MANAGEMENT’S DISCUSSION AND ANALYSIS OF 

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

For the Six Months Ended June 30, 2005

* *

*Inthe following discussion and analysis of our financial condition and results ofoperations, unless the context indicates or otherwise requires, references to“we,” “us,” “our” or “PLDT Group” mean the Philippine Long Distance TelephoneCompany and its consolidated subsidiaries, and references to “PLDT” mean thePhilippine Long Distance Telephone Company, not including its consolidatedsubsidiaries (see Note 2 – Summary of Significant Accounting Policies andPractices to the accompanying unaudited consolidated financial statements for alist of these subsidiaries, including a description of their respectiveprincipal business activities).*

* *

*Thefollowing discussion and analysis of our financial condition and results ofoperations should be read in conjunction with the accompanying unauditedconsolidated financial statements and the related notes.  Our financialstatements, and the financial information discussed below, have been preparedin accordance with Philippine generally accepted accounting principles, orPhilippine GAAP, which differs in certain significant respects from generallyaccepted accounting principles in the United States.*

* *

*Thefinancial information appearing in this report and in the accompanyingunaudited consolidated financial statements is stated in Philippine pesos.  Allreferences to “pesos,” “Philippine pesos” or “Php” are to the lawful currencyof the Philippines; all references to “U.S. dollars,” “US$” or “dollars” are tothe lawful currency of the United States; all references to “Japanese yen,”“JP¥” or “¥” are to the lawful currency of Japan**and all references to “Euro” or “€” are to thelawful currency of the European Union**.  Translations of Philippine pesoamounts into U.S. dollars in this report and in the accompanying unauditedconsolidated financial statements were made based on the exchange rate ofPhp56.177 to US$1.00, the volume weighted average exchange rate at**June 30, 2005**quoted through the Philippine Dealing System.*

* *

*Someinformation in this report may contain forward-looking statements within themeaning of Section 27A of the**U.S.**Securities Act of 1933 and Section 21E of the**U.S.**Securities Exchange Act of 1934.  We have based these forward-lookingstatements on our current beliefs, expectations and intentions as to facts,actions and events that will or may occur in the future.  Such statementsgenerally are identified by forward-looking words such as “believe,” “plan,”“anticipate,” “continue,” “estimate,” “expect,” “may,” “will” or other similarwords.*

* *

*Aforward-looking statement may include a statement of the assumptions or basesunderlying the forward-looking statement.  We have chosen these assumptions orbases in good faith, and we believe that they are reasonable in all materialrespects.  However, we caution you that forward-looking statements and assumedfacts or bases almost always vary from actual results, and the differencesbetween the results implied by the forward-looking statements and assumed factsor bases and actual results can be material, depending on the circumstances.When considering forward-looking statements, you should keep in mind thedescription of risks and cautionary statements in this report.  You should alsokeep in mind that any forward-looking statement made by us in this report orelsewhere speaks only as at the date on which we made it.  New risks anduncertainties come up from time to time, and it is impossible for us to predictthese events or how they may affect us.  We have no duty to, and do not intendto, update or revise the forward-looking statements in this report after thedate hereof.  In light of these risks and uncertainties, any forward-looking statementmade in this report or elsewhere might not occur.*

* *

*Ouraudited consolidated financial statements as at and for the year ended December31, 2004 incorporate certain changes in accounting policies which have affectedour financial position and results of operations retrospectively.  For furtherdiscussion please see Note 2 – Summary of Significant Accounting Policies andPractices to the accompanying unaudited consolidated financial statements.*

* *

**Financial Highlights and Key Performance Indicators**

* *

| ** **                                           | **June 30,**                  | ** ** | **December 31,** | ** ** | **Increase (Decrease)** |
|------------------------------------------------------|-------------------------------|------------|------------------|------------|-------------------------|
| **(in millions)**                                    | **2005**                      |       | **2004**         | ** ** | **Amount**              | ** ** | **%** |
|                                                 | (Unaudited)                   |       | (Audited)        |       |                    |   |   |
| **Consolidated Balance Sheets**                      |                          |       |             |       |                    |   |   |
| Total assets                                         | Php263,189                    |       | Php265,473       |       | (Php2,284)              |   | (1) |
| Property, plant and equipment                        | 190,176                       |       | 194,525          |       | (4,349)                 |   | (2) |
| Cash and cash equivalents and short-term investments | 35,656                        |       | 31,194           |       | 4,462                   |   | 14 |
| Total equity                                         | 59,304                        |       | 48,515           |       | 10,789                  |   | 22 |
| Interest-bearing financial liabilities               | 146,265                       |       | 164,489          |       | (18,224)                |   | (11) |
| Notes payable and long-term debt                     | 131,611                       |       | 149,088          |       | (17,477)                |   | (12) |
| Net debt to equity ratio(1)                          | 1.62x                         |       | 2.43x            |       | –                  |   | – |
| ** **                                           | ** **                    |
| ** **                                           | **Six Months Ended June 30,** |
|                                                 | ** **                    |       | ** **       | ** ** | **Increase (Decrease)** |
|                                                 | **2005**                      |       | **2004**(2)      | ** ** | **Amount**              | ** ** | **%** |
|                                                 | (Unaudited)                   |
| **Consolidated Statements of Income**                | ** **                    | ** ** | ** **       | ** ** | ** **              | ** ** | ** ** |
| Revenues and other income                            | Php61,138                     |       | Php62,299        |       | (Php1,161)              |   | (2) |
| Service income                                       | 59,522                        |       | 57,841           |       | 1,681                   |   | 3 |
| Expenses                                             | 38,627                        |       | 46,040           |       | (7,413)                 |   | (16) |
| Income before income tax                             | 22,511                        |       | 16,259           |       | 6,252                   |   | 38 |
| Net income attributable to equity holders            | 16,785                        |       | 12,423           |       | 4,362                   |   | 35 |
| Net income margin                                    | 27%                           |       | 20%              |       | –                  |   | – |
| **Consolidated Statements of Cash Flows**            |                          |       |             |       |                    |   |   |
| Net cash provided by operating activities            | 34,619                        |       | 38,080           |       | (3,461)                 |   | (9) |
| Net cash used in investing activities                | 2,220                         |       | 13,435           |       | (11,215)                |   | (83) |
| Capital expenditures                                 | 7,012                         |       | 11,575           |       | (4,563)                 |   | (39) |
| Net cash used in financing activities                | 23,996                        |       | 21,151           |       | 2,845                   |   | 13 |
| **Operational Data**                                 | ** **                    | ** ** | ** **       | ** ** | ** **              | ** ** | ** ** |
| Number of cellular subscribers                       | 20,789,469                    |       | 16,028,407       |       | 4,761,062               |   | 30 |
| Number of fixed lines in service                     | 2,137,813                     |       | 2,201,257        |       | (63,444)                |   | (3) |
| Number of employees                                  | 18,649                        |       | 17,849           |       | 800                     |   | 4 |

 

| **Exchange Rates** | **Php per US$** |   | **Php per JP¥** |
|--------------------|-----------------|--------|---------------------|
|               |            |   |                |
| June 30, 2005      | Php56.177       |   | Php0.5067           |
| December 31, 2004  | 56.341          |   | 0.5495              |
| June 30, 2004      | 56.176          |   | 0.5166              |
| December 31, 2003  | 55.586          |   | 0.5193              |

______________

* *

*(1)    **Net debt is derived bydeducting cash and cash equivalents and short-term investment from long-termdebt.*

*(2)    **As restated to reflect theeffects of the changes in accounting policies, as discussed in Note 2 – Summaryof Significant Accounting Policies and Practices to the accompanying unauditedconsolidated financial statements.*

 

**Overview**

 

We are the largest andmost diversified telecommunications company in the Philippines.  We haveorganized our business into three main segments:

 

•           *Wireless**—***wirelesstelecommunications services provided by Smart Communications, Inc., or Smart,and Pilipino Telephone Corporation, or Piltel, our cellular service providers,and Mabuhay Satellite Corporation, ACeS Philippines Cellular SatelliteCorporation, and Telesat, Inc., our satellite and very small aperture terminal,or VSAT, operators;**

 

•           *Fixed Line**—***fixed linetelecommunications services primarily provided through PLDT.  We also providefixed line services through PLDT’s subsidiaries PLDT Clark Telecom, Inc., SubicTelecommunications Company, Inc., PLDT-Maratel, Inc., Piltel and Bonifacio CommunicationsCorporation, which together account for approximately 3% of our consolidatedfixed lines in service, and PLDT Global Corporation; and

 

•           *Information and CommunicationsTechnology**—***informationand communications infrastructure and services for internet applications,internet protocol-based solutions and multimedia content delivery provided byPLDT’s subsidiary ePLDT, Inc.; call center services provided by ePLDT’ssubsidiaries Parlance Systems, Inc., Vocativ Systems, Inc. and ePLDT Ventus,Inc.; internet access and gaming services provided by ePLDT’s subsidiaries,Infocom Technologies, Inc., Digital Paradise, Inc. and netGames, Inc.; ande-commerce, and IT-related services provided by other investees of ePLDT, asdiscussed in *Note 9 – Investments in Associates* to the accompanyingunaudited consolidated financial statements. 

** **

We registered totalrevenues and other income of Php61,138 million, a decrease of Php1,161 millionin the first half of 2005 as compared to Php62,299 million in the same periodin 2004 primarily due to the Php2,944 million decline in our non-servicewireless revenues, partially offset by Php1,681 million net increase in ourservice revenues.  Total service revenues increased by 3% in the first half of2005 compared to the same period in 2004.

 

Expenses decreased byPhp7,413 million, or 16%, to Php38,627 million in the first half of 2005 fromPhp46,040 million in the same period in 2004 largely resulting from decreasesin financing costs mostly driven by the appreciation of the peso against theU.S. dollar and Japanese yen and lower cost of sales.

 

With the expiration ofSmart’s income tax holiday in May 2004, we recognized a higher provision forincome tax of Php5,694 million for the first half of 2005 as compared to Php3,811 million in the same period in 2004.

 

As a result of theforegoing, our net income attributable to equity holders increased by Php4,362million, or 35%, to Php16,785 million in the first half of 2005 from Php12,423million in the same period in 2004.

** **

Accounting Changes 
 

The accountingpolicies adopted are consistent with those of the previous financial periodexcept that we have adopted in year-end 2004 the following new accountingstandards effective for financial years beginning January 1, 2005.  Our June 30, 2004 unaudited consolidated financial statements herein have been restated togive effect to the provisions of the new standard adopted: 

 
- *PAS 19, “Employee Benefits”.*  PAS 19 requires the use of the projected unit credit method in measuring retirement benefit expense and a change in the manner of computing benefit expense relating to past service cost and actuarial gains and losses.  Past service cost is recognized as an expense on a straight-line basis over the average period until the benefits become vested.  On the initial adoption of this standard, the effect of the change in accounting policy includes all actuarial gains and losses that arose in earlier periods even if they fall inside the 10% corridor.  In subsequent periods, portion of actuarial gains or losses is recognized as income or expense if the cumulative unrecognized actuarial gains and losses at the end of the previous reporting period exceed the greater of: (i) 10% of the present value of the defined benefit obligation at that date (before deducting plan assets); and (ii) 10% of the fair value of any planned assets at that date by dividing the excess determined by the expected average remaining working lives of the employees participating in that plan is recognized immediately as income or expense. 

 
- *PAS 21, “The Effects of Changes in Foreign Exchange Rates”.*  PAS 21 requires the recognition of foreign exchange gains and losses in the period they are incurred.  Upon the adoption of PAS 21, we adjusted previously recorded undepreciated capitalized foreign exchange losses, net of exchange losses that qualify as borrowing cost and income tax effect, against beginning retained earnings, to the extent that such capitalized amounts do not meet the conditions for capitalization under the new accounting standard, and restated prior periods’ unaudited consolidated financial statements.  Further, PAS 21 requires the determination of the functional currency of an entity.  Exchange differences from any retranslation are taken directly as a separate component of equity.  On disposal of an entity with a functional currency other than the Philippine peso, the deferred cumulative amount recognized in equity relating to that particular foreign operation shall be recognized in the consolidated income statement.  

 
- *PAS 27, “Consolidated and Separate Financial Statements”.*   PAS 27 supersedes SFAS 27/IAS 27, “Consolidated Financial Statements and Accounting for Investments in Subsidiaries”.  Under PAS 27, the exclusion of a subsidiary from consolidation when there are severe long-term restrictions that significantly impair a subsidiary’s ability to transfer funds to the parent company under the superseded standard was removed.  Consequently, Piltel was required to be included in our unaudited consolidated financial statements retrospectively.

 
- *PAS 32, “Financial Instruments: Disclosure and Presentation”.*  PAS 32 covers the disclosure and presentation of all financial instruments. This standard requires more comprehensive disclosures about a company’s financial instruments, whether recognized or unrecognized in the financial statements.  New disclosure requirements include terms and conditions of financial instruments used, types of risks associated with both recognized and unrecognized financial instruments (market risk, price risk, credit risk, liquidity risk, and cash flow risk), fair value information of both recognized and unrecognized financial assets and financial liabilities, and our financial risk management policies and objectives.  This standard also requires financial instruments to be classified as liabilities or equity in accordance with their substance and not their legal form. Consequently, we have designated PLDT’s Convertible Preferred Stock Series V, VI and VII as compound instruments consisting of liability and equity components.  The total fair value of the Convertible Preferred Stock Series V, VI and VII was determined at issue date, of which the aggregate fair value of the liability component of the Series V, VI and VII Convertible Preferred Stock as at issuance date is included as a financial liability under  Interest-bearing Financial Liabilities  account in the accompanying unaudited consolidated balance sheets.  The residual amount was assigned as the equity component.

 
- *PAS 39, “Financial Instruments: Recognition and Measurement”.*  PAS 39 establishes the accounting and reporting standards for recognizing and measuring our financial assets and financial liabilities.  This standard requires a financial asset or financial liability to be recognized initially at fair value.  Subsequent to initial recognition, we are to continue to measure financial assets at their fair values, except for loans and receivables and held-to-maturity investments, which are measured at cost or amortized cost using the effective interest rate method. Financial liabilities are subsequently measured at cost or amortized cost, except for liabilities classified as “at fair value through profit and loss” and derivatives, which are measured at fair value.

** **

PAS 39 also covers the accounting for derivative instruments.  Thisstandard has expanded the definition of a derivative instrument to includederivatives (derivative-like provisions) embedded in non-derivative contracts.Under this standard, every derivative instrument is recorded in the balancesheet as either an asset or liability measured at its fair value.  Derivativesthat are not designated and do not qualify as hedges are adjusted to fair valuethrough income.  If the derivative is designated and qualifies as a hedge,depending on the nature of the hedge, changes in the fair value of derivativesare either offset against the change in fair value of the hedged assets,liabilities, or firm commitments through earnings, or recognized in equityuntil the hedged item is recognized in earnings.

 
- *PAS 40, “Investment Property”.*  PAS 40 prescribes the accounting treatment for investment properties which are defined as land and/or building held to generate income or for capital appreciation or both.  An investment property is initially recognized at cost.  Subsequent to initial recognition, an investment property is either carried at (i) cost, less accumulated depreciation or any accumulated impairment losses, or (ii) fair value, wherein fair value movements are recognized as income or expense.  Transfers to or from investment property classification are made only when there is evidence of a change in use.

 
- *PFRS 2, “Share-Based Payment”.*  PFRS 2 requires an entity to recognize goods or services received or acquired in a share-based payment transaction when it obtains the goods or as the services are received.  The entity shall recognize a corresponding increase in equity if the goods or services were received in an equity-settled share-based payment transaction, or a liability if the goods or services were acquired in a cash-settled share-based payment transaction.  In line with our adoption of PFRS 2, we recognized in our consolidated statements of income the costs of employees’ and directors’ share options and other share-based incentives by using an option-pricing model, further details of which are given in  Note 21 – Employee Benefits  to the accompanying unaudited consolidated financial statements .

*** ***
- *PFRS 3, “Business Combinations”, PAS 36, “Impairment of Assets” and PAS 38, “Intangible Assets”.*  PFRS 3 requires all business combinations within its scope to be accounted for by applying the purchase method.  In addition, this standard requires the acquirer to initially measure separately the identifiable assets, liabilities and contingent liabilities at their fair values, at acquisition date, irrespective of the extent of any minority interest.

 

PFRS 3 also requiresgoodwill in a business combination to be recognized by an acquirer as an assetfrom the acquisition date, initially measured as the excess of the cost of thebusiness combination over the acquirer’s interest in the net fair value of theacquiree’s identifiable assets and liabilities.  Further, the amortization ofgoodwill acquired in a business combination is prohibited; instead, goodwill isto be tested annually, or more frequently, if events or changes incircumstances indicate that the asset might be impaired. 

 

Moreover, the useful lives of intangible assets areassessed at the individual asset level as having either a finite or indefinitelife.  Where an intangible asset has a finite life, it will be amortized overits useful life.  Amortization periods and methodsfor intangible assets with finite useful lives are reviewed annually or earlierwhere an indicator or impairment exists.  Intangibles assessed as havingindefinite useful lives are not amortized, as there is no foreseeable limit tothe period over which the asset is expected to generate net cash inflows for thePLDT Group.  However, intangibles with indefinite useful lives are reviewedannually to ensure that their carrying values do not exceed the recoverableamounts regardless of any impairment indicators present. 

 
- *PFRS 5, “Non-Current Assets Held-for-Sale and Discontinued Operations”.*  Under the superseded SFAS 35/IAS 35, “Discontinuing Operations”,  we would have previously recognized a discontinued operation at the earlier of when (a) we enter into a binding agreement; and (b) the Board of Directors have approved and announced a formal disposal plan.  PFRS 5 now requires an operation to be classified as discontinued when the criteria to be classified as held-for-sale have been met or we have disposed of the operation.

 

Followingadditional guidelines from PAS 16, “Property, Plant and Equipment”, we haverecognized the initial settlement of thenet present value of legal and constructive obligations associated with theretirement of a tangible long-lived asset that resulted from the acquisition,construction or development and the normal operation of a long-lived asset inthe period in which it is incurred.  The asset retirement obligations wererecognized in the period in which they are incurred if a reasonable estimate offair values can be made.  The related asset retirement costs are capitalized aspart of the carrying amount of the corresponding property, plant and equipmentwhich are being depreciated on a straight-line basis over the useful lives ofthe related assets or the contract periods, whichever is lower.

