 30% in and will be further reduced to 29% in 2006 and 28% in 2007 and thereafter. The effects of this change represented a benefit in income of the year and for Ps. 272 and Ps. 61,806, respectively. e) The Company has tax loss carryforwards that according to the income effective in Mexican Tax Law, may be amortized against fiscal income generated over the first ten years. Tax loss carryforwards may be restated following certain procedures established by law. The Company has tax on assets paid, which according to the applicable law, may be creditable against the excess of ISR over IMPAC of the following ten years. Receivable tax on assets can be recovered subject to certain conditions established in Mexican Tax Law. In 2003,, and, Interceramic did not make any payment for tax on assets because of immediate deduction option of investments on fixed assets. For years ended 2003, and some subsidiaries paid tax on assets for $ 5,325, $ 1,582 and $ 1,117, respectively. Restated amounts of tax loss carryforwards and tax on assets as of December 31,, are as follows: Year of tax loss carryforwards or payment of tax on assets Year of expiration Tax loss carryforwards Recoverable tax on assets ,291 48,094 Ps. 281,107 1,812 4,252 6,179 6,069 6,699 5,904 5,416 1,826 1,118 Ps. 39,275 Interceramic, Inc., the Company s US subsidiary, has net operating loss carryforwards for federal income tax purposes, which if are not utilized to offset future taxable income, will expire at various dates as summarized below: Year of tax loss Year of expiration Tax loss carryforwards 2, ,696 24,000 16,587 64,539 29,468 Ps. 264,655 35

38 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 11. Income taxes, tax on assets and employee statutory profit sharing (conclude) As of December 31, 2003, and, the balances of the stockholders equity tax accounts are: Contributed capital account ( CUCA ) Net tax income account ( CUFIN ) Net reinvested tax income account ( CUFINRE ) 2003 Ps. 1,878,010 Ps. 122,287 Ps. 1,852 Ps. 1,974,896 Ps. 232,786 Ps. 2,135 Ps. 2,532,888 Ps. 284,991 Ps. 8,115 Beginning in 1999 and through 2001, the Income Tax law allowed the option of deferring payments of a part of income taxes due during those years. Deferred of said tax and related income is controlled through the Net reinvested tax income account ( CUFINRE ). Earnings distributed in excess of fiscal balances from CUFINRE and CUFIN, will be subject to enacted corporative income tax rate. Effective January 1, 2002, the abovementioned option of deferring a portion of income tax, was eliminated. 12. Information by industry segment and geographical area Financial information by geographical area is as follows: For the year ended December 31, 2003 Mexico United States Eliminations and other adjustments Consolidated Net sales: General customers Interarea transfers Interest expense, net of monetary effect Net income Depreciation Capital expenditures Total assets Longlived assets: Property, plant and equipment Other assets and investment in associated companies Ps. 2,131, ,955 Ps. 2,995,882 Ps. ( 27,449) 24, , ,104 4,315,351 1,781, ,255 Ps. 2,561,707 Ps. 1,507,706 48,108 Ps. 1,555,814 Ps.( 3,033) 7,738 50,784 18, , ,980 11,798 Ps. 319,778 Ps. ( 912,063) Ps.( 912,063) Ps. 2,233 ( 1,551,679) ( 690,966) Ps.( 690,966) Ps. 3,639,633 Ps. 3,639,633 Ps.( 30,482) 34, , ,332 3,664,865 2,089, ,087 Ps. 2,190,519 36

39 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 12. Information by industry segment and geographical area (continued) For the year ended December 31, Mexico United States Eliminations and other adjustments Consolidated Net sales: General customers Interarea transfers Ps. 2,329,646 1,603,375 Ps. 3,933,021 Ps. 1,666,529 Ps. 1,666,529 Ps. ( 1,603,375) Ps.( 1,603,375) Ps. 3,996,175 Ps. 3,996,175 Interest expense, net of monetary effect Net income Depreciation Capital expenditures Total assets Longlived assets: Property, plant and equipment Other assets and investment in associated companies Ps.( 19,883) 180, , ,551 5,076,823 2,231, ,262 Ps. 3,191,945 Ps.( 266) 21,128 52,087 23, , ,154 5,098 Ps. 290,252 Ps. ( 18,277) ( 1,548,332) ( 863,903) Ps.( 863,903) Ps.( 20,149) 183, , ,642 4,447,389 2,516, ,457 Ps. 2,618,294 For the year ended December 31, Mexico United States Eliminations and other adjustments Consolidated Net sales: General customers Interarea transfers Ps. 2,532,380 2,006,349 Ps. 4,538,729 Ps. 1,929,606 Ps. 1,929,606 Ps. ( 2,006,349) Ps.( 2,006,349) Ps. 4,461,986 Ps. 4,461,986 Interest expense, net of monetary effect Net income Depreciation Capital expenditures Total assets Longlived assets: Property, plant and equipment Other assets and investment in associated companies Ps.( 71,481) 199, , ,764 5,213,235 1,990,576 1,232,794 Ps. 3,223,370 Ps. 4,066 75,698 71,572 25,552 1,003, ,846 4,959 Ps. 254,805 Ps. 7,110 ( 1,836,697) ( 1,107,418) Ps.( 1,107,418) Ps.( 67,415) 282, , ,316 4,379,802 2,240, ,335 Ps. 2,370,757 37