 

The following is the reconciliation from net incomeas previously reported to net income as restated, including the effect of theserestatements on per share amounts:

 

 

 

For the Six Months Ended June 30,

2004

(in millions, except per share amounts)

 

 

**Net income, as previously reported**

** **

Php12,008

PAS 16 – Property, Plant and Equipment

 

(34)

PAS 17 – Leases

 

1

PAS 19 – Employee Benefits 

 

(15)

PAS 21 – The Effects of Changes in Foreign Exchange Rates

 

1,226

PAS 27 – Consolidated and Separate Financial Statements

 

840

PAS 32 – Financial Instruments:  Disclosure and Presentation

 

(647)

PAS 39 – Financial Instruments:  Recognition and Measurement

 

(830)

PAS 40 – Investment Property

 

(7)

PFRS 2 – Share-Based Payment

 

(93)

PFRS 3 – Business Combinations, PAS 36 – Impairment of Assets and  PAS 38 – Intangible Assets

 

(26)

**Net income, as restated**

 

Php12,423

** **

 

 

** **

 

 

** **

 

 

** **

** **

** **

** **

** **

 

 

**Earnings per common share, as previously reported**

 

Php65.62

Earnings per share impact of restated items:

 

 

PAS 16 – Property, Plant and Equipment

 

(0.20)

PAS 17 – Leases

 

0.01

PAS 19 – Employee Benefits 

 

(0.09)

PAS 21 – The Effects of Changes in Foreign Exchange Rates

 

7.17

PAS 27 – Consolidated and Separate Financial Statements

 

4.95

PAS 32 – Financial Instruments:  Disclosure and Presentation

 

(3.04)

PAS 39 – Financial Instruments:  Recognition and Measurement

 

(4.90)

PAS 40 – Investment Property

 

(0.04)

PFRS 2 – Share-Based Payment

 

(0.55)

PFRS 3 – Business Combinations, PAS 36 – Impairment of Assets and  PAS 38 – Intangible Assets

 

(0.15)

**Earnings per common share, as restated**

 

Php68.78

 

We fully adopted PAS16 in 2005, which requires us to determine the depreciation charge separatelyfor each significant part of an item of property, plant and equipment.Consequently, we changed the estimated useful lives of certain components ofour property, plant and equipment and we recognized the effect of the change inaccounting estimate prospectively, in accordance with *PAS 8, “AccountingPolicies, Changes in Accounting Estimates and Errors”.*  Our full adoptionof this standard reduced our consolidated net income by Php698 million (Php475million after tax effect) for the six months ended June 30, 2005.

 

 

For a detailed discussion regarding changes inaccounting policies, please refer to *Note 2 –**Summary of Significant Accounting Policies**and Practices* to theaccompanying unaudited consolidated financial statements.

** **

**Results of Operations**

** **

The table below shows the contribution by each of ourbusiness segments to our revenues and other income, expenses and net income (losses)for the six months ended June 30, 2005 and 2004.  Most of our revenues are derived from ouroperations within the Philippines.

** **

 

**Wireless**

** **

** **

** **

**Fixed Line**

** **

** **

** **

**ICT**

** **

 

** **

**Inter-segment Transactions**

** **

**Total**

** **

** **

**(in millions)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the six months ended****June 30, 2005******(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues and other income

Php38,051

 

 

 

Php24,336

 

 

 

Php1,587

 

 

 

(Php2,836)

 

Php61,138

 

 

Service

36,703

 

 

 

24,214

 

 

 

1,328

 

 

 

(2,723)

 

59,522

 

 

Non-service

1,291

 

 

 

–

 

 

 

215

 

 

 

(84)

 

1,422

 

 

Other income

57

 

 

 

122

 

 

 

44

 

 

 

(29)

 

194

 

 

Expenses

20,459

 

 

 

19,486

 

 

 

1,518

 

 

 

(2,836)

 

38,627

 

 

Income before tax

17,592

 

 

 

4,850

 

 

 

69

 

 

 

–

 

22,511

 

 

Net income attributable to equity holders

13,324

 

 

 

3,378

 

 

 

83

 

 

 

–

 

16,785

 

 

** **

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**For the six months ended****June 30, 2004**(1) (Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues and other income

38,353

 

 

 

24,215

 

 

 

1,127

 

 

 

(1,396)

 

62,299

 

 

Service

33,983

 

 

 

24,108

 

 

 

953

 

 

 

(1,203)

 

57,841

 

 

Non-service

4,235

 

 

 

–

 

 

 

161

 

 

 

(85)

 

4,311

 

 

Other income

135

 

 

 

107

 

 

 

13

 

 

 

(108)

 

147

 

 

Expenses

23,055

 

 

 

23,307

 

 

 

1,074

 

 

 

(1,396)

 

46,040

 

 

Income before tax

15,298

 

 

 

908

 

 

 

53

 

 

 

–

 

16,259

 

 

Net income attributable to equity holders

11,735

 

 

 

638

 

 

 

50

 

 

 

–

 

12,423

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

** **

**Amount**

** **

%

** **

**Amount**

** **

%

** **

**Amount**

** **

%

** **

**Amount**

** **

**Amount**

** **

**%**

**Increase (Decrease)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues and other income

(Php302)

 

(1)

 

Php121

 

–

 

Php460

 

41

 

(Php1,440)

 

(Php1,161)

 

(2)

Service

2,720

 

8

 

106

 

–

 

375

 

39

 

(1,520)

 

1,681

 

3

Non-service

(2,944)

 

(70)

 

–

 

–

 

54

 

34

 

1

 

(2,889)

 

(67)

Other income

(78)

 

(58)

 

15

 

14

 

31

 

238

 

79

 

47

 

32

Expenses

(2,596)

 

(11)

 

(3,821)

 

(16)

 

444

 

41

 

(1,440)

 

(7,413)

 

(16)

Income before tax

2,294

 

15

 

3,942

 

434

 

16

 

30

 

–

 

6,252

 

38

Net income attributable to equity holders

1,589

 

14

 

2,740

 

429

 

33

 

66

 

–

 

4,362

 

35

* *

*_____________*

*(1)    **As restated to reflect theeffects of the changes in accounting policies, as discussed in Note 2 – Summaryof Significant Accounting Policies and Practices to the accompanying unauditedconsolidated financial statements.*

** **

**Wireless**

* *

Revenues and Other Income
 

Our wireless businesssegment offers cellular services as well as satellite, VSAT, wireless broadband,and other services.

 

The following table summarizes our service andnon-service revenues and other income from our wireless business for the sixmonths ended June 30, 2005 and 2004 by service segment:

 

** **

**Six months ended June 30,**

** **

** **

** **

** **

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2005**

** **

**%**

** **

**2004**(1)

** **

**%**

** **

**Amount**

** **

**%**

** **

(Unaudited)

**(in millions)**

 

Wireless services:

 

 

 

 

 

 

 

 

 

 

 

Service Revenues

 

 

 

 

 

 

 

 

 

 

 

Cellular 

Php35,448

 

93

 

Php32,973

 

86

 

Php2,475

 

8

Satellite, VSAT, wireless broadband and others

1,255

 

3

 

1,010

 

3

 

245

 

24

 

36,703

 

96

 

33,983

 

89

 

2,720

 

8

Non-service Revenues

 

 

 

 

 

 

 

 

 

 

 

Sale of handsets and SIM-packs

1,291

 

4

 

4,235

 

11

 

(2,944)

 

(70)

 

 

 

 

 

 

 

 

 

 

 

 

Other Income

57

 

–

 

135

 

–

 

(78)

 

(58)

 

 

 

 

 

 

 

 

 

 

 

 

Total Wireless Revenues and Other Income

Php38,051

 

100

 

Php38,353

 

100

 

(Php302)

 

(1)

*___________*

* *

*(1) As restated to reflect the effects of the changesin accounting policies, as discussed in Note 2 – Summary of SignificantAccounting Policies and Practices to the accompanying unaudited consolidatedfinancial statements.*

 

*Service Revenues*

 

Our wireless servicerevenues increased by Php2,720 million, or 8%, to Php36,703 million in thefirst half of 2005 compared to Php33,983 million in the same period in 2004,mainly as a result of the continued growth of Smart’s and Piltel’s subscriberbase.  Accordingly, as a percentage of our total wireless revenues and otherincome, service revenues increased to 96% in the first half of 2005 from 89% inthe same period in 2004. 

 

*Cellular Service*

 

Our cellular service revenues consist of: 

 

•        revenues derived from actual usageof the network by prepaid subscribers and any unused peso value of expiredprepaid cards or electronic air time loads, net of discounts given to dealers; 

 

•        monthly service fees from postpaidsubscribers, including (1) charges for calls in excess of allocated free localcalls, (2) toll charges for national and international long distance calls, (3)charges for text messages of our service customers in excess of allotted freetext messages, and (4) charges for value-added services, net of related contentprovider costs;

 

•        revenues generated from incomingcalls and messages to our subscribers, net of interconnection expenses; feesfrom reciprocal traffic from international correspondents; and revenues frominbound international roaming calls for the service; and

 

•        other charges, including those forreconnection and migration. 

 

Our cellular servicerevenues in the first half of 2005 amounted to Php35,448 million, an increaseof Php2,475 million, or 8%, from Php32,973 million in the same period in 2004.Cellular service revenues accounted for 97% of wireless service revenues in thefirst half of 2005 and 2004.  

 

As at June 30, 2005, Smart and Piltel cellular subscribers reached 20,789,469, an increase of4,761,062, or 30%, over the combined cellular subscriber base of 16,028,407 as at June 30, 2004.  Prepaid subscribers accounted for 99% and 98% of our totalsubscriber base as at June 30, 2005 and 2004, respectively.  Prepaid netsubscriber activations totaled 1,587,478 in the first half of 2005, or amonthly average addition of 264,580 subscribers.  Postpaid subscribers totaled268,253 subscribers, reflecting a net reduction of 6,241 in the first half of2005.  

 

Smartmarkets nationwide cellular communications services under the brand names *SmartBuddy, Smart Gold,**addict mobile,**addict mobile prepaid*, or *amp*,*Smart Infinity,**Smart Kid*and*Smart Kid prepaid.  Smart Buddy,addict mobile prepaid*and *Smart Kid prepaid* are prepaid serviceswhile *Smart Gold, addict mobile*, *Smart Infinity* and *Smart Kid*are postpaid services, which are all provided through Smart's digital network.

 

Piltel markets itscellular prepaid service under the brand name *Talk ‘N Text* and isprovided through Smart’s network.  On December 22, 2004, the Board of Directorsof Smart and Piltel approved the amendment of Piltel’s and Smart’s revenuesharing arrangement of 50-50 for the *Talk ‘N Text*service to 80-20 infavor of Piltel.

 

On August 1, 2004, Smart launched *Smart Padala*, one ofthe many innovative initiatives from our *Smart Money* platform.  *SmartPadala* is the first cash remittance service through text and is faster andcheaper than traditional remittance arrangements.  It was launched initially asan international remittance service for overseas Filipino workers but is nowavailable for domestic remittances as well.

 

Inorder to test the apparent market demand for fixed rate or “bucket” plans forvoice and text services, Smart launched from March 11, 2005 the *Smart 258**Unlimited Call*and *Text* promotion wherein Smart and *Talk ‘NText* prepaid subscribers had the optionfor the duration of the promotion, to register for unlimited on-network(Smart-to-Smart) voice calls or unlimited on-network (Smart-to-Smart) textmessaging service.  Available as a promotion for 30 days initially, *Smart 258*has since been extended and modified as follows:

 
- On April 22, 2005,  Smart 25 8  Unlimited Call  and  Text  promotions were modified as follows: 

 

•           the *Smart 258**UnlimitedCall* Php115 load are valid for seven days with a maximum call duration ofthree minutes for peak hours which is from 6:01am to 11pm and five minutes foroff-peak hours beginning 11:01pm to 6am;

 

•           the Smart *258Unlimited Text* Php60 load are valid for four days; and

 

•           subscribers could avail of *Smart258**Unlimited Call* and *Text* simultaneously.

 
- On July 31, 2005,  Smart 258 Unlimited Text  added a Php30 load, which is only valid for two days.  

 

Wehad 1.4 million subscribers registered under the *Smart 258**UnlimitedText*promotion as of June 30, 2005.

 

The following table summarizes key measures of ourcellular business as at and for the six months ended June 30, 2005 and 2004:

 

** **

**Six months ended June 30,**

** **

** **

** **

** **

** **

**Increase**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

** **

(Unaudited)

**(in millions)**

 

 

 

 

 

 

 

Cellular service revenues 

Php35,448

 

Php32,973

 

Php2,475

 

8

 

 

 

 

 

 

 

 

*By component*

*34,546*

* *

*32,174*

* *

*2,372*

* *

*7*

Voice

17,105

 

16,636

 

469

 

3

Data

17,441

 

15,538

 

1,903

 

12

* *

* *

* *

* *

* *

* *

* *

* *

*By service type*

*34,546*

* *

*32,174*

* *

*2,372*

* *

*7*

Prepaid

32,439

 

30,146

 

2,293

 

8

Postpaid

2,107

 

2,028

 

79

 

4

* *

* *

* *

* *

* *

* *

* *

* *

*Others*(1)

*902*

* *

*799*

* *

*103*

* *

*13*

______________

 

 

 

 

 

 

 

* *

*(1)    **Refers to othernon-subscriber-related revenues consisting primarily of inbound internationalroaming fees, revenues from Smart’s public calling offices and payphonebusinesses, revenues from Wolfpac and Smart Money Holdings Corporation and asmall number of leased line contracts.*

* *

 

 

**As at June 30,**

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

(Unaudited)

 

 

 

 

 

 

 

 

Cellular subscriber base 

20,789,469

 

16,028,407

 

4,761,062

 

30

Prepaid 

20,521,216

 

15,754,873

 

4,766,343

 

30

Smart 

15,556,780

 

12,200,978

 

3,355,802

 

28

Piltel

4,964,436

 

3,553,895

 

1,410,541

 

40

Postpaid

268,253

 

273,534

 

(5,281)

 

(2)

 

 

**Six months ended June 30,**

 

** **

** **

** **

** **

**Increase**

 

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

(Unaudited)

Systemwide traffic volumes(1) (in millions)

 

 

 

 

 

 

 

Calls (in minutes) 

2,647

 

2,448

 

199

 

8

Domestic 

1,912

 

1,764

 

148

 

8

International

735

 

684

 

51

 

7

Inbound

649

 

601

 

48

 

8

Outbound

86

 

83

 

3

 

4

 

 

 

 

 

 

 

 

Text messages 

20,778

 

20,312

 

466

 

2

Smart

16,971

 

16,774

 

197

 

1

Piltel

3,807

 

3,538

 

269

 

8

__________

*(1)   Excludes traffic volumes relating to Smart 258**Unlimited****Call and Text promotions.*

* *

*VoiceServices*

 

Cellular revenues fromvoice services, which include all voice traffic and voice value-added servicessuch as voice mail and international roaming, increased by Php469 million, or 3%,to Php17,105 million in the first half of 2005 from Php16,636 million in thesame period in 2004 mainly due to an increase in subscriber base whichcompensated for a 24% drop in the average voice usage per subscriber from 21 minutesper month in the first half of 2004 to 16 minutes per month in the same periodin 2005.

 

Air time rates for postpaid subscribers vary depending on thetype of postpaid plan selected by subscribers.  Beginning January 25, 2004, *Smart Gold*,*Smart Infinity* and *addict mobile* launched flatrate-regular plans and consumable plans.

 

*Data Services*

 

Cellularrevenues from data services, whichinclude all text messaging-related services as well as value-added services,increased by Php1,903 million, or 12%, to Php17,441 million in the first halfof 2005 from Php15,538 million in the same period in 2004.  Cellular dataservices accounted for 49% of cellular service revenues in the first half of2005, compared to 47% in the same period in 2004.  

 

The following table shows the breakdown of cellulardata revenues for the six months ended June 30, 2005 and 2004:

* *

** **

**Six months ended June 30,**

** **

** **

** **

**Increase (Decrease)**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

** **

(Unaudited)

**(in millions)**

** **

** **

** **

** **

** **

** **

** **

Text messaging

 

 

 

 

 

 

 

Domestic

Php14,832

 

Php13,192

 

Php1,640

 

12

International

856

 

947

 

(91)

 

(10)

 

15,688

 

14,139

 

1,549

 

11

Value-added services

 

 

 

 

 

 

 

Non-Zed(1)

1,138

 

761

 

377

 

50

*Smart Zed*TM

287

 

293

 

(6)

 

(2)

*Smart Money*

47

 

20

 

27

 

135

Mobile Banking

3

 

1

 

2

 

200

Roaming SMS and WAP**

278

 

324

 

(46)

 

(14)

 

1,753

 

1,399

 

354

 

25

Total 

Php17,441

 

Php15,538

 

1,903

 

12

_________________

* *

*(1)   Value-added servicesdeveloped by Smart on its own platform.*

Textmessaging-related services contributed revenues of Php15,688 million in the firsthalf of 2005, an increase of 11%, compared to Php14,139 million in the sameperiod in 2004, and accounted for 90% and 91% of the total cellular datarevenues for the first half of 2005 and 2004, respectively.  The increase inrevenues from text messaging-related services resulted mainly from an increasein domestic text messaging owing to the introduction of *Smart 258**Unlimited Text*promotion in March 2005.  Value-added services contributed revenues of Php1,753million in the first half of 2005, increasing by Php354 million, or 25%, fromPhp1,399 million in the same period in 2004 as a result of a significantincrease in ringtone/caller ringtunes download activity as well as increasedusage emanating from *Smart Padala*.

* *

*SubscriberBase, ARPU and Churn Rates*

* *

Prepaid subscribersaccounted for approximately 99% of our 20,789,469 subscribers as at June 30, 2005, while postpaid subscribers accounted for the remaining 1%.  The cellularprepaid subscriber base grew by 30% to 20,521,216 as at June 30, 2005 from15,754,873 as at June 30, 2004, whereas postpaid subscriber base decreased by2% to 268,253 as at June 30, 2005 from 273,534 as at June 30, 2004.  

 

Our net subscriber activations (reductions) for thefirst half of 2005 and 2004 are as follows:

** **

 

**Six months ended June 30,**

 

** **

** **

** **

** **

**Decrease**

 

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

 

 

 

 

 

 

 

Prepaid

1,587,478

 

3,056,653

 

(1,469,175)

 

(48)

Smart

1,235,492

 

2,369,843

 

(1,134,351)

 

(48)

Piltel

351,986

 

686,810

 

(334,824)

 

(49)

** **

 

 

 

 

 

 

 

Postpaid

(6,241)

 

24,557

 

(30,798)

 

(125)

 

 

 

 

 

 

 

 

Total

1,581,237

 

3,081,210

 

(1,499,973)

 

(49)

 

Our quarterly net subscriber activations (reductions)for the four quarters of 2004 and first two quarters of 2005 are as follows:

 

 

**2004**

** **

**2005**

 

**1Q**

** **

**2Q**

** **

**3Q**

** **

**4Q**

** **

**1Q**

** **

**2Q**

 

 

 

 

 

 

 

 

 

 

 

 

Prepaid

1,380,339

 

1,676,314

 

1,433,664

 

1,745,201

 

1,050,638

 

536,840

Smart

1,162,301

 

1,207,542

 

797,686

 

1,322,624

 

920,885

 

314,607

Piltel

218,038

 

468,772

 

635,978

 

422,577

 

129,753

 

222,233

** **

 

 

 

 

 

 

 

 

 

 

 

Postpaid

16,866

 

7,691

 

10,445

 

(9,485)

 

(6,357)

 

116

 

 

 

 

 

 

 

 

 

 

 

 

Total

1,397,205

 

1,684,005

 

1,444,109

 

1,735,716

 

1,044,281

 

536,956

 

Revenues attributableto our cellular prepaid service amounted to Php32,439 million in the first halfof 2005, an 8% increase over the Php30,146 million earned in the same period in2004.  Prepaid service revenues in the first half of 2005 and 2004 accountedfor 94% of voice and data revenues.  Revenues attributable to Smart’s postpaidservice amounted to Php2,107 million in the first half of 2005, a 4% increaseover the Php2,028 million earned in the same period in 2004.  Postpaid servicerevenues in the first half of 2005 and 2004 accounted for 6% of voice and datarevenues.

 

The following table summarizes our cellular ARPUs forthe six months ended June 30, 2005 and 2004:

 

 

**Six months ended June 30,**

 

**Gross**

** **

**Increase (Decrease)**

** **

**Net**

 

**Increase (Decrease)**

 

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

** **

**2005**

** **

**2004**

 

**Amount**

 

**%**

 

 

 

**(Unaudited)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Prepaid

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Smart

Php357

Php459

 

(Php102)

 

(22)

 

Php292

 

Php381

 

(Php89)

 

(23)

Piltel

266

341

 

(75)

 

(22)

 

216

 

288

 

(72)

 

(25)

Prepaid – Blended

335

433

 

(98)

 

(23)

 

274

 

361

 

(87)

 

(24)

Postpaid – Smart

1,831

1,709

 

122

 

7

 

1,308

 

1,282

 

26

 

2

Prepaid and Postpaid Blended

355

456

 

(101)

 

(22)

 

287

 

377

 

(90)

 

(24)

 

ARPU is computed foreach month by dividing the revenues for the relevant services for the month bythe average of the number of subscribers at the beginning and at the end of themonth.  Gross monthly ARPU is computed by dividing the revenues for therelevant services, gross of dealer discounts and allocated content-providercosts, including interconnection income but excluding inbound roaming revenues,by the average number of subscribers.  Net monthly ARPU, on the other hand, iscalculated based on revenues net of dealer discounts and allocatedcontent-provider costs and interconnection income net of interconnectionexpense.  ARPU for any period of more than one month is calculated as thesimple average of the monthly ARPUs in that period.

 

Prepaidservice revenues consist mainly of charges for subscribers' actual usage oftheir loads.  Gross monthly ARPU for Smart prepaid subscribers in the firsthalf of 2005 was Php357, a decrease of 22%, compared to Php459 in the sameperiod in 2004.  The decline was attributable mainly to a decrease in theaverage text messaging revenue per subscriber as well as lower average outboundlocal voice revenue per subscriber in the first half of 2005.  On a net basis,ARPU in the first half of 2005 decreased by 23% to Php292 from Php381 in thesame period in 2004.  Gross monthly ARPU for *Talk ‘N Text* subscribers inthe first half of 2005 was Php266, a decrease of 22% compared to Php341 in thesame period in 2004.  The decline was similarly attributable to a decrease inthe average text messaging revenue per subscriber as well as lower averageoutbound local voice revenue per subscriber in the first half of 2005.  On anet basis, ARPU in the first half of 2005 decreased by 25% to Php216 from Php288in the same period in 2004.  

 

Monthly ARPU forSmart’s postpaid services is calculated in a manner similar to that of prepaidservice, except that the revenues consist mainly of monthly service fees andcharges on usage in excess of the monthly service fees.  

 

Gross monthly ARPU forpostpaid subscribers increased by 7% to Php1,831 while net monthly ARPUincreased by 2% to Php1,308, in the first half of 2005 compared to the sameperiod in 2004.  Prepaid and postpaid monthly gross blended ARPU was Php355 inthe first half of 2005, a decrease of 22% compared to Php456 in the same periodin 2004.  Monthly net blended ARPU decreased by 24% to Php287 in the first halfof 2005 from Php377 in the same period in 2004.

 

Our quarterly prepaid and postpaid ARPUsfor 2005 and 2004 are as follows:

*** ***

 

**Prepaid**

** **

**Postpaid**

 

**Smart**

** **

**Piltel**

** **

**Smart**

 

**Gross**

** **

**Net**

** **

**Gross**

** **

**Net**

** **

**Gross**

** **

**Net**

**2004**

 

 

 

 

 

 

 

 

 

 

 

First Quarter

Php463

 

Php383

 

Php341

 

Php287

 

Php1,736

 

Php1,326

Second Quarter

455

 

380

 

341

 

289

 

1,683

 

1,239

Third Quarter

399

 

329

 

287

 

241

 

1,780

 

1,176

Fourth Quarter

395

 

328

 

275

 

220

 

1,763

 

1,402

 

 

 

 

 

 

 

 

 

 

 

 

**2005**

 

 

 

 

 

 

 

 

 

 

 

First Quarter

Php356

 

Php289

 

Php269

 

Php220

 

Php1,767

 

Php1,257

Second Quarter

357

 

294

 

262

 

212

 

1,896

 

1,360

 

Churn, or the rate at which existing subscribers havetheir service cancelled in a given period, is computed based on totaldisconnections in the period, net of reconnections in the case of postpaidsubscribers, divided by the average of the number of subscribers at thebeginning and at the end of a month, all divided by the number of months in thesame period.

 

Prior to June 2004, a prepaid cellular subscriber wasrecognized as an active subscriber when that subscriber activated and used theSIM card in the handset, which already contains Php50 of pre-stored air time (reducedfrom Php100 in April 2004).  Subscribers can reload their air time bypurchasing prepaid “call and text” cards that are sold in denominations ofPhp300, Php500 and Php1,000; by purchasing additional air time “over the air”via *Smart**Load* in smaller denominations of Php30, Php60, Php115and Php200; and by receiving loads of Php2, Php5, Php10 and Php15 via *Pasa**Load*, or through their handsets using *Smart Money*.  Reloads havevalidity periods ranging from one day to two months, depending on the amount reloaded.A prepaid cellular subscriber is disconnected if the subscriber does not reloadwithin four months after the full usage or expiry of the last reload.  Ourcurrent policy is to recognize a prepaid subscriber as “active” only when thesubscriber activates and uses the SIM card and reloads at least once during themonth of initial activation or in the immediate succeeding month.  For example,if a customer activated a SIM card in April but had not reloaded by May 31,this customer would not be counted as a subscriber.  The rationale for thischange stems from our observance of “SIM-swapping” activities in the marketwhereby “SIM-swapping” refers to the promotional activity wherein subscriberscan exchange their current prepaid SIM card for another operator’s SIM card atno cost to the subscriber.  We believe that these activities have given rise toa situation where certain subscribers swap their SIM cards between mobileoperators upon full usage of the pre-stored air time, which may result in oursubscriber base reflecting a certain number of transient subscribers at any onepoint in time.  In May 2005, we terminated our “SIM swapping” promotions.  As aresult, we expect our churn rates to increase significantly in the next fewmonths as the subscribers acquired through “SIM swapping” leave the system.  

 

For Smartprepaid, the average monthly churn rate for the first half of 2005 was 3.4%,compared to 2.0% in the same period in 2004 while the average monthly churnrate for *Talk ‘N Text* subscribers was 4.6% in the first half of 2005compared to 3.2% in the same period in 2004.  The increased churn in ourprepaid service can be attributed to the “SIM-swapping” activities describedabove.  

 

The average monthlychurn rate for Smart's postpaid subscribers for the first half of 2005 was2.3%, compared to 0.4% in the same period in 2004 as a result of increasedcompetition in this market segment.  Smart's policy is to redirect outgoingcalls to an interactive voice response system if the postpaid subscriber's accountis either 45 days overdue or the subscriber has exceeded the prescribed creditlimit.  If the subscriber does not make a payment within 44 days ofredirection, the account is disconnected.  Within this 44-day period, a seriesof collection activities are implemented, involving the sending of a collectionletter, call-out reminders and collection messages via text messaging.

 

*Satellite, VSAT, Wireless Broadband and Other Services*

 

Our revenues fromsatellite, VSAT, wireless broadband and other services consist mainly ofrentals received for the lease of Mabuhay Satellite's transponders andTelesat's VSAT facilities to other companies, wireless broadband servicerevenues for Meridian, charges for ACeS Philippines’ satellite phone serviceand service revenues generated from a PLDT Global subsidiary’s mobile virtualnetwork operations.  Gross revenues from these services for the first half of2005 amounted to Php1,255 million, an increase of Php245 million, or 24%, fromPhp1,010 million in the same period in 2004.

 

*Non-service Revenues*

 

Our wireless non-service revenues consist of:

 
- Proceeds from sale of cellular handsets; and

 
- Proceeds from sale of cellular SIM-packs.

 

Ourwireless non-service revenues decreased by Php2,944 million, or 70%, to Php1,291 million in the first half of 2005 as compared to Php4,235 million inthe same period in 2004 mainly attributable to lower handset sales.  In thefirst half of 2005, activations were driven more by SIM-pack sales and SIM-swapactivities.  

 

*Other Income*
 

All other income/gains such as rental income, gainon disposal of property, which do not fall under service and non-servicerevenues are included under this classification.  Our wireless business segmentgenerated other income of Php57 million in the first half of 2005, a decreaseof Php78 million, or 58%, from Php135 million in the same period in 2004.

 

*Expenses*
 

Expenses associatedwith our wireless business in the first half of 2005 amounted to Php20,459million, a decrease of Php2,596 million, or 11%, from Php23,055 million in thesame period in 2004.  A significant portion of this decrease was attributableto lower cost of sales, financing costs, and depreciation and amortization,partially offset by higher cash expenses particularly rent and maintenance.  Asa percentage of our total wireless revenues and other income, expensesassociated with our wireless business decreased to 54% in the first half of2005 from 60% in the same period in 2004.

 

Cellular business expenses accounted for 96% of ourwireless business expenses while satellite, VSAT, wireless broadband and otherbusiness expenses accounted for the remaining 4% of our wireless businessexpenses in the first half of 2005 and 2004.

 

The following table summarizes our wireless-relatedexpenses for the six months ended June 30, 2005 and 2004 and the percentage ofeach expense item to the total:

 

 

**Six months ended June 30,**

 

** **

 

** **

 

** **

 

** **

** **

**Increase (Decrease)**

 

**2005**

 

**%**

 

**2004**(1)

 

**%**

** **

**Amount**

** **

**%**

** **

(Unaudited)

**(in millions)**

 

 

 

 

 

 

 

 

 

 

 

Wireless services

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

Php4,970

 

24

 

Php5,779

 

25

 

(Php809)

 

(14)

Cost of sales

3,271

 

16

 

6,599

 

28

 

(3,328)

 

(50)

Rent

2,255

 

11

 

1,071

 

5

 

1,184

 

111

Compensation and benefits(2)

1,890

 

9

 

1,781

 

8

 

109

 

6

Selling and promotions

1,702

 

8

 

1,598

 

7

 

104

 

7

Maintenance

1,617

 

8

 

1,163

 

5

 

454

 

39

Financing costs

1,214

 

6

 

2,079

 

9

 

(865)

 

(42)

Taxes and licenses

667

 

3

 

417

 

2

 

250

 

60

Professional and other service fees

595

 

3

 

485

 

2

 

110

 

23

Insurance and security services

492

 

3

 

443

 

2

 

49

 

11

Provisions

437

 

2

 

608

 

3

 

(171)

 

(28)

Other expenses

1,349

 

7

 

1,032

 

4

 

317

 

31

Total 

Php20,459

 

100

 

Php23,055

 

100

 

(Php2,596)

 

(11)

__________

* *

*(1)    **As restated to reflect theeffects of the changes in accounting policies, as discussed in Note 2 – Summaryof Significant Accounting Policies and Practices to the accompanying unauditedconsolidated financial statements.*

*(2)    **Includes salaries andbenefits, incentive plan, pension and manpower rightsizing program, or MRP,costs.*

 

Depreciationand amortization charges decreased by Php809 million, or 14%, to Php4,970 million in the first half of 2005 substantially due to a decrease inthe depreciable asset base as certain of our wireless assets were fullydepreciated by the end of 2004, partially offset by the effect of our fulladoption of PAS 16 which increased depreciation charges by Php336 million forthe first half of 2005.  See *Note 2 – Summary of Significant AccountingPolicies and Practices* to the accompanying unaudited consolidated financialstatements.

 

Costof sales decreased by Php3,328 million, or 50%, to Php3,271 million asactivations in the first half of 2005 were driven more by SIM-pack sales andSIM-swap activities compared to handset sales in the same period in 2004.  Thebreakdown of cost of sales for our wireless business for the six months ended June 30, 2005 and2004 is as follows:

 

** **

**Six months ended June 30,**

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

 

 

(Unaudited)

 

 

 

 

 

 

 

 

 

 

Cost of cellular handsets and SIM-packs sold

Php3,149

 

Php6,478

 

(Php3,329)

 

(51)

Cost of satellite air time and terminal units

122

 

121

 

1

 

1

 

Php3,271

 

Php6,599

 

(Php3,328)

 

(50)

 

Rent expensesincreased by Php1,184 million, or 111%, to Php2,255 million on account of anincrease in the number of leased lines, transmission links and higher cell sitespace rentals for the increased number of cell sites.  As at June 30, 2005, we had 4,148 cell sites and 5,573 base stations, compared with 3,494 cellsites and 4,565 base stations as at June 30, 2004.

 

Compensation and benefits increased by Php109million, or 6%, to Php1,890 million primarily due to an increase in headcount,salaries and performance bonuses of Smart’s employees.  Smart's employeeheadcount increased by 4% to 5,105 as at June 30, 2005 from 4,903 as at June 30, 2004.  

 

Selling and promotion expenses increased by Php104million, or 7%, to Php1,702 million due to advertising and promotions costsincurred to attract new subscriptions and retain existing subscribers.

 

Maintenance expensesincreased by Php454 million, or 39%, to Php1,617 million mainly on account ofhigher utility expenses, repairs and maintenance costs due to the continuedgrowth in the number of cell sites and other network facilities as well asincreased fuel and electricity costs.

 

Financing costs in the first half of 2005 amountedto Php1,214 million, a decrease of Php865 million, or 42%, from Php2,079million in the same period in 2004, primarily as a result of a 0.3% and 8% appreciationof the average of the peso to the U.S. dollar and Japanese yen, respectively,from December 31, 2004 to June 30, 2005.  Foreign exchange losses were recordedin the same period in 2004 with the peso depreciation against the U.S. dollarby 1%, partially offset by approximately 1% peso appreciation against theJapanese yen from December 31, 2003 to June 30, 2004.  In addition, interestincome increased due to higher cash balances in 2005 as compared to 2004.  Thebreakdown of our financing costs for wireless business for the six months ended June 30, 2005 and 2004 is as follows:

 

** **

**Six months ended June 30,**

** **

** **

** **

** **

** **

**Change**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

 

 

(Unaudited)

 

 

 

 

 

 

 

 

 

 

Accretion on financial liabilities

Php1,303

 

Php1,315

 

(Php12)

 

(1)

Interest on loans and related items

905

 

904

 

1

 

–

Foreign exchange losses (gains) – net

(772)

 

219

 

(991)

 

(453)

Interest income

(543)

 

(367)

 

(176)

 

(48)

Loss (gain) on derivative transactions – net

148

 

(84)

 

232

 

276

Dividends on preferred stock subject to mandatory redemption

132

 

117

 

15

 

13

Financing charges

48

 

27

 

21

 

78

Capitalized interest

(7)

 

(52)

 

45

 

87

 

Php1,214

 

Php2,079

 

(Php865)

 

(42)

 

Taxesand licenses increased by Php250 million, or 60%, to Php667 million mainly dueto an increase in Smart’s business-related taxes.  

 

Professionaland other service fees increased by Php110 million, or 23%, to Php595 millionmainly as a result of increased technical service, consultancy and paymentfacility fees.

 

Insurance and securityservices increased by Php49 million, or 11%, to Php492 million mainly due tothe increase in our number of cell sites and in the amount of network equipmentinsured as a result of the continued growth and expansion of our network.

 

Provisions decreased by Php171 million, or 28%, toPhp437 million mainly due to a lower carrier receivable balances as of June 30,2005 as a result of significant settlements made during 2004 and the firstquarter of 2005.  The breakdown of provisions for the six months ended June 30, 2005 and 2004 is as follows:

 

** **

**Six months ended June 30,**

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

** **

(Unaudited)

 

 

 

 

 

 

 

 

Doubtful accounts

Php112

 

Php480

 

(Php368)

 

(77)

Write-down of inventories at net realizable value 

325

 

128

 

197

 

154

 

Php437

 

Php608

 

(Php171)

 

(28)

 

Otherexpenses increased by Php317 million, or 31%, to Php1,349 million due tovarious business and operational-related expenses such as facility usage fees,travel, training, communication and delivery expenses and the amortization ofintangible assets.

 

Provision for Income Tax
 

Provisionfor income tax increased by Php688 million, or 19%, to Php4,217 million in thefirst half of 2005 from Php3,529 million in the same period in 2004 as Smart’sincome tax holiday expired in the second quarter of 2004 and as Piltel’s incometax position reversed from net tax loss to net tax payable.  In the first halfof 2005, the effective tax rate for our wireless business after the reversal ofthe deferred tax asset in the utilized portion of Piltel’s NOLCO and therelease of certain valuation allowances was 24% compared to 23% in the sameperiod in 2004.  

 

Smart'sthree-year income tax holiday, which expired in May 2004, applied to theincremental income generated from its GSM network expansion.  The income taxholiday was computed by applying the exemption rate against the income taxderived from GSM operations.  The exemption rate was computed by dividing theincremental revenues by eligible GSM revenues (both gross of interconnectionrevenues) where the incremental GSM revenues were derived by deducting theBoard of Investments, or BOI-prescribed base figure (Smart’s gross GSM revenuein 2000) from the total GSM revenues.  After adjusting for non-deductible itemsand unrealized and realized foreign exchange losses, Smart’s net taxable incomewas multiplied by the statutory corporate income tax rate of 32% and theexemption rate.  The resulting figure was the income tax holiday that wasdeducted from the income tax due on GSM revenues with the difference being theincome tax due for the period.  

 

Net Income
 

Our wireless business segment recorded a net incomeof Php13,324 million in the first half of 2005, an increase of Php1,589million, or 14%, over Php11,735 million registered in the same period in 2004due primarily to the growth in our cellular revenues, augmented by an 11%decrease in wireless expenses.

 

Fixed Line
 

***Revenues and Other Income***

*** ***

Our fixed line business provides local exchangeservice, international and national long distance services, data and othernetwork services, and miscellaneous services.  Total fixed line revenuesgenerated from our fixed line business in the first half of 2005 totaled Php24,336million, an increase of Php121 million from Php24,215 million in the sameperiod in 2004.  