40 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 12. Information by industry segment and geographical area (conclude) Geographical sales by customer location are as follows: México Ventas en Estados Unidos Total domestic sales Wholly owned distributors Independent distributors Others (*) Total U.S. sales Total sales Net sales 2003 Ps. 2,040,923 Ps. 1,096,968 Ps. 410,738 Ps. 91,005 Ps. 1,598,710 Ps. 3,639,633 Net sales Ps. 2,228,374 Ps. 1,224,047 Ps. 432,910 Ps. 110,843 Ps. 1,767,800 Ps. 3,996,175 Net sales Ps. 2,532,379 Ps. 1,386,275 Ps. 402,039 Ps. 141,292 Ps. 1,929,606 Ps. 4,461,986 (*) A small part of these sales did not occur in the United States. 13. Commitments and contingencies The Company has entered into rental agreements for office space, manufacturing facilities, and equipment used in its operations under noncancelable operating leases. Future minimum lease commitments under these agreements as of December 31, are as follows: Amount Thereafter Total future minimum lease commitments Ps. 126, , ,387 79,867 69, ,993 Ps. 788,034 Rental expense incurred under operating leases for the years ended December 31, 2003, and was Ps.99,504, Ps. 112,066 and Ps. 123,714, respectively. Under certain lease agreements the respective monthly lease payments will increase annually in accordance with the NCPI. The Company is party to various claims, legal actions, and complaints arising in the ordinary course of business. In the opinion of management and the Company s independent lawyers, all such matters are without merit or are of such nature, or involve such amounts, that an unfavorable disposition would not have a material effect on the financial position or results of operations of the Company. 38

41 (Thousands of Mexican pesos of purchasing power of December 31, and thousands of U.S. dollars, except for number of shares and units, minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.)) 14. Subsequent events On January 1, 2006, the requirements of the Mexican Board for Research and Development of Financial Reporting Standards (Consejo Mexicano para la Investigación y Desarrollo de Normas de Información Financiera, A.C. or CINIF) went into effect and replaces the standards previously issued by the Mexican Institute of Public Accountants. The adoption of these new rules will give rise to no changes in the Company s financial structure or in the significant disclosures in its financial statements. 39

42 Board of Directors Chairman of the Board Oscar E. Almeida Chabre Vicechairman / Chief Executive Officer Víctor D. Almeida García Secretary Norma Almeida de Champion Directors Alfredo Harp Calderoni Vicepresident of Foundation Alfredo Harp Helú, A.C. David Kohler Group President, Kitchen and Bath Group. Kohler Co. Federico Terrazas Torres Chairman, Grupo Cementos de Chihuahua, S.A. de C.V. Silvia Almeida President, Corporación Administrativa y Técnica, S.A. de C.V. Diana E. Almeida Director Patricia Almeida Director Mark Blaugrund President, RECON Real Estate Consultants, Inc. Humberto Valles Hernández Retired Member of Mancera S.C., Member of Ernst & Young Global Carlos Elías Terrazas Chairman, Comercial Corporativa del Norte, S.A. de C.V. Directors Elected by Series D Shareholders Augusto O. Champion Chairman, Arquitectura Habitacional e Industrial, S.A. de C.V. Sergio Mares Delgado President, Grupo Futurama Statutory Auditor Americo de la Paz de la Garza Partner of Mancera, S.C., Member of Ernst & Young Global This document contains forwardlooking statements which reflect the Company's views about future events and financial performance. Actual events and results could differ materially from those stated herein and, accordingly, undue reliance should not be placed upon them. The forwardlooking statements speak only of their dates and the Company undertakes no obligation to update or revise any of them.