 

The following table summarizes revenues from ourfixed line business for the six months ended June 30, 2005 and 2004 by service segment:

 

 

**Six months ended June 30,**

 

** **

** **

** **

** **

** **

** **

** **

** **

**Increase********(Decrease)**

 

**2005**

** **

**%**

** **

**2004**(1)

** **

**%**

** **

**Amount**

** **

**%**

** **

(Unaudited)

**(in millions)**

 

 

 

 

 

 

 

 

 

 

 

Fixed line services:

 

 

 

 

 

 

 

 

 

 

 

Service Revenues

 

 

 

 

 

 

 

 

 

 

 

Local exchange

Php10,227

 

42

 

Php10,591

 

44

 

(Php364)

 

(3)

International long distance

6,253

 

26

 

6,454

 

27

 

(201)

 

(3)

National long distance

2,538

 

10

 

3,554

 

15

 

(1,016)

 

(29)

Data and other network

4,589

 

19

 

3,036

 

12

 

1,553

 

51

Miscellaneous

607

 

2

 

473

 

2

 

134

 

28

 

24,214

 

99

 

24,108

 

100

 

106

 

–

Other Income

122

 

1

 

107

 

–

 

15

 

14

Total Fixed Line Revenues and Other Income

Php24,336

 

100

 

Php24,215

 

100

 

Php121

 

–

_______________

 

*(1)   As restated to reflect the effects of the changesin accounting policies, as discussed in Note 2 – Summary of SignificantAccounting Policies and Practices to the accompanying unaudited consolidatedfinancial statements.*

Service Revenues
 

*Local Exchange Service*

 

Our local exchange service revenues consist of: 

 

•           flat monthly fees for our postpaidservice; 

 

•           installation charges and otherone-time fees associated with the establishment of customer service;

 

•           fixed charges paid by othertelephone companies, charges retained by PLDT for calls terminating to cellularsubscribers within the local area, and local access charges paid by cellularoperators for calls by cellular subscribers that terminate to our localexchange network;

 

•           revenues from usage of prepaidcards for calls within the local area and any unused peso value of expiredprepaid cards; and

 

•           charges for special features,including bundled value-added services such as call waiting, call forwarding,multi-party conference calling, speed calling and caller ID. 

 

The following table summarizes key measures of ourlocal exchange service business segment as at and for the six months ended June 30, 2005 and 2004:

 

 

**Six months ended June 30,**

 

** **

** **

** **

** **

**Increase (Decrease)**

 

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

(Unaudited)

 

 

 

 

 

 

 

 

Total local exchange service revenues (in millions)

Php10,227

 

Php10,591

 

(Php364)

 

(3)

Number of fixed lines in service

2,137,813

 

2,201,257

 

(63,444)

 

(3)

Number of fixed line employees

9,582

 

10,197

 

(615)

 

(6)

Number of fixed lines in service per employee

223

 

216

 

7

 

3

 

Revenues from ourlocal exchange service decreased by Php364 million, or 3%, to Php10,227 millionin the first half of 2005 from Php10,591 million in the same period in 2004.The decrease was primarily due to the 3% decline in number of fixed lines inservice and the appreciation of the peso which required us to make downwardadjustments in our monthly local service rates.  The percentage contribution oflocal exchange revenues to our fixed line service revenues decreased to 42% inthe first half of 2005 compared to 44% in the same period in 2004.

 

Fixedline net reduction in the first half of 2005 was 14,214 as against netadditions of 11,862 in the same period in 2004.  While fixed line additionstotaled 1,391 for postpaid fixed line services, prepaid fixed lines in servicedeclined by 15,605 in the first half of 2005.  As at June 30, 2005,postpaid and prepaid fixed line subscribers totaled 1,784,582 and 353,231,respectively, which accounted for approximately 83% and 17%, respectively, of ourtotal fixed lines in service.

 

Initially intended asan affordable alternative telephone service for consumers under difficulteconomic conditions, our prepaid fixed line services**now form animportant part of our overall churn and credit risk exposure management andsubscriber retention strategy.  Prepaid**subscribers are charged based onusage at a rate of Php1.00 per minute for local calls but the rates for prepaidand postpaid fixed line subscribers for national and international longdistance calls are the same.  A prepaid fixed line subscriber is recognized asan active subscriber when that subscriber activates and uses a prepaid callcard.  Prepaid fixed line subscribers can reload their accounts by purchasingcall cards that are sold in denominations of Php500, Php300 and Php150.Reloads are valid for two months for the Php500 and Php300 cards.  The lowerdenominated Php150 card has an account life of 15 days.  A prepaid fixed linesubscriber is disconnected if that subscriber does not reload within one monthfor the Php500 card, four months for the Php300 card, and 15 days for thePhp150 card after the expiry of the last reload.  All sales of prepaid cards,whether through dealers or through PLDT's business offices, are non-refundable.

 

Pursuant to a currencyexchange rate adjustment mechanism authorized by the Philippine NationalTelecommunications Commission, or the NTC, we adjust our monthly local servicerates upward or downward by 1% for every Php0.10 change in the peso-to-dollarexchange rate relative to a base rate of Php11.00 to US$1.00.  During the firsthalf of 2005, we implemented four downward adjustments in our monthly localservice rates compared to four upward adjustments and one downward adjustmentin the same period in 2004.  The average Philippine peso to U.S. dollar rate factoredin our monthly local service rates in the first half of 2005 was Php54.94 toUS$1.00, compared to the average of Php55.75 to US$1.00 in the same period in2004.  This change in the average peso-to-dollar rate translated to a pesoappreciation of 1.5%, which resulted in an average net decrease of 1.4% in ourmonthly local service rates in the first half of 2005. 

 

*International Long Distance Service*

 

Our international long distance service revenues,which we generate through our international gateway facilities, consist of:

 

•        inbound call revenues representingsettlements from foreign telecommunications carriers for inbound internationalcalls, virtual transit and hubbing service and reverse charged calls such asreceived collect and home country direct service;

 

•        access charges paid to us by otherPhilippine telecommunications carriers for terminating inbound internationalcalls to our local exchange network; and

 

•        outbound call revenuesrepresenting amounts billed to our customers (other than our cellularcustomers) for outbound international calls, net of amounts payable to foreigntelecommunications carriers for terminating calls in their territories.

 

The following table shows information about ourinternational fixed line long distance business for the six months ended June 30, 2005 and 2004:

 

** **

**Six months ended June 30,**

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

(Unaudited)

 

 

 

 

 

 

 

 

Total international long distance service revenues (in millions)

Php6,253
 

Php6,454

 

(Php201)

 

(3)

Inbound

5,165

 

5,218

 

(53)

 

(1)

Outbound

1,088

 

1,236

 

(148)

 

(12)

 

 

 

 

 

 

 

 

International call volumes (in million minutes, except call ratio)

1,155

 

1,159

 

(4)

 

–

Inbound

1,084

 

1,083

 

1

 

–

Outbound

71

 

76

 

(5)

 

(7)

Inbound-outbound call ratio

15.3:1

 

14.3:1

 

–

 

–

 

Our totalinternational long distance service revenues decreased by Php201 million, or 3%,to Php6,253 million in the first half of 2005 from Php6,454 million in the sameperiod in 2004.  The percentage contribution of international long distanceservice revenues to our fixed line service revenues decreased to 26% in thefirst half of 2005 from 27% in the same period in 2004.

 

Ourrevenues from inbound international long distance service decreased by Php53million, or 1%, to Php5,165 million in the first half of 2005 from Php5,218million in the same period in 2004 primarily due to the peso appreciation in2005.  Our inbound international long distance call volumes in the first halfof 2005 increased by 1 million minutes to 1,084 million minutes from 1,083million minutes in the same period in 2004, largely due to an increase intransit calls.

 

The2% appreciation of the average of the peso to the U.S. dollar from Php54.835during the first half of 2005 compared to Php55.952 during the same period in2004 contributed to the decrease in our inbound international long distancerevenues in peso terms since settlement charges for inbound calls are billed inU.S. dollars or in special drawing rights, an established method of settlementamong international telecommunications carriers using values based on a basketof foreign currencies that are translated into peso at the time of billing.

 

Our revenues fromoutbound international long distance service decreased by Php148 million, or 12%, to Php1,088 million in the first half of 2005 fromPhp1,236 million in the same period in 2004.  The decrease resulted from thedecline in call volumes and the appreciation of the peso as outboundinternational calls are charged in U.S. dollar rates and billed to subscribersin pesos at the prevailing exchange rates at the time of billing.

 

Our outboundinternational long distance call volumes declined by 7% in the first half of2005 as compared to the same period in 2004 due to cellular substitution(subscribers opting to use cellular for international outbound calls) and thepopularity of alternative means of communications such as e-mailing,international text messaging and internet telephony.

 

National Long Distance Service
 

Our national long distance service revenues consistof: 

 

•              per minute charges for calls madeby our fixed line customers outside of the local service areas but within thePhilippines, net of interconnection charges payable for calls carried throughthe backbone network of, and/or terminating to the customer of, anothertelecommunications carrier; and

 

•              access charges received from othertelecommunications carriers for calls carried through our backbone networkand/or terminating to our customers.

 

The following table shows our national long distanceservice revenues and call volumes for the six months ended June 30, 2005 and2004:

 

** **

**Six months ended June 30,**

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

(Unaudited)

 

 

 

 

 

 

 

 

Total national long distance service revenues (in millions)

Php2,538

 

Php3,554

 

(Php1,016)

 

(29)

National long distance call volumes (in million minutes)

995

 

969

 

26

 

3

 

Our national longdistance service revenues decreased by Php1,016 million, or 29%, to Php2,538million in the first half of 2005 from Php3,554 million in the same period in2004 as a result of: (1) a decrease in average revenue per minute brought aboutby our Php10 per call promotion starting February 14, 2005; and (2) theintegration of local exchanges into a single calling area.  Accordingly, the percentagecontribution of national long distance revenues to our fixed line servicerevenues decreased to 10% for the first half of 2005 compared to 15% in thesame period in 2004.

 

On February 14, 2005, welaunched a Php10 per call promotion to any PLDT landline subscriber nationwideand to all Smart and *Talk N’ Text* subscribers.  This promotion waslaunched with the objective of determining a more effective tariff structurethat would stimulate landline usage.  Under the promotion, NDD calls betweenany PLDT landline subscriber nationwide and to all Smart and *Talk 'N Text*subscribers are charged Php10 per call instead of being charged on a per minutebasis.  

 

On May 12, 2005, PLDTbegan offering the Php10 per call promotion with an additional Php5 per call forthe same unlimited talktime to Smart and *Talk ‘N Text* subscribers.  PLDTto PLDT NDD calls below the equivalent Php10 toll usage are charged based onthe regular rate per minute.  

 

Ournational long distance call volumes increased by approximately 3% to 995million minutes in the first half of 2005 from 969 million minutes in the sameperiod in 2004.  This was mainly due to the Php10 per call promotion currentlybeing offered to PLDT landline subscribers nationwide.  

 

Theintegration of some of our local exchanges into a single local calling area, asapproved by the NTC, has also negatively affected our national long distancecall volumes, and consequently, our revenues.  Because of this integration,calls between two exchanges located within the same province are no longerconsidered national long distance calls but treated as local calls.

 

Data and Other Network Services
 

Our data and other network services in the first halfof 2005 posted revenues of Php4,589 million, an increase of Php1,553 million, or 51%, from Php3,036million in the same period in 2004.  The revenue contribution of this servicesegment to our fixed line service revenues increased to 19% in the first halfof 2005 from 12% in the same period in 2004.

 

Data and other network services we currently provideinclude leased lines, IP-based, packet-based and switch-based services.  Theseservices are used for domestic and international communications such as privatenetworking, broadband and narrowband internet-based data communications, andpacket-based communication.  

 

Ofour total first half 2005 revenues, leased lines accounted for 53%, IP-basedservices accounted for 30%, packet-based services accounted for 12% andswitched-based services accounted for the remaining 5%, compared to 51%, 25%,16% and 8%, respectively, in the same period in 2004.  These percentage increasesindicate a continuing demand for broadband services, particularly the highbandwidth clear data requirements of business process outsourcing companies, orBPOs, and call centers.  We expect this trend to continue due to growth in theareas of e-commerce, online services and BPOs particularly among call centers,medical transcription, animation and shared services.

 

Internet-based products are bannered by *PLDT Vibe*, *PLDT**DSL* (*myDSL andBizDSL*) and I-Gate.  *PLDT Vibe,* or PLDT’s dial-up/narrowband Internetservice, is targeted for light to medium residential or individual internetusers; while *PLDT**DSL*broadbandInternet service is targeted for heavy individual internet users as well as forsmall and medium enterprises.  I-Gate, on the other hand, is targeted toenterprises and value-added service providers.

 

Asat June 30, 2005, the number of PLDT’s fixed line subscribers for *PLDTVibe*stood at 449,685, of which 161,899 are exclusive postpaid users,211,917 are exclusive prepaid users, and 75,869 are both postpaid and prepaidusers.  As at June 30, 2004, *PLDT Vibe* subscribers totaled 299,950, of which 136,591 wereexclusive postpaid users, 119,265 were exclusive prepaid users, and 44,094 wereboth postpaid and prepaid users.  Inaddition, PLDT *DSL* has reached 68,827 subscribers as at June 30, 2005compared with 33,576 subscribers during the same period of 2004.  I-Gatesubscription grew by 84% from a base of 93 as at June 2004 to 171 as of thefirst half of 2005.

 

The continued growthin data services revenues can be attributed to several product offerings.  Thesteady demand for dedicated connection or private networking from the corporatemarket using PLDT’s traditional bandwidth offerings – Fibernet, Arcstar,Acacia, I-Gate, Diginet, BRAINS, among others – continues to provide us with astable revenue source.  In addition, we provide Smart’s increasing fiber opticand leased line data requirements included under our national data services.

 

PLDTexpects to further generate strong demand for data connectivity after adding *PLDTWeRoam* to its portfolio of data and other network services.  *PLDT WeRoam*,introduced last March 10, 2005 and running on Smart’s nationwide wirelessnetwork (using GPRS, EDGE and WiFi technologies) and PLDT’s extensive IPinfrastructure, provides laptop-carrying mobile employees and remote officesunder Local Area Network, wireless data connectivity to their corporateheadquarters’ Intranet and/or to the global Internet.

* *

Miscellaneous
 

Miscellaneous servicerevenues are derived mostly from directory advertising and facilities rental.In the first half of 2005, these revenues increased by Php134 million, or 28%,to Php607 million from Php473 million in the same period in 2004.  Theimprovement was mainly due to an increase in co-location charges from moreco-location sites coupled with an increase in rent income on duct utilizationand cable restoration.  Miscellaneous service revenues remained flat at 2% ofour fixed line service revenues in the first half of 2005 and 2004.

 

*Other Income*

 

All other income/gains such as rental income, gainon disposal of property, which do not fall under service and non-servicerevenues are included under this classification.  In 2005, our fixed linebusiness segment registered an increase in other income of Php15 million, or14%, to Php122 million in the first half of 2005 from Php107 million in thesame period in 2004 mainly due to higher service and facilities fees.  

 

Expenses
 

Expenses related to our fixed line business in thefirst half of 2005 totaled Php19,486 million, a decrease of Php3,821 million, or 16%, compared toPhp23,307 million in the same period in 2004.  The decrease was primarily dueto lower financing costs partially offset by higher depreciation andamortization, selling and promotions, and compensation and benefits expenses.As a percentage of our total fixed line revenues, fixed line-related expensesdecreased to 80% in the first half of 2005, compared to 96% in the same periodin 2004.

 

The following table shows the breakdown of our totalfixed line-related expenses for the six months ended June 30, 2005 and 2004 and the percentage of each expense item to the total:

 

 

**Six months ended June 30,**

 

** **

 

** **

 

** **

 

** **

** **

**Increase (Decrease)**

 

**2005**

 

**%**

 

**2004**(1)

 

**%**

** **

**Amount**

** **

**%**

** **

(Unaudited)

**(in millions)**

 

 

 

 

 

 

 

 

 

 

 

Fixed line services:

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization

Php5,704

 

29

 

Php5,000

 

21

 

Php704

 

14

Compensation and benefits(2)

3,977

 

20

 

3,823

 

16

 

154

 

4

Financing costs

3,127

 

16

 

7,799

 

33

 

(4,672)

 

(60)

Maintenance

1,718

 

9

 

1,665

 

7

 

53

 

3

Provisions

1,531

 

8

 

1,568

 

7

 

(37)

 

(2)

Selling and promotions

866

 

5

 

632

 

3

 

234

 

37

Rent

860

 

4

 

871

 

4

 

(11)

 

(1)

Professional and other service fees

464

 

2

 

535

 

2

 

(71)

 

(13)

Taxes and licenses

349

 

2

 

344

 

2

 

5

 

1

Insurance and security services

329

 

2

 

364

 

2

 

(35)

 

(10)

Asset impairment 

–

 

–

 

85

 

–

 

(85)

 

(100)

Other expenses

561

 

3

 

621

 

3

 

(60)

 

(10)

Total 

Php19,486

 

100

 

Php23,307

 

100

 

(Php3,821)

 

(16)

____________

*(1)   As restated to reflect the effects of the changesin accounting policies, as discussed in Note 2 – Summary of SignificantAccounting Policies and Practices to the accompanying unaudited consolidated financialstatements.*

*(2)   Includes salaries and benefits, incentive plan,pension and MRP costs.*

* *

 

Depreciationand amortization charges increased by Php704 million, or 14%, to Php5,704 million mainly due to higher depreciation of our regular asset baseprimarily resulting from additional completed projects and the effect of ourfull adoption of PAS 16 which increased our depreciation charges by Php362million for the first half of 2005.

 

Compensation andbenefits increased by Php154 million, or 4%, to Php3,977 million mainly due tothe effect of the collective bargaining agreement-related increases on salariesand benefits of PLDT employees and an increase in incentive plan-relatedaccruals partially offset by a reduction in headcount due to PLDT’s MRP.

* *

Financing costsdecreased by Php4,672 million, or 60%, to Php3,127 million due to: (1) thestrengthening of the peso relative to the U.S. dollar and Japanese yenresulting in foreign exchange gains in the first half of 2005 as compared toforeign exchange losses recorded during the first half of 2004; (2) recordedgains on derivatives in the first half of 2005 as compared to recorded losses onderivatives in the first half of 2004; and (3) lower interest on loans andrelated items owing to lower debt balances in the first half of 2005 comparedwith the same period in 2004.  The breakdown of our financing costs for ourfixed line business for the six months ended June 30, 2005 and 2004 is as follows:

 

** **

**Six months ended June 30,**

** **

** **

** **

** **

** **

**Change**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

(Unaudited)

 

 

 

 

 

 

 

 

Interest on loans and related items

Php4,737

 

Php5,574

 

(Php837)

 

(15)

Loss (gains) on derivative transactions – net

(1,335)

 

589

 

(1,924)

 

(327)

Foreign exchange losses (gains) – net

(603)

 

1,177

 

(1,780)

 

(151)

Hedge cost

557

 

567

 

(10)

 

(2)

Capitalized interest

(196)

 

(250)

 

54

 

22

Interest income

(193)

 

(98)

 

(95)

 

(97)

Accretion on financial liabilities

134

 

181

 

(47)

 

(26)

Financing charges

26

 

59

 

(33)

 

(56)

 

Php3,127

 

Php7,799

 

(Php4,672)

 

(60)

 

Maintenance expensesincreased by Php53 million, or 3%, to Php1,718 million primarily due to highermaintenance costs for foreign cable and wire facilities as more operating andmaintenance-related restorations were incurred in the first half of 2005 ascompared to the same period in 2004.  

 

Provisionsdecreased by Php37 million, or 2%, to Php1,531 million primarily on account ofa lower provision for onerous contracts by PLDT as a result of the pesoappreciation partially offset by an increase in our provision for doubtfulaccounts.  We make provisions for anticipated uncollectible accounts based onthe aging profile of our accounts receivables.  PLDT’s provision for doubtfulaccounts for the first half of 2005 and 2004 was equivalent to 6% of itsservice revenues.  The breakdown of provisions for our fixed line business forthe six months ended June 30, 2005 and 2004 is as follows:

 

** **

**Six months ended June 30,**

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

 

(Unaudited)

 

 

 

 

 

 

 

 

Doubtful accounts

Php1,414

 

Php1,395

 

Php19

 

1

Onerous contracts

117

 

173

 

(56)

 

(32)

 

Php1,531

 

Php1,568

 

(Php37)

 

(2)

 

Selling and promotionexpenses increased by Php234 million, or 37%, to Php866 million mainly as aresult of an increase in PLDT’s promotional activities in relation to variousproducts and services, partially offset by reduced corporate public relationsexpenses.

 

Rent expenses decreased by Php11 million, or 1%, toPhp860 million due to a decrease in international leased circuits and rentalfor bundled sales/value added service units.

 

Professional and otherservice fees decreased by Php71 million, or 13%, to Php464 million due to adecrease in number of consultants coupled with lower legal fees in the firsthalf of 2005 for various services, partially offset by an increase in collectionagency fees. 

 

Taxesand licenses increased by Php5 million, or 1%, to Php349 million mainly onaccount of higher business-related taxes paid in the first half of 2005 ascompared to the same period in 2004.

 

Insuranceand security services decreased by Php35 million, or 10%, to Php329 millionprimarily due to lower premiums on property all-risk, industrial all-risk andindustrial fire insurance and a lower number of contracted security guards.

 

Assetimpairment decreased by Php85 million owing to an impairment of a fixed linesubsidiary’s facilities in the first half of 2004; no impairment charge wasrecognized in the first half of 2005.

 

Otherexpenses decreased by Php60 million, or 10%, to Php561 million due to loweroffice supplies consumption and printing costs resulting from PLDT’s continuingcost-containing activities, partially offset by higher contracted costs fortechnical and helpdesk resources and related computer and maintenance andin-house systems development.

 

Provision for Income Tax
 

Provisionfor income tax increased by Php1,187 million to Php1,471 million in the firsthalf of 2005 from Php284 million in the same period in 2004 due to higherincome subject to tax.  In the first half of 2005, our effective tax ratewas 30%.  Our effective tax rate was lower than the 32% statutory corporate taxrate due to income already subjected to final tax; income already subjected tolower tax rate; and equity in net income of our subsidiaries, which has alreadybeen subjected to tax and therefore, is no longer subject to income tax.

 

Net Income 
 

In the first half of2005, our fixed line business segment contributed a net income of Php3,378million, compared to Php638 million in the same period in 2004 mainly as aresult of a decrease in fixed line-related expenses by 16% particularlyfinancing costs.  

 

Information andCommunications Technology
 

***Revenues and Other Income***
 

Our information and communications technologybusiness is conducted by ePLDT, a wholly-owned subsidiary of PLDT.  

 

Inthe first half of 2005, our information and communications technology businessgenerated revenues of Php1,587 million, an increase of Php460 million, or 41%,from Php1,127 million in the same period in 2004.  Going forward, we expect revenuesfrom our call center and Internet and gaming businesses to continue tocontribute significantly to our information and communications technologyrevenues with the growing demand for our call center services.

 

The following table summarizes revenues from ourinformation and communications technology business for the six months ended June 30, 2005 and 2004 by service segment:

 

** **

**Six months ended June 30,**

 

** **

 

** **

 

** **

 

** **

** **

**Increase**

 

**2005**

 

**%**

 

**2004**(1)

 

**%**

** **

**Amount**

** **

**%**

 

(Unaudited)

Service Revenues

 

 

 

 

 

 

 

 

 

 

 

Call center

Php836

 

53

 

Php551

 

49

 

Php285

 

52

Internet and gaming 

287

 

18

 

276

 

25

 

11

 

4

*VitroTM*data center

173

 

11

 

100

 

9

 

73

 

73

Others

32

 

2

 

26

 

2

 

6

 

23

 

1,328

 

84

 

953

 

85

 

375

 

39

 

 

 

 

 

 

 

 

 

 

 

 

Non-service Revenues

 

 

 

 

 

 

 

 

 

 

 

Point of Product Sales

215

 

13

 

161

 

14

 

54

 

34

 

 

 

 

 

 

 

 

 

 

 

 

Other Income

44

 

3

 

13

 

1

 

31

 

238

 

 

 

 

 

 

 

 

 

 

 

 

Total ICT Revenues and Other Income

Php1,587

 

100

 

Php1,127

 

100

 

Php460

 

41

 

*Call****Center*

 

We are focused on developing our call center businesswhich capitalizes on the availability of English-speaking college graduates inthe Philippines with a strong customer service orientation.  The callcenter service business is currently being undertaken by the followingwholly-owned subsidiaries of ePLDT:

 

•              Vocativ Systems, Inc., or Vocativ,which owns and operates a 1,300-seat call center facility with 890 customerservice representatives, or CSRs, providing customer and technical support toits clients in the Philippines, U.S. and U.K.;  

 

•              Parlance Systems, Inc., orParlance, which owns and operates a 1,230-seat call center facility with 1,300CSRs exclusively for one of the largest direct-to-home satellite serviceproviders in the United States for customer support and billing requirements;Parlance is expanding with another 670-seat call center facility in MandaluyongCity which is expected to be completed in December 2005; and   

 

•              ePLDT Ventus, Inc., or Ventus,which owns a 400-seat call center facility located in Iloiloprovince and commenced commercial operations in March 2005.  CSR headcount inVentus-Iloilo reflected seasonal swings from a core of 50 CSRs to a high of 350CSRs in the first half of 2005, as the company addressed seasonal requirementsof its client.  Ventus will be expanding in Metro Manila with a 270-seat callcenter facility in Makati and a 640-seat call center facility in Ortigas, Pasig City toaccommodate current and new client requirements.  These facilities are expectedto be completed by October 2005 and January 2006, respectively.

 

Inaddition, domestic call center projects are being undertaken by ePLDT which operatesan 80-seat facility in Makati and a 180-seat facility in Quezon City, witha combined headcount of 330 CSRs.  The total seat count of each facility coversworkstations of CSRs and business support units that are intrinsic to thedelivery of the business.

Call center revenues consist of:

 

•              inbound calls for customer care,product inquiries, sales and technical support based on active minutes,billable hours and full-time equivalents;

 

•              outbound calls for sales andcollections based on active minutes, billable hours and full-time equivalents;and 

 

•              service income for e-mailhandling, web chat, web co-browsing, data entry and business processoutsourcing based on transaction volume.

 

Revenues related to our call center business in thefirst half of 2005 increased by Php285 million, or 52%, to Php836 million from Php551 million in the sameperiod in 2004 due to the combined effects of the following:

 

•              Vocativ’s upward price adjustmentfor voice and voice over internet protocol, or VoIP, and an increase inprograms being handled; 

 

•              an upward price adjustment byParlance for its inbound and outbound projects, coupled with an increase in thenumber of registered minutes; 

 

•              continuous ramp up of CSRs by 868,or 50%, from a total of 1,730 in the first half of 2004 to 2,598 in the sameperiod in 2005; and

 

•              commencement of Ventus operationsin Iloilo in March 2005.

 

Call center revenues accounted for 63% and 58% oftotal information and communications technology service revenues in the firsthalf of 2005 and 2004, respectively.

* *

*Internet and gaming*

 

ePLDT has also invested in a number of othere-commerce and internet-related businesses, which include:

 

•              a 99.6% interest in Infocom, oneof the country’s leading internet service providers.  Infocom offers consumerprepaid and postpaid internet access, corporate leased lines, dedicateddial-up, multi-user dial-up, broadband internet access through DSL, webconsulting and development, hosting and other value-added services; 

 

•              a 69% interest in DigitalParadise, Inc., or DigiPar, an internet café business which assumed the assetsof Netopia Computer Technologies, Inc., and the brand *Netopia*.  *Netopia* isnow one of the largest and fastest growing internet café chains in the countrywith over 160 branches and over 7,000 work stations.  DigiPar offers high-speedinternet services, including internet advertising, gaming and printing; 

 

•              a 51% interest in Digital ParadiseThailand, Inc., an affiliate of Digital Paradise, Inc. offering similarproducts and services.  Digital Paradise Thailand currently has three branches in addition to its headoffice all situated in Bangkok, Thailand; and

 

•              a 60% interest in netGames, Inc.,a publisher for Massively Multi-player Online Game in the Philippines.netGames is the Philippine licensee of Khan Online, the country’s first full 3Donline game.  netGames commenced full commercial operations in February 2005.

 

Internet Service revenues consist of: 

 

•              revenues derived from actual usageof internet access network by prepaid subscribers and any unused peso value ofexpired prepaid cards or electronic internet time loads, net of discounts givento dealers; 

 

•              monthly service fees from postpaidcorporate and consumer subscribers, including (1) charges for internet usage inexcess of allocated free plan internet hours; (2) one-time installation andactivation fees; and (3) fees for value added services such as additionalmailbox accounts;

 

•              monthly service fees on valueadded services, including e-mail and web hosting services;

 

•              one-time fees generated fromresellership of internet-related solutions such as security solutions anddomain registration; 

 

•              sales revenues from retailing ofprepaid cards for cellular, landline and internet access;

 

•              franchise fees for *Netopia*Internet cafés, including a one-time subscription fee and monthly recurringfranchise fees based on certain conditions on the franchise agreement; and 

 

•              share in revenues of text, voiceand internet messages for cellular, landline and internet-based content andapplications.

 

Revenues from ourinternet business for the first half of 2005 increased by Php11 million, or 4%,to Php287 million from Php276 million in the same period in 2004 primarily dueto the consolidation of DigiPar in June 2004.  Our internet business revenuesaccounted for 22% and 29% of service revenues from information andcommunications technology business in the first half of 2005 and 2004,respectively.

 

*VitroTM*data center

 

ePLDT operates an internet data center under the brandname *VitroTM*.  Granted pioneerstatus as an internet data center by the BOI, *VitroTM* provides co-location services, server hosting,hardware and software maintenance services, website development and maintenanceservices, webcasting and webhosting, shared applications, data disasterrecovery and business continuity services, intrusion detection, and securityservices such as firewall and managed firewall.  

 

*VitroTM* revenues consist of:

 

•              monthly service fees derived fromco-location services, server hosting, hardware and software maintenanceservices, website development and maintenance services, web hosting, datarecovery security services and other value added services;

 

•              installation charges and otherone-time fees associated with the set-up of services; and 

 

•              monthly service fees or one-timefees generated from professional services of Vitro’s certified professionals.

 

Inthe first half of 2005, *VitroTM*contributed revenues of Php173 million, an increase of Php73 million, or 73%,from Php100 million in the same period in 2004, primarily due to an increase inco-location revenues, server hosting and other services.   *VitroTM* revenues accounted for 13% and 10% of servicerevenues from information and communications technology business in the firsthalf of 2005 and 2004, respectively.

 

*Others*

 

Other revenues consist of:

 

•              fees generated for issuance ofdigital certificates; and 

 

•              revenues derived from IThelpdesk/contact center solutions and terminals for credit, debit and creditcard transactions.

 

Revenues from other businesses related to ourinformation and communications technology segment in the first half of 2005increased to Php32 million from Php26 million in the same period in 2004largely due to IT helpdesk/contact center services rendered coupled with anincrease in number of digital certificates sold.

 

Pleaserefer to *Note 9 – Investments**in Associates* to the accompanyingunaudited consolidated financial statements for further discussion on ePLDT’sother information and communications technology services.

 

*Non-service Revenues*

 

Non-service revenues consist of sales generated fromresellership of Microsoft products, server solutions, networking products,storage products and data security products.  In the first half of 2005,non-service revenues generated by our information and communications technologybusiness increased by Php54 million, or 34%, to Php215 million prompted byhigher revenues from sales of networking equipment and Microsoft licenses.

 

*Other Income*
 

All other income/gainswhich do not fall under service and non-service revenues are included underthis classification.  Other income generated from our information andcommunications technology business segment increased to Php44 million in thefirst half of 2005 from Php13 million in the same period in 2004 owing toInfocom’s sale of its *NOW* cable internet business on February 1, 2005.  

 

*Expenses*
 

Expenses associatedwith our information and communications technology business totaled Php1,518million in the first half of 2005, an increase of Php444 million, or 41%, fromPhp1,074 million in the same period in 2004.  As a percentage of ourinformation and communications technology revenues, expenses related to ourinformation and communications technology business were at 96% and 95% for thefirst half of 2005 and 2004, respectively.  

 

The following table shows the breakdown of our totalinformation and communications technology-related expenses for the six monthsended June 30, 2005 and 2004 and the percentage of each expense item to thetotal:

 

 

**Six months ended June 30,**

 

** **

 

** **

 

** **

 

** **

** **

**Increase (Decrease)**

 

**2005**

 

**%**

 

**2004**(1)

 

**%**

** **

**Amount**

** **

**%**

** **

(Unaudited)

**(in millions)**

 

 

 

 

 

 

 

 

 

 

 

Information and communications technology services:

 

 

 

 

 

 

 

 

 

 

 

Compensation and benefits(2)

Php625

 

41

 

Php392

 

36

 

Php233

 

59

Rent

208

 

14

 

154

 

14

 

54

 

35

Selling and promotions

205

 

14

 

158

 

15

 

47

 

30

Depreciation and amortization

187

 

12

 

148

 

14

 

39

 

26

Maintenance

149

 

10

 

124

 

12

 

25

 

20

Professional and other service fees

36

 

2

 

42

 

4

 

(6)

 

(14)

Taxes and licenses

18

 

1

 

10

 

1

 

8

 

80

Financing costs

8

 

1

 

23

 

2

 

(15)

 

(65)

Insurance and security services

5

 

–

 

3

 

–

 

2

 

67

Other expenses

77

 

5

 

20

 

2

 

57

 

285

Total 

Php1,518

 

100

 

Php1,074

 

100

 

Php444

 

41

____________

 

*(1)   As restated to reflect the effects of the changesin accounting policies, as discussed in Note 2 – Summary of SignificantAccounting Policies and Practices to the accompanying unaudited consolidatedfinancial statements.*

*(2)   Includes salaries andbenefits, incentive plan, pension and MRP costs.*

 

Compensationand benefits increased by Php233 million, or 59%, to Php625 million mainly dueto the expansion of our call center facilities which resulted in an increase inheadcount coupled with an increase in salaries, bonuses and various incentivesof employees.

 

Rent expensesincreased by Php54 million, or 35%, to Php208 million due to the opening ofseveral *Netopia* branches countrywide and abroad in the first half of 2005.

 

Selling and promotion expenses increased by Php47million, or 30%, to Php205 million mainly as a result of the consolidation ofDigiPar in June 2004 and the continuous expansion of its *Netopia*branches nationwide in the first half of 2005 compared to the same period in2004.  In addition, selling expenses for *Khan Online* were recognizedstarting February 2005 when netGames commenced its commercial operations.  

 

Depreciation andamortization charges increased by Php39 million, or 26%, to Php187 million primarily due to an increase in depreciable asset base inrelation to the expansion of our call center business and internet and gamingsegments.

 

Maintenance expensesincreased by Php25 million, or 20%, to Php149 million primarily due to a changein maintenance agreement which resulted in higher annual maintenance in respectof our digital certificate business.

 

Professional and otherservice fees decreased by Php6 million, or 14%, to Php36 million primarily dueto lower training and shuttling expenses relating to our call centerrepresentatives.

 

Taxesand licenses increased by Php8 million, or 80%, to Php18 million mainly onaccount of documentary stamp taxes paid by ePLDT and Ventus in its issuance ofadditional capital stock in the first half of 2005 as compared to the sameperiod in 2004.

 

Financing costsdecreased by Php15 million, or 65%, to Php8 million due to lower interestexpense on loans as debt balances decreased in the first half of 2005 ascompared to the same period in 2004.

 

Insuranceand security services increased by Php2 million, or 67%, to Php5 millionprimarily due to higher premium costs and an increase in the assets insured inthe first half of 2005 as compared to same period in 2004.

 

Other expensesincreased by Php57 million, or 285%, to Php77 million due to various businessand operational-related expenses such as travel, supplies and communicationexpenses.

 

*Provision for (Benefit from) Income Tax*
 

A provisionfor income tax of Php6 million was recorded in the first half of 2005 as asubstantial portion of our ICT business are under income tax holiday.  Benefitfrom income tax of Php2 million was recognized in the first six months of 2004due to a tax loss position as non-tax deductible charges were higher during thefirst half of 2004.

 

*Net Income*
 

In the first half of2005, our information and communications technology business segment registereda net income of Php83 million compared to a net income of Php50 million postedin the same period in 2004 mainly on account of higher net income contributionof our call center business, partially offset by Infocom’s operating loss in2005 and DigiPar’s high operating costs due to expansion.

 

**Liquidity and Capital Resources**

 

The following table shows our consolidated cash flowsfor the six months ended June 30, 2005 and 2004 as well as consolidated capitalization andother selected financial data as at June 30, 2005and 2004:

 

 

**Six months ended June 30,**

 

**2005**

 

**2004**(1)

** **

(Unaudited)

**(in millions)**

 

 

 

**Cash Flows**

 

 

 

Net cash provided by operating activities

Php34,619

 

Php38,080

Net cash used in investing activities

2,220

 

13,435

Capital expenditures

7,012

 

11,575

Net cash used in financing activities

23,996

 

21,151

Net increase in cash and cash equivalents

8,308

 

3,427

 

** **

 

** **

 

**June 30,**

** **

**December 31,**

 

**2005**

 

**2004**

**(in millions)**

(Unaudited)

 

(Audited)

**Capitalization**

 

 

 

Long-term portion of interest-bearing financial liabilities – net of current portion

 

 

 

Long-term debt

Php102,675

 

Php121,012

Obligations under capital lease

516

 

601

Preferred stock subject to mandatory redemption

13,611

 

14,375

 

116,802

 

135,988

 

 

 

 

Current portion of interest-bearing financial liabilities 

 

 

 

Notes payable

56

 

58

Long-term debt maturing within one year

28,880

 

28,018

Obligations under capital lease maturing within one year

527

 

425

 

29,463

 

28,501

Total interest-bearing financial liabilities

146,265

 

164,489

Total equity

59,304

 

48,515

 

Php205,569

 

Php213,004

** **

 

 

 

**Other Financial Data**

 

 

 

Total assets

Php263,189

 

Php265,473

Property, plant and equipment - net

190,176

 

194,525

Cash and cash equivalents

35,629

 

27,321

_______________

* *

*(1)**As restated to reflect the effects of the changes inaccounting policies, as discussed in Note 2 – Summary of Significant AccountingPolicies and Practices to the accompanying unaudited consolidated financialstatements.*

* *

 

As at June 30, 2005, our consolidated cash and cash equivalents totaled Php35,629 million.Principal sources of consolidated cash and cash equivalents in the first halfof 2005 were cash flows from operations amounting to Php34,619 million anddrawings from Smart’s facilities aggregating Php5,471 million.  These fundswere used principally for capital outlays of Php7,012 million, total debtprincipal payments of Php22,441 million and interest payments of Php5,671million.

 

***Operating Activities***

 

Our consolidated netcash flows from operating activities in the first half of 2005 decreased byPhp3,461 million, or 9%, to Php34,619 million from Php38,080 million in thesame period in 2004 as we settled current liabilities relating to various tradesuppliers in the first six months of 2005.

 

A growing portion of our cash flow is generated byour wireless business, which accounted for 59% and 57% of our service revenuesin the first half of 2005 and 2004, respectively.  Revenues from our fixed lineand information and communications technology services accounted for 39% and2%, respectively, of our service revenues in the first half of 2005 compared to41% and 2%, respectively, in the same period in 2004. 

 

Cash flows from operating activities of our wirelessbusiness amounted to Php20,540 million in the first half of 2005, a decrease of Php2,431 million, or11%, compared to Php22,971 million in the same period in 2004.  Likewise, ourfixed line business contributed Php13,846 million in the first half of 2005, adecrease of Php1,099 million, or 7%, compared to Php14,945 million in the sameperiod in 2004.  The decline in both our wireless and fixed line business segmentswas mainly due to settlement of our outstanding current liabilities in thefirst half of 2005.  Our wireless business segment accounted for 59% of ourcash flows from operating activities while our fixed line segment accounted for41% during the first half of 2005.  We believe that our continuing strong cashflows on a consolidated basis will allow us to defray our current liabilitiesdespite our current ratio being less than 1:1 as at June 30, 2005. 

 

WhileSmart is subject to loan covenants that restrict its ability to pay dividends,redeem preferred shares, make distributions to PLDT or otherwise provide fundsto PLDT or any associate without the consent of its lenders, Smart has beenable to obtain waivers from Finnvera and certain of its lenders for each of thedividend payments made by Smart to PLDT in 2004, 2003 and 2002 aggregatingPhp16,100 million, Php6,166 million and Php1,540 million, respectively.  Smarthas also obtained the necessary consents from its lenders to make similardistributions to PLDT in 2005, amounting to about Php20,000 million, of whichPhp6,000 million and Php8,000 million was paid by Smart to PLDT in March andJune 2005, respectively.  

 

Investing Activities
 

Net cash used in investing activities in the firsthalf of 2005 amounted to Php2,220 million, a decrease of Php11,215 million, or83%, compared to Php13,435 million in the same period in 2004.  This decrease resultedfrom the decline in short-term investments and capital expenditures by Php5,784million and Php4,563 million, respectively.

 

Inthe first half of 2005, short-term investments of Php3,847 million maturedrelating to prepaid forward exchange contracts of Smart.  Smart did not bookadditional prepaid forwards in the first half of 2005; conversely, Smart bookedshort-term investments of Php1,937 million in the first half of 2004.

 

Our consolidatedcapital expenditures in the first half of 2005 totaled Php7,012 million, adecrease of Php4,563 million, or 39%, from Php11,575 million in the same periodin 2004 primarily due to Smart’s lower capital spending partially offset byPLDT’s higher capital spending.  Smart's capital spending of Php3,569 millionin the first half of 2005 was used to further expand and upgrade itstransmission network facilities to increase capacity and coverage in respect ofbasic and advanced cellular services.  PLDT's capital spending of Php3,118million was principally used to finance the expansion of its fixed line dataand IP-based network services.  ePLDT and its subsidiaries’ capital spending ofPhp305 million was used to primarily fund its *VitroTM*,DigiPar and call center business operations.  The balance represented othersubsidiaries’ capital spending.  Consolidated capital expenditures in the firsthalf of 2004 amounted to Php11,575 million, of which Php8,826 million, Php2,667million and Php75 million were attributable to Smart, PLDT and ePLDT,respectively.  The balance represented other subsidiaries’ capital spending.

 

***Financing Activities***

 

On a consolidated basis, we used net cash of Php23,996million for financing activities in the first half of 2005, compared to Php21,151million in the same period in 2004.  The net cash used in financing activitiesin the first half of 2005 was mainly attributable to debt repayments and interestpayments by PLDT in line with its ongoing debt reduction program and dividendpayments distributed to common and preferred stockholders.  

 

Debt Financing 
 

Additions to our consolidated long-term debt in thefirst half of 2005 totaled Php5,471 million from Smart's drawings related to the refinancing of its Phase5A/5B loan facilities.  Payments in respect of principal and interest of ourtotal debt amounted to Php22,441 million and Php5,671 million, respectively, inthe first half of 2005, of which Php13,380 million and Php4,747 million wereattributable to PLDT, respectively.

 

The following tableshows our long-term debt, including current portion as at June 30, 2005 and 2004:

 

** **

**June 30,**

** **

**December 31,**

** **

**Increase (Decrease)**

** **

**2005**

** **

**2004**

** **

**Amount**

** **

**%**

**(in millions)**

(Unaudited)

 

(Audited)

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

U.S. Dollar Debt:

 

 

 

 

 

** **

 

Export Credit Agencies-Supported Loans

Php32,802

 

Php41,266

 

(Php8,464)

** **

(21)

Fixed Rate Notes

66,043

 

68,795

 

(2,752)

** **

(4)

Term Loans

16,466

 

20,492

 

(4,026)

** **

(20)

Restructured Loans

4,917

 

4,815

 

102

** **

2

Satellite Acquisition Loans

3,635

 

4,064

 

(429)

** **

(11)

 

123,863

 

139,432

 

(15,569)

** **

(11)

Japanese Yen Debt:

 

 

 

 

 

** **

 

JBIC’s Overseas Investment Loan

4,238

 

5,363

 

(1,125)

** **

(21)

Export Credit Agency-Supported Loan

956

 

1,212

 

(256)

** **

(21)

 

5,194

 

6,575

 

(1,381)

** **

(21)

Philippine Peso Debt:

 

 

 

 

 

** **

 

Peso Fixed Rate Corporate Notes

1,575

 

1,675

 

(100)

** **

(6)

Term Loans

552

 

985

 

(433)

** **

(44)

Restructured Loans

371

 

363

 

8

** **

2

 

2,498

 

3,023

 

(525)

** **

(17)

 

Php131,555

 

Php149,030

 

(Php17,475)

** **

(12)

 

Fora complete discussion of long-term debt, see *Note 17 – Interest-bearingFinancial Liabilities*to the accompanying unaudited consolidated financialstatements.

 

Our long-term debtdecreased by Php17,475 million, or 12%, to Php131,555 million as at June 30,2005 largely due to debt amortizations and prepayments in line with PLDT’sefforts to reduce its overall debt level and also due to the appreciation ofthe peso.  PLDT’s debt was reduced by 13% to Php95,731 million by the end ofthe first half 2005.  In addition, the debt levels of Smart, Mabuhay, ePLDT andMaratel as at June 30, 2005 relative to the debt balances as at December 31,2004 decreased by 8%, 11%, 30% and 55% to Php31,977 million, Php3,635 million, Php207 million and Php5 million, respectively, due to the peso appreciation anddebt amortizations during the first half of 2005.

 

Asat June 30, 2005, PLDT had no undrawn committed long-term credit facilities.The JP¥3,095 million undrawn portion of the JP¥5,615 million syndicated termloan facility supported by Nippon Export and Investment Insurance of Japan andUS$4 million undrawn portion of the US$12 million term loan facility extendedby DEG-Deutsche Investitions-und Entwicklungsgesellschaft mbH were cancelled onDecember 3, 2004 and September 26, 2004, respectively.  In addition, PLDT alsowaived further disbursements from the US$149 million Kreditanstalt fürWiederaufbau refinancing facility effective September 1, 2004, thus, canceling the undrawn portion of US$9 million.  As at June 30, 2005, Smart still had available facilities under its €50 million Framework Agreement with BayerischeHypo-und Vereinsbank Aktiengesellschaft up to a maximum aggregate amount of €44million. 

 

The scheduled maturities of our outstandingconsolidated long-term debt at nominal values as at June 30, 2005 are as follows:  

 

**Year**

** **

**US$ Loans**(1)

** **

**JP¥ Loans**(2)

** **

**Peso Loans**

** **

**Total**

 

 

**(in millions)**

** **

 

 

 

 

 

 

 

 

 

 

 

 

2005(3)

 

US$238

 

Php13,389

 

JP¥1,709

 

Php866

 

Php368

 

Php14,623

2006

 

337

 

18,947

 

3,418

 

1,732

 

847

 

21,526

2007

 

443

 

24,882

 

3,418

 

1,732

 

73

 

26,687

2008

 

118

 

6,630

 

1,709

 

866

 

61

 

7,557

2009

 

271

 

15,219

 

–

 

–

 

52

 

15,271

2010 and onwards

 

972

 

54,590

 

–

 

–

 

1,214

 

55,804

________________

*(1)       **The exchange rate used wasPhp56.177 to US$1.00.*

*(2)       **The exchange rate used wasPhp0.5067 to JP**¥1.00.*

*(3)       **July 1, 2005**through December31, 2005.*

 

Approximately Php85,664million principal amount of our consolidated outstanding long-term debt as at June 30, 2005 is scheduled to mature over the period from 2005 to 2009.  Of this amount,approximately Php63,064 million is attributable to PLDT, Php18,751 million toSmart, and the remainder to Mabuhay Satellite, Maratel and ePLDT.

 

*DebtCovenants*

 

Ourdebt instruments contain restrictive covenants, including covenants that couldprohibit us from paying common dividends under certain circumstances, andrequire us to comply with specified financial ratios and other financial tests,calculated in conformity with accounting principles generally accepted in the Philippines,at relevant measurement dates, principally at the end of each quarterly period. We have complied with all of ourmaintenance financial ratios as required under our loan covenants and otherdebt instruments.  

 

Pleasesee *Note 17 – Interest-bearing Financial Liabilities*to the accompanyingunaudited consolidated financial statements for a detailed discussion of ourcovenants.

 

Financing Requirements
 

We believe that our available cash, including cashflow from operations, will provide sufficient liquidity to fund our projectedoperating, investment, capital expenditures and debt service requirements forthe next 12 months.  

 

Since 2002, we have been utilizing internallygenerated cash particularly from our cellular business to reduce our overalllevel of indebtedness.  In line with this objective, we have managed ourcapital expenditures, reduced our investments and suspended dividend paymentsto common shareholders from April 2001 to 2004.  As a result of our improvingcash flows and reduced debt levels, we have restored the payment of commondividends in May 2005 and intend to gradually increase our dividend payoutratio in succeeding years as we improve our leverage ratios. 

 

*Credit Ratings*****

 

None of our existing indebtedness contains provisionsunder which credit rating downgrades would trigger a default, changes inapplicable interest rates or other similar terms and conditions.  

 

On July 11, 2005, FitchRatings revised the outlook on PLDT’s long-term foreign currency rating tonegative from stable.  The revision in outlook reflects a similar change inFitch’s outlook on the Republic of the Philippines’ “BB” long-term foreign currency rating to negativefrom stable.  PLDT’s long-term foreign currency rating, global bonds and seniornotes has been maintained at “BB” and convertible preferred stock remainunchanged at “B+.”  The outlook on PLDT’s long-term local currency rating hasalso been affirmed as “BB+” and the stable outlook on this rating still remainsin place.  

 

On May 3, 2005, FitchRatings upgraded PLDT’s long-term local currency rating to “BB+” with a stableoutlook.  Simultaneously, Fitch has affirmed PLDT’s long-term foreign currencyrating, global bonds and senior notes at “BB” and PLDT’s convertible preferredstock at “B+.”

 

On February 16, 2005, Moody’s Investor Service, orMoody’s, downgraded the foreign currency senior unsecured debt rating of PLDTby one-notch to Ba3 from Ba2 with a stable outlook.  The rating action wastaken as part of Moody’s two-notch downgrade of the Republic of the Philippines’foreign currency country ceiling to B1 from Ba2.  On the same date, Moody’saffirmed PLDT’s B1 preferred stock rating with a stable outlook.  Moody's viewsthat there is a differential between PLDT's foreign currency rating and thesovereign rating.  According to Moody's, PLDT's foreign currency bond rating isa function of its own risk of default and is less likely to be subject to adebt moratorium which the Philippine government may declare in case of an eventof default by government.

 

OnJanuary 17, 2005, Standard and Poor’s Ratings Group, or Standard and Poor’s,revised its long-term foreign currency rating on PLDT from “BB” to “BB-“ (BBminus) with a stable outlook.  The rating action was taken immediately afterStandard and Poor’s downgraded the foreign currency rating on the Republic ofthe Philippines to “BB-“ (BB minus).

 

*EquityFinancing*

 

PLDT raised Php131million and Php64 million from the exercise by certain officers and executivesof stock options in the first half of 2005 and 2004, respectively.  Inaddition, through our subscriber investment plan, or SIP, which providespostpaid fixed line subscribers the opportunity to buy shares of our 10%cumulative convertible preferred stock as part of the upfront paymentscollected from subscribers, PLDT was able to raise Php2 million in the first halfof 2005 and Php4 million in the same period in 2004.  

 

Cashdividend payments in the first half of 2005 amounted to Php2,963 million, ofwhich Php2,372 million and Php591 million were paid to common and preferredshareholders, respectively, compared to Php601 million in the same period in2004, all of which were paid to preferred shareholders of PLDT.  On March 2, 2005, PLDT declared cash dividends of Php14 per common share to holders of recordas at March 31, 2005 paid on May 12, 2005. This was the first cash dividenddeclaration to common shareholders in four years since April 2001.  Inaddition, on May 5, 2005, PLDT declared cash dividend of Php21 per common shareto holders of record as at June 3, 2005 paid on July 14, 2005.  

 

***Contractual Obligations and Commercial Commitments***

 

*Contractual Obligations*

 

The following table discloses our contractualobligations outstanding as at June 30, 2005: 

 

 

**Payments Due by Period**

 

**Total**

** **

**Within 1 year**

** **

**2****-****3 years**

** **

**4****-****5 years**

** **

**After 5 years**

 

(Unaudited)

**(in millions)**

 

 

 

 

 

 

 

 

 

Long-term debt (1)

Php141,468

 

Php29,036

 

Php38,385

 

Php21,173

 

Php52,874

Long-term lease obligations:

 

 

 

 

 

 

 

 

 

Operating Lease

3,704

 

624

 

1,103

 

843

 

1,134

Capital Lease

1,742

 

760

 

524

 

13

 

445

Unconditional purchase obligations(2)

11,861

 

4,556

 

2,249

 

2,247

 

2,809

Other long-term obligations

19,633

 

–

 

5,853

 

13,780

 

–

Total contractual obligations

Php178,408

 

Php34,976

 

Php48,114

 

Php38,056

 

Php57,262

___________

* *

*(1)    **Before deducting unamortizeddebt discount and debt issuance cost**s.*

*(2)    **Based on the original AirTime Purchase Agreement with AIL.*

* *

*Long-term Debt*

* *

For a discussion of our long-term debt, see *Note 17 – Interest-bearing Financial Liabilities*to the accompanying unaudited consolidated financialstatements.

* *

*Long-term Operating Lease Obligations*

 

***DomesticFiber Optic Network Submerged Plant Maintenance Agreement***.   On July 4, 2000, PLDT entered into an agreementwith NTT World Engineering Marine Corporation, or NTT WEMC for the submarinecable repair and other related services in relation to the maintenance ofPLDT's domestic fiber optic network, or DFON, submerged plant for a period offive years up to July 4, 2005.  This agreement has been extended up to the end of2005.  Under this agreement, PLDT is required to pay NTT WEMC a fixed annualstanding charge of US$2 million, excluding cost for the use of aremotely-operated submersible vehicle at US$5,000 for every day of use andrepair cost computed at US$19,000 per day of actual repair.  As at June 30, 2005, PLDT’saggregate remaining obligation under this agreement was approximately Php39million. 

 

***DigitalPassage Service Contracts***.****PLDThas existing Digital Passage Service Contracts with foreign telecommunicationadministrations for several dedicated circuits to various destinations for tento 25 years expiring at various dates.  As at June 30, 2005, PLDT’s aggregateremaining obligation under these contracts amounted to approximately Php24million.

 

***License Agreement with Mobius Management Systems (******Australia******) Pty Ltd., or Mobius****.*PLDTentered into a license agreement with Mobius pursuant to which Mobius hasgranted PLDT a non-exclusive, non-assignable and non-transferable license forthe use of computer software components.  Under this agreement, Mobius is alsorequired to provide maintenance services for a period of one year at noadditional maintenance charge.  PLDT may purchase maintenance services uponexpiration of the first year for a fee of 15% of the current published licensefee.  As at June 30, 2005, PLDT’s aggregate remaining obligation under thisagreement was approximately Php40 million.

 

***Other Long-term Operating Lease Obligations***.  The PLDT Group has various long-term leasecontracts for periods ranging from two to ten years covering certain offices,warehouses, cell sites, telecommunication equipment locations and variousoffice equipment.  In particular, Smart has lease obligations aggregating Php3,325million as at June 30, 2005 in respect of office and cell site rentals with over3,000 lessors nationwide.  PLDT has lease obligations aggregating Php96 million as at June 30, 2005, and ePLDT has lease obligations aggregating Php180million as at June 30, 2005 in respect of certain office space rentals.

 

*Long-termCapital Lease Obligation*s

 

For a discussion of our long-term capital leaseobligations, see *Note 17 –Interest-bearing Financial Liabilities*tothe accompanying unaudited consolidated financial statements.

 

*UnconditionalPurchase Obligations*

 

***AirTime Purchase Agreement with AIL***.PLDT is a party to a Founder NSP, or National Service Provider, Air TimePurchase Agreement with AIL in March 1997, which was amended in December 1998,under which PLDT is granted the exclusive right to sell AIL services in thePhilippines.  In exchange, the Air Time Purchase Agreement required PLDT topurchase from AIL a minimum of US$5 million worth of air time annually over tenyears commencing on January 1, 2002, the date of commercial operations of theGaruda I Satellite.  

 

Inthe event that AIL’s aggregate billing revenue is less than US$45 million inany given year, the Air Time Purchase Agreement also states that PLDT has tomake supplemental air time purchase payments not to exceed US$15 million peryear during the ten-year term. 

 

PLDT and the otherfounder NSPs are endeavoring to amend the Air Time Purchase Agreement due tothe occurrence of partial satellite loss, changes in the primary business ofAceS and the other events affecting the business.

 

In March 2003, PLDT,together with the other founder NSPs, entered into a Standstill Agreement withAIL suspending the application and enforcement of the minimum and supplementalair time payments under the original Air Time Purchase Agreement.  The partiesagreed that AIL shall provide PLDT and the other founder shareholders, withunlimited use of air time for the year 2003 in exchange for a fixed fee in theamount of US$3.8 million for PLDT.  Moreover, PLDT is also obliged to purchasefrom AIL 13,750 satellite phone units in 2003 at US$395 F.O.B. per unit,subject to quarterly price adjustments.  The parties to the StandstillAgreement also agreed to negotiate in good faith and use their best efforts toreach an agreement on a revised Air Time Purchase Agreement before November 15,2003 that will cover, among other things, the amended minimum and supplementalair time payment provisions subject to the approval of AIL’s creditors.

 

On February 10, 2004, notwithstanding the ongoingnegotiations, AIL advised PLDT of the termination of the Standstill Agreementand the reinstatement of the terms under the original Air Time PurchaseAgreement effective January 1, 2002 following the lapse of the November 15,2003 deadline set in the Standstill Agreement for the negotiation of a revisedAir Time Purchase Agreement.  

 

As at June 30, 2005, PLDT’s aggregate remaining minimum obligation under the original Air TimePurchase Agreement was approximately Php11,857 million.  Negotiations arecontinuing with the relevant parties towards an amicable settlement of thismatter.  See *Note 20 – Related Party Transactions* and *Note 23 –Provisions and Contingencies* to the accompanying unaudited consolidatedfinancial statements for further details relating to the Air Time PurchaseAgreement with AIL.

 

***InternationalAffiliate Agreement with VeriSign, Inc., or VeriSign.***  On September 15, 2000, ePLDT entered into anagreement with VeriSign for the non-exclusive, non-transferable right andlicense to use the VeriSign software, brand and Certification PracticeStatement for the purpose of approving, issuing, suspending or revoking digitalcertificates for users of the internet or similar open systems in the Philippinesfor a period of seven years.  Under this agreement, ePLDT is required to payVeriSign a certain percentage of the revenue derived from the services subjectto minimum annual royalty payments aggregating to US$11 million, which wassubsequently reduced to US$1 million, for the seven-year contract period.  Inaddition, ePLDT was required to pay an annual support fee totaling US$0.5 millionduring the first year and US$0.3 million in each year thereafter.

 

Effective July 1,2003, VeriSign has agreed to amend the Agreement and issued Addendum 6 towrite-off all past due invoices and payments owed to VeriSign, which wereinvoiced or scheduled to be invoiced under the agreement prior to this Addendum6.  All royalty payments and annual support fees due through June 2003 werepart of the write-off in the amount of US$0.8 million.  For contract year 4 (September 2003 to August 2004), theannual support fee was reduced from US$0.3 million to US$ 40,000 and forcontract years 5 to 7 (September 2004 to August 2007) from US$0.3 million toUS$0.16 million.  In addition, VeriSign agreed to reduce the affiliate revenuesharing rates from 50% of suggested retail price to 25% of suggested retailprice for both enterprise and internet products for 12 months starting July2003 and negotiable thereafter.  

 

Moreover,effective July 1, 2004, VeriSign has agreed to amend the Agreement andissued Addendum 8 as extension of Addendum 6.  Under this amendment, annualsupport fee for year 5 (September 2004 to August 2005) will remain at US$40,000and affiliate revenue sharing rates will remain at 25%.  As at June 30, 2005,ePLDT’s aggregate remaining minimum obligation under this agreement wasapproximately Php4 million pertaining to annual support fee.

 

***LicensePurchase Agreement with I-Contact Solutions Pte. Ltd****.*  On April2, 2003, iPlus Intelligent Network Inc., or iPlus, a wholly-owned subsidiary ofePLDT and the Philippines’ pioneer in IP-based IT response center, entered intoan Application Services Provider, or ASP, and Reseller Contract with I-ContactSolutions Pte. Ltd., or I-Contact, of Singapore.  Under the agreement, iPlus will purchase licensesof the CosmoCall Universe TM IP-based contact center solution.  CosmoCallUniverse supports multi-channel customer interactions including telephone, webchat, web voice, web video, web collaboration, e-mail and voicemail in one highcapacity, high availability, multi-tenant platform.  CosmoCall Universe is acomplete, unified contact center suite that includes ACD, IVR, CTI, predictivedialing, multimedia recording and a complement of other managementapplications.  The aggregate value of these licenses is US$2.1 million andthese licenses will be delivered quarterly over a two-year period.  Further tothe agreement, I-Contact will appoint iPlus as the exclusive reseller and ASPfor the Philippine market and will provide iPlus with all the necessary supportin terms of sales, marketing, and technical services.  Effective March 30, 2004, I-Contact has agreed to amend the agreement andwaived all financial obligations and committed seats requirement over thetwo-year period.  iPlus will pay all its remaining obligations pertaining onlyto the 300 seats delivered by I-Contact.  In June 2005, iPlus committed topurchase additional 50 predictive dialer and Cosmocorder licenses in the amountof Php18 million.

 

*OtherLong-term Obligations*

 

***MandatoryConversion and Purchase of Shares***.As discussed in *Note 9 – Investments in Associates* and *Note 17 –Interest-bearing Financial Liabilities*, as at June 30, 2005 PLDT had issueda total of 3 million shares of Series V Convertible Preferred Stock, 5 millionshares of Series VI Convertible Preferred Stock and 4 million shares of SeriesVII Convertible Preferred Stock in exchange for a total of 58 million shares ofSeries K Class I Convertible Preferred Stock of Piltel, pursuant to the debtrestructuring plan of Piltel adopted in June 2004.  

 

Eachshare of Series V, VI and VII Convertible Preferred Stock is convertible at anytime at the option of the holder into one PLDT common share.  On the dateimmediately following the seventh anniversary of the issue date of the Series Vand Series VI Convertible Preferred Stocks and on the eighth anniversary of theissue date of the Series VII Convertible Preferred Stock, the remainingoutstanding shares under these series will be mandatorily converted to PLDTcommon shares.  Under a put option exercisable for 30 days, holders of commonshares received on mandatory conversion of the Series V, VI and VII ConvertiblePreferred Stock will be able to require PLDT to purchase such PLDT commonshares for Php1,700 per share, US$36.132 per share, and JP¥4,071.89 per share,respectively.

 

Asat June 30, 2005, 1,435,905 shares of Series V Convertible PreferredStock and 604,449 shares of Series VI Convertible Preferred Stock had beenconverted to PLDT common shares.  The aggregate value of the put option basedon outstanding shares as at June 30, 2005 was Php19,633 million, of which Php11,706 million is payable on June 4, 2008 andPhp7,927 million on June 4, 2009, if all of the outstanding shares of Series V,VI and VII Convertible Preferred Stocks were mandatorily converted and all theunderlying shares of common stock were put to PLDT.  As at June 30, 2005,1,285,535 shares of Series V, 4,690,655 shares of Series VI and 3,842,000shares of Series VII Convertible Preferred Stock remain outstanding.  Themarket value of the underlying shares of common stock was Php13,549 million,based on the market price of PLDT common shares of Php1,620 per share as at June 30, 2005.

 

Pleaserefer to *Note 17 – Interest-bearing Financial Liabilities*to theaccompanying unaudited consolidated financial statements for furtherdiscussion.

 

*Commercial Commitments*

 

As at June 30, 2005, our outstanding commercial commitments, in the form of letters of credit,amounted to Php947 million.  These commitments will expire within one year.

 

**Quantitative and Qualitative Disclosures about Market Risks**

 

Our operations are exposed to various risks,including liquidity risk, foreign exchange risk and interest rate risk.  Theimportance of managing these risks has significantly increased in light ofconsiderable change and continuing volatility in the Philippine andinternational financial markets.  With a view to managing these risks, we haveincorporated financial risk management functions in our organization,particularly in our treasury operations.

 

Liquidity Risk Management
 

We seek to manage our liquidity profile to be ableto finance our capital expenditures and service our maturing debts.  To coverour financing requirements, we intend to use internally generated funds andproceeds from debt and equity issues and sales of certain assets. 

 

As part of ourliquidity risk management program, we regularly evaluate our projected andactual cash flow information and continuously assess conditions in thefinancial markets for opportunities to pursue fund-raising initiatives.  Theseinitiatives may include bank loans, export credit agency-guaranteed facilities,and debt capital and equity market issues.

 

***Foreign Exchange Risk Management***

 

As at June 30, 2005, the Philippine peso had appreciated against the U.S. dollar to Php56.177 toUS$1.00 from Php56.341 to US$1.00 as at December 31, 2004.  As at June 30, 2004, on the other hand, the peso depreciated by 1% to Php56.176 to US$1.00from Php55.586 to US$1.00 as at December 31, 2003.  As at June 30, 2005, the Philippine peso had appreciated by 8% against the Japanese yen to Php0.5067 to JP¥1from Php0.5495 to JP¥1 as at December 31, 2004.  Likewise, as at June 30, 2004, the peso appreciated by approximately 1% to Php0.5166 to JP¥1 from Php0.5193to JP¥1 as at December 31, 2003.  As such, we recognized foreign exchange gainsof Php1,530 million in the first half of 2005 as compared to foreign exchangelosses of Php1,452 million recorded in the same period in 2004.  

 

Whilea certain percentage of our revenues is either linked to or denominated in U.S.dollars, substantially all of our indebtedness, a substantial portion of ourcapital expenditures and a portion of our operating expenses are denominated inforeign currencies, mostly in U.S. dollars.

* *

As at June 30, 2005,approximately 98% of our total consolidated debts were denominated in foreigncurrencies.  Of our foreign currency-denominated debts, 4% are in Japanese yenon a consolidated basis and the balance in U.S. dollars.  Thus, a weakening ofthe peso against the U.S. dollar or Japanese yen will increase both theprincipal amount of our unhedged foreign currency-denominated debts(representing 62% of our consolidated debts), and interest expense on our debtin peso terms.  In addition, many of our financial ratios and other financialtests will be negatively affected.  If, among other things, the value of thepeso against the U.S. dollar substantially drops from its current level, we maybe unable to maintain compliance with these ratios, which could result inacceleration of some or all of our indebtedness.  For further information onour loan covenants, see “Liquidity and Capital Resources –– FinancingActivities –– Covenants” above and *Note 17 – Interest-bearing FinancialLiabilities*to the accompanying unaudited consolidated financialstatements.

 

To manage our foreignexchange risks, stabilize cash flows, and improve investment and cash flowplanning, we enter into forward foreign exchange contracts, foreign currencyswap contracts, currency options and other hedging products aimed at reducingand/or managing the adverse impact of changes in foreign exchange rates on ouroperating results and cash flows.  However, these hedges do not cover all ofour exposure to foreign exchange risks.

 

Specifically,we use forward foreign exchange contracts, foreign currency swap contracts andcurrency option contracts to manage the foreign exchange risk associated withour foreign currency-denominated loans. In order to manage hedge costs of thesecontracts, we utilize structures that include credit-linkage with PLDT as thereference entity, combination of currency option contracts, and fixed tofloating coupon only swap agreements.  Accounted as either cash flow hedges ortransactions not designated as hedges, changes in the fair value of theseinstruments are recognized as cumulative translation adjustments in equityuntil the hedged item is recognized in earnings or directly to income for theperiod. As at June 30, 2005, PLDT’s outstanding forward foreign exchange contracts,principal-only long-term cross-currency swap contracts and currency optioncontracts amounted to US$87 million and JP¥879 million; US$550 million; and US$263 million, respectively.  Smart’s has no outstanding forward foreignexchange contracts as at June 30, 2005. 

 

For further discussions of these contracts, see *Note24 –Financial Assets and Liabilities – Derivative Financial Instruments*tothe accompanying unaudited consolidated financial statements.

 

***Interest Rate Risk Management***

 

On a limited basis, we enter into interest rate swapagreements in order to manage our exposure to interest rate fluctuations. As at June 30, 2005, PLDT’s outstanding interest rate swap contracts amounted toUS$125 million. For further discussions of these contracts, see *Note 24 –Financial Assets and Liabilities – Derivative Financial Instruments*to theaccompanying unaudited consolidated financial statements.

 

Wemake use of hedging instruments and structures solely for reducing oreliminating financial risks associated with our liabilities and not for tradingor speculative purposes.

** **

**Impact of Inflation and Changing Prices**

** **

Inflation can be asignificant factor in the Philippine economy, and we are continually seekingways to minimize its impact.  In recent periods, while decreases in therelative value of the peso have had a significant effect on us, we do notbelieve inflation has had a material impact on our operations.  The averageinflation rate in the Philippines in the first half of 2005 was 7.1%, comparedto 5.1% in the same period in 2004.

** **

**OTHER INFORMATION**

 

*Related Party Transactions*
 

In the ordinary course of business, a number ofcompanies related to but outside of the consolidated PLDT Group are engaged inarm’s-length intercompany transactions.  We believe that the terms of thesetransactions are comparable with those available from unrelated parties. 

 

Transactions to which PLDT or its subsidiaries is aparty, in which a director or key officer or owner of more than 10% of thecommon shares of PLDT, or any member of the immediate family of a director orkey officer or owner of more than 10% of the common shares of PLDT had a director indirect material interest in PLDT or its subsidiaries, as at June 30, 2005and December 31, 2004 and for the six months ended June 30, 2005 and 2004 areas follows:

 

*Agreements with NTTCommunications and/or its Affiliates*—agreements under which (1) NTT Communications provides advisory services forvarious business areas of PLDT; (2) NTT World Engineering Marine Corporationprovides maintenance services to PLDT’s DFON; (3) PLDT is licensed to marketmanaged data and other services using NTT Communications’ Arcstar brand; and(4) PLDT and NTT Communications agreed to cooperative arrangements forconventional international telecommunication services.  Total fees under theseagreements totaled Php114 million and Php146 million for the six months ended June 30, 2005 and2004, respectively.  PLDT’s outstanding obligations under these agreementsamounted to Php55 million and Php49 million as at June 30, 2005 and December 31, 2004,respectively.

 

*Agreements between Smartand**Asia**Link B.V*. —agreements under which Asia Link undertakes to provide technical supportservices and assistance in the operations and maintenance of Smart’s cellularbusiness.  Total fees under these agreements totaled Php278 million and Php239million for the six months ended June 30, 2005 and 2004, respectively.  Underthese agreements, Smart had outstanding payables of Php284 million and Php267million as at June 30, 2005 and December 31, 2004, respectively.  Asia Link is asubsidiary of the First Pacific Group.

 

*Agreements relating toinsurance companies* — Gotuaco delRosario and Associates, or Gotuaco, acts as the broker for certain insurancecompanies to cover certain insurable properties of the PLDT Group.  Insurancepremiums are remitted to Gotuaco and the broker’s fees are settled betweenGotuaco and the insurance companies.  In addition, PLDT has an insurance policywith Malayan Insurance Co., Inc., or Malayan, wherein premiums are directlypaid to Malayan.  Total insurance expenses paid under these agreements amountedto Php268 million and Php238 for the six months ended June 30, 2005 and 2004,respectively.  Two directors of PLDT have direct/indirect interests in or serveas a director/officer of Gotuaco and Malayan.

 

For a more detailed discussion of the related party transactionsenumerated above, see *Note 20 –Related Party Transactions* to theaccompanying**unaudited**consolidated financial statements. 

`

 

 

 

 

 

 

 

 

 

 

 

 

  

 

 

 

 

 

 

**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY ANDSUBSIDIARIES**

 

**CONSOLIDATED FINANCIAL STATEMENTS**

 

AS AT JUNE 30, 2005 (UNAUDITED) AND DECEMBER 31, 2004(AUDITED)

AND FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004(UNAUDITED)

 

 

 

 
****
**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY ANDSUBSIDIARIES**

** **

CONSOLIDATEDBALANCE SHEETS

**(in million pesos, except par value amounts)**

** **

** **

**June 30, 2005**

 

December 31, 2004

** **

**(Unaudited)**

 

(Audited)

**ASSETS**

**Noncurrent Assets**

** **

** **

** **

Property, plant and equipment (Notes 2, 8 and 17)

**190,176**

 

194,525

Investments in associates (Notes 2, 9 and 17)

**12**

 

8

Investments-available-for-sale (Notes 2 and 24)

**109**

 

104

Investment properties (Notes 2 and 10)

**732**

 

743

Goodwill and intangible assets (Notes 2, 3 and 11)

**3,727**

 

3,864

Deferred income tax assets (Notes 2 and 6)

**12,291**

 

12,738

Derivative assets (Notes 2 and 24)

**3,694**

 

4,116

Notes receivable (notes 2, 12 and 24)

**346**

 

286

Prepayments (Note 17)

**1,207**

 

997

Other noncurrent assets (Note 2)

**1,063**

 

1,237

Total Noncurrent Assets 

**213,357**

 

218,618

**Current Assets**

** **

 

 

Cash and cash equivalents (Notes 2, 13 and 24)

**35,629**

 

27,321

Short-term investments (Notes 2 and 24)

**27**

 

3,873

Trade and other receivables (Notes 2, 14 and 24)

**8,457**

 

10,404

Inventories and supplies (Notes 2 and 15)

**2,255**

 

2,140

Derivative assets (Notes 2 and 24)

**217**

 

335

Prepayments (Note 17)

**1,474**

 

1,271

Other current assets (Notes 2 and 20)

**1,773**

 

1,511

Total Current Assets 

**49,832**

 

46,855

 

**263,189**

 

265,473

 

** **

 

 

**EQUITY AND LIABILITIES**

**Equity******(Notes 2, 7 and 16)

** **

 

 

Preferred stock, Php10 par value, authorized 822,500,000 shares; issued and  outstanding 448,708,863 as at June 30, 2005 and 449,682,057 shares as at  December 31, 2004

**4,487**

 

4,497

Common stock, Php5 par value, authorized 234,000,000 shares; issued and  outstanding 171,363,153 as at June 30, 2005 and 170,213,722 shares as at  December 31, 2004 

**857**

 

851

Stock options issued (Note 21)

**124**

 

181

Equity portion of convertible preferred stock (Note 17)

**1,264**

 

1,459

Capital in excess of par value

**51,941**

 

50,528

Deficit (Note 7)

**(117)**

 

(10,220)

Cumulative translation adjustments (Note 24)

**(134)**

 

362

                Total Equity Attributable to Equity Holders

**58,422**

 

47,658

Minority interest

**882**

 

857

Total Equity

**59,304**

 

48,515

**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY ANDSUBSIDIARIES**

** **

CONSOLIDATEDBALANCE SHEETS (*continued*)

(in million pesos, except par value amounts)

 

** **

**June 30,  2005**

 

December 31, 2004

** **

**(Unaudited)**

 

(Audited)

**Noncurrent Liabilities**

** **

 

 

Interest-bearing financial liabilities - net of current portion (Notes 2, 8, 17, 22 and 24)

**116,802**

 

135,988

Deferred income tax liabilities (Notes 2 and 6)

**1,955**

 

1,943

Derivative liabilities (Notes 2 and 24)

**4,755**

 

5,903

Provision for onerous contracts and assessments - net of current portion  (Notes 20, 22 and 23)

**4,068**

 

3,951

Pension and other benefits (Notes 2 and 21)

**3,702**

 

2,908

Customers’ deposits

**2,142**

 

2,174

Other noncurrent liabilities (Notes 2, 8, 14 and 18)

**8,641**

 

7,159

Total Noncurrent Liabilities

**142,065**

 

160,026

**Current Liabilities**

** **

 

 

Accounts payable (Notes 2 and 24)

**5,300**

 

7,029

Accrued expenses and other current liabilities (Notes 2, 17, 19, 20, 24 and 25)

**16,104**

 

14,811

Unearned revenues (Note 2)

**2,639**

 

2,892

Derivative liabilities (Notes 2 and 24)

**229**

 

474

Current portion of provision for onerous contracts and assessments (Notes 20 and 23)

**699**

 

597

Current portion of interest-bearing financial liabilities (Notes 2, 8, 17, 22 and 24)

**29,463**

 

28,501

Dividends payable (Notes 2, 7, 17 and 24)

**4,366**

 

652

Income tax payable (Notes 2 and 6)

**3,020**

 

1,976

Total Current Liabilities

**61,820**

 

56,932

 

**263,189**

 

265,473

* *

*See accompanying Notes toUnaudited Consolidated Financial Statements.*

* *
****
**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY AND SUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF INCOME**

**(in million pesos, except per share amounts)**

** **

** **

**Six Months Ended June 30,**

 

Three Months Ended June 30,

 

**2005**

2004

 

**2005**

2004

 

(Unaudited)

**INCOME**(Notes 2 and 4)

** **

 

 

 

 

Service revenues

**59,522**

57,841

 

**30,161**

29,734

Non-service revenues (Note 5)

**1,422**

4,311

 

**607**

1,680

Other income 

**194**

147

 

**119**

62

 

**61,138**

62,299

 

**30,887**

31,476

**EXPENSES**(Notes 2 and 4)

** **

 

 

** **

 

Depreciation and amortization (Note 8)

**10,861**

10,927

 

**5,305**

5,590

Compensation and benefits (Notes 5 and 21)

**6,492**

5,996

 

**3,406**

3,012

Financing costs (Note 5)

**4,349**

9,901

 

**4,282**

5,483

Maintenance (Note 20)

**3,320**

2,776

 

**1,776**

1,465

Cost of sales (Notes 5, 20 and 22)

**3,271**

6,599

 

**1,267**

2,730

Selling and promotions

**2,770**

2,386

 

**1,318**

1,261

Provisions (Notes 5, 14, 15, 20 and 22)

**1,968**

2,176

 

**1,369**

840

Professional and other service fees (Note 20)

**1,043**

1,005

 

**629**

565

Taxes and licenses (Note 23)

**1,034**

771

 

**460**

384

Rent

**954**

1,060

 

**324**

511

Insurance and security services (Note 20)

**825**

810

 

**414**

412

Asset impairment (Notes 8 and 9)

–

85

 

**–**

–

Other expenses (Notes 5 and 20)

**1,740**

1,548

 

**752**

681

 

**38,627**

46,040

 

**21,302**

22,934

**INCOME BEFORE INCOME TAX**

**22,511**

16,259

 

**9,585**

8,542

**PROVISION FOR INCOME TAX** (Notes 2 and 6)

**5,694**

3,811

 

**2,151**

1,775

**NET INCOME FOR THE PERIOD**

**16,817**

12,448

 

**7,434**

6,767

**ATTRIBUTABLE TO:**

** **

 

 

** **

 

Equity holders

**16,785**

12,423

 

**7,424**

6,737

Minority interest

**32**

25

** **

**10**

30

** **

**16,817**

12,448

 

**7,434**

6,767

**Earnings Per Common Share** (Note 7)

** **

 

 

** **

** **

Basic

**94.00**

68.78

 

**41.22**

37.48

Diluted

**88.83**

68.00

 

**41.22**

36.70

* *

*See accompanying Notes to**Unaudited Consolidated Financial Statements.*

* *

* *
**
**PHILIPPINE LONGDISTANCE TELEPHONE COMPANY AND SUBSIDIARIES**

** **

**CONSOLIDATEDSTATEMENTS OF CHANGES IN EQUITY**

**(in million pesos)**

** **

 

**Preferred Stock**

**Common Stock**

**Stock Options Issued**

**Equity Portion of Convertible Preferred Stock**

**Capital in Excess of  Par Value**

**Retained Earnings (Deficit)**

**Cumulative Translation Adjustments**

**Equity Attributable to Equity Holders of PLDT**

**Minority Interest**

**Total  Equity**

 

(Unaudited)

Balances at January 1, 2004 (As restated)

4,505

847

286

1,536

49,690

(36,736)

549

20,677

771

21,448

Changes in equity:

 

 

 

 

 

 

 

 

 

 

Net income for the period

 

 

 

 

 

 

 

 

 

 

As previously reported

–

–

–

–

–

12,008

–

12,008

18

12,026

Effect of changes in accounting policies  (Note 2)

–

–

–

–

–

415

–

 415

7

 422

As restated

 

 

 

 

 

12,423

–

12,423

  25

12,448

Cash dividends

–

–

–

–

–

(708)

–

(708)

–

(708)

Currency translation differences (Note 24)

–

–

–

–

–

–

13

  13

–

  13

Issuance of capital stock - net (Note 16)

(5)

–

–

–

9

–

–

   4

–

   4

Exercised shares

–

1

(27)

–

91

–

–

  65

–

  65

Cancelled option shares (Note 21)

–

–

(5)

–

5

–

–

–

–

–

Cost of share-based payments

–

–

7

–

–

–

–

   7

–

   7

Minority interest

–

–

–

–

–

–

–

–

48

  48

Balances at June 30, 2004 (As restated – Note 2)

4,500

 848

 261

1,536

49,795

(25,021) 

 562

32,481

 844

33,325

 

 

 

 

 

 

 

 

 

 

 

Balances at January 1, 2005

4,497

851

181

1,459

50,528

(10,220)

362

47,658

857

48,515

Changes in equity:

 

 

 

 

 

 

 

 

 

 

Net income for the period

–

–

–

–

–

16,785

 

16,785

32

16,817

Cash dividends

–

–

–

–

–

(6,682)

 

(6,682)

 

(6,682)

Currency translation differences (Note 24)

 

 

 

 

 

 

(2)

(2)

–

(2) 

Net gains on available-for-sale financial assets (Note 24)

–

–

–

–

–

–

6

   6

–

   6

Net loss on cash flow hedges (Note 24)

–

–

–

–

–

–

(500)

(500)

–

(500)

Issuance of capital stock - net (Note 16)

(10)

5

 

(195)

1,226

–

–

1,026

–

1,026

Exercised shares

–

1

(57)

–

187

–

–

 131

–

 131

Minority interest

–

–

–

–

–

–

–

–

(7)

(7)

Balances at June 30, 2005 (Unaudited)

4,487

 857

 124

1,264

51,941

(117)

(134)

58,422

 882

59,304

* *

*See accompanying Notes to Unaudited Consolidated Financial Statements.*

* *
**
**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY ANDSUBSIDIARIES**

 

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(in million pesos)**

 

** **

**Six Months Ended June 30,**

** **

**2005**

 

2004

** **

(Unaudited)

**CASH FLOWS FROM OPERATING ACTIVITIES**

** **

 

 

Income before income tax

**22,511**

 

16,259

Adjustments for:

** **

 

 

Depreciation and amortization

**10,861**

 

10,927

Interest on loans and related items - net of capitalized interest (Note 5)

**5,453**

 

6,201

Provision for doubtful accounts (Note 5)

**1,526**

 

1,875

Accretion on financial liabilities - net (Note 5)

**1,437**

 

1,496

Write-down of inventories at net realizable value (Note 5)

**325**

 

128

Dividends on preferred stock subject to mandatory redemption (Note 5)

**132**

 

117

Provision for onerous contracts (Note 5)

**117**

 

173

Equity in net losses (income) of associates (Note 5)

**(3)**

 

36

Interest income (Note 5)

**(741)**

 

(468)

Foreign exchange (gains) losses - net

**(1,376)**

 

1,397

Loss (gain) on derivative transactions - net (Note 5)

**(1,719)**

 

604

Asset impairment

–

 

85

Others

**201**

 

307

Operating income before working capital changes

**38,724**

 

39,137

Decrease (increase) in:

** **

 

 

Trade and other receivables

**466**

 

(510)

Inventories and supplies

**(463)**

 

(624)

Prepayments

**(554)**

 

17

Other current assets

**(260)**

 

59

Increase (decrease) in:

** **

 

 

Accounts payable

**(1,872)**

 

3,677

Accrued expenses and other current liabilities

**1,907**

 

(446)

Unearned revenues

**(252)**

 

(279)

Pension and other benefits

**794**

 

(819)

Net cash generated from operations

**38,490**

 

40,212

Income taxes paid

**(3,871)**

 

(2,132)

Net cash provided by operating activities

**34,619**

 

38,080

**CASH FLOWS FROM INVESTING ACTIVITIES**

** **

 

 

Additions to property, plant and equipment

**(6,809)**

 

(11,273)

Proceeds from disposal of property, plant and equipment

**300**

 

22

Interest paid - capitalized to property, plant and equipment (Note 5)

**(203)**

 

(302)

Payments for purchase of investments

**(238)**

 

(147)

Additions to investment properties

**–**

 

(2)

Payments for purchase of investments-available-for-sale

**(4)**

 

(3)

Decrease (increase) in short-term investments

**3,847**

 

(1,937)

Investments in notes receivable

**(60)**

 

–

Interest received

**747**

 

468

Decrease in other noncurrent assets

**200**

 

(261)

Net cash used in investing activities

**(2,220)**

 

(13,435)

**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY ANDSUBSIDIARIES**

** **

**CONSOLIDATED STATEMENTS OF CASH FLOWS (*continued*)**

(in million pesos)

 

** **

**Six Months Ended June 30,**

** **

**2005**

 

2004

** **

(Unaudited)

**CASH FLOWS FROM FINANCING ACTIVITIES**

** **

 

 

Proceeds from long-term debt

**5,471**

 

4,824

Payments of long-term debt

**(22,187)**

 

(17,436)

Proceeds from notes payable

**251**

 

45

Payments of notes payable

**(254)**

 

(2,045)

Payments of obligations under capital lease

**(43)**

 

(14)

Interest paid - net of capitalized portion

**(5,671)**

 

(6,339)

Cash dividends paid

**(2,963)**

 

(601)

Proceeds from issuance of capital stock

**133**

 

68

Payments of debt issuance costs

**(133)**

 

(21)

Increase (decrease) in:

** **

 

 

Customers’ deposits

**(30)**

 

22

Other noncurrent liabilities

**1,430**

 

346

Net cash used in financing activities

**(23,996)**

 

(21,151)

**EFFECT OF EXCHANGE RATE CHANGES ON CASH AND  CASH EQUIVALENTS**

**(95)**

 

(67)

**NET INCREASE IN CASH AND CASH EQUIVALENTS**

**8,308**

 

3,427

**CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD**

**27,321**

 

19,372

**CASH AND CASH EQUIVALENTS AT END OF PERIOD**

**35,629**

 

22,799

* *

*Seeaccompanying Notes to Unaudited Consolidated Financial Statements.*

* *

 
****
**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY ANDSUBSIDIARIES**

 

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

 

 

**1.       ****CorporateInformation**

 

ThePhilippine Long Distance Telephone Company, or PLDT, or Parent Company, wasincorporated under the old Corporation Law of the Philippines (Act 1459, asamended) on November 28, 1928, following the merger of four telephone companiesunder common United States ownership.  Under its amended Articles ofIncorporation, PLDT’s corporate term is limited through 2028.  In 1967,effective control of PLDT was sold by General Telephone and ElectronicsCorporation (a major shareholder since PLDT’s incorporation) to a group ofFilipino businessmen.  In 1981, in furtherance of the then existing policy ofthe Philippine government to integrate the Philippine telecommunicationsindustry, PLDT purchased substantially all of the assets and liabilities of theRepublic Telephone Company which at that time was the second largest telephonecompany in the Philippines.  During 1998, First Pacific through its Philippineand other affiliates, acquired a significant interest in PLDT.  On March 24, 2000, NTT Communications Corporation, through NTTC-UK, became PLDT’s strategicpartner with approximately 15% economic and voting interest in the issuedcommon capital stock of PLDT.  Simultaneous with NTT CommunicationsCorporations’ investment in PLDT, we acquired 100% of Smart Communications,Inc., or Smart.

 

Thecommon shares of PLDT are listed and traded on the Philippine Stock Exchange,or PSE, and prior to October 19, 1994, were listed and traded on the American StockExchange and Archipelago Exchange in the United States.  On October 19, 1994, an AmericanDepositary Receipts, or ADRs, facility was established, pursuant to whichCitibank N.A., as the depositary, issued ADRs evidencing American DepositaryShares, or ADSs, with each ADS representing one PLDT common share with a parvalue of Php5 per share.  JP Morgan Chase Bank has been appointed as successordepositary for PLDT’s ADRs effective February 10, 2003.The ADSs are listed and traded on the New York Stock Exchange and theArchipelago Exchange in the United States.

 

PLDT’scharter, like those of all other Philippine corporations, was initially limitedto a period of 50 years but has since been extended twice for 25 years each,the last extension being for an additional 

25-yearperiod to 2028.  Under its amended charter (Republic Act No. 7082), whichbecame effective on August 24, 1991, PLDT is authorized to provide virtuallyevery type of telecommunications service, both within the Philippines andbetween the Philippines and other countries.

 

PLDToperates under the jurisdiction of the Philippine National TelecommunicationsCommission, or NTC, which jurisdiction extends, among other things, toapproving major services offered by PLDT and certain rates charged by PLDT.

 

Theregistered office address of PLDT is Ramon Cojuangco Building, Makati Avenue, Makati City, Philippines.

 

 

**2.       ****Summary ofSignificant Accounting Policies and Practices**

** **

**Basis of Preparation**

 

Ourunaudited consolidated financial statements have been prepared in conformitywith Philippine Generally Accepted Accounting Principles, or Philippine GAAP,under the historical cost convention as modified by the revaluation ofderivative financial instruments, available-for-sale financial assets andinvestment properties that are measured at fair value.  The carrying values ofrecognized assets and liabilities that are hedged are adjusted to recordchanges in the fair values attributable to the risks that are being hedged.  

 

Ourunaudited consolidated financial statements include, in our opinion, alladjustments consisting only of normal recurring adjustments, necessary topresent fairly the results of operations for the interim periods.  The resultsof operations for the six months ended June 30, 2005are not necessarily indicative of the results of operations that may beexpected for the full year.

 

Ourunaudited consolidated financial statements are presented in Philippine pesosand all values are rounded to the nearest million except when otherwiseindicated.

 

**Changes in Accounting Policies**

 

Inrecent years, the Philippine Accounting Standards Committee, or ASC, has beenadopting the International Accounting Standards, or IAS, issued by theInternational Accounting Standards Committee, or IASC, with no local equivalentstandards and has been replacing existing local standards.

 

TheInternational Accounting Standards Board, or IASB, has assumed from the IASCthe responsibility for setting IAS.  The standards issued by the IASB aredesignated as International Financial Reporting Standards, or IFRS.  Upon itsadoption, the IASB also adopted the IAS issued by the IASC.  The IASB carriedon improvements in certain IAS in preparation for the full adoption of IFRSeffective January 1, 2005.

 

TheASC has re-named the new standards “Philippine Accounting Standards”, or PAS,and “Philippine Financial Reporting Standards”, or PFRS, to correspond with theadopted IAS and IFRS of the IASB.  ASC standards were previously designated as“Statements of Financial Accounting Standards”, or SFAS.

** **

The accounting policies adopted are consistent withthose of the previous financial period except that we have adopted in year-end2004 the following new accounting standards intended to be mandatory beginning January 1, 2005.  OurJune 30, 2004 unaudited consolidated financial statements hereinhave been restated to give effect to the provisions of the new standardsadopted.

 

***PAS19, “Employee Benefits”.*** PAS 19requires the use of the projected unit credit method in measuring retirementbenefit expense and a change in the manner of computing benefit expenserelating to past service cost and actuarial gains and losses.  Past servicecost is recognized as an expense on a straight-line basis over the averageperiod until the benefits become vested.  On the initial adoption of thisstandard, the effect of the change in accounting policy includes all actuarialgains and losses that arose in earlier periods even if they fall inside the 10%corridor.  In subsequent periods, portion of actuarial gains or losses isrecognized as income or expense if the cumulative unrecognized actuarial gainsand losses at the end of the previous reporting period exceed the greater of:(i) 10% of the present value of the defined benefit obligation at that date(before deducting plan assets); and (ii) 10% of the fair value of any plannedassets at that date by dividing the excess determined by the expected average remaining workinglives of the employees participating in that plan is recognized immediately asincome or expense.  Our adoption of this standard reduced our consolidated netincome by Php20 million (Php15 million after tax effect) for the six monthsended June 30, 2004.

 

***PAS 21, “The Effects ofChanges in Foreign Exchange Rates”.***  PAS 21 requires the recognition offoreign exchange gains and losses in the periodthey are incurred.  Upon the adoption of PAS 21, we adjusted previouslyrecorded undepreciated capitalized foreign exchange losses, net of exchangelosses that qualify as borrowing cost and income tax effect, against beginningretained earnings, to the extent that such capitalized amounts do not meet theconditions for capitalization under the new accounting standard, and restatedprior periods’ unaudited consolidated financial statements.  Further, PAS 21requires the determination of the functional currency of an entity.  Exchangedifferences from any retranslation are taken directly as a separate componentof equity.  On disposal of an entity with a functional currency other than thePhilippine peso, the deferred cumulative amount recognized in equity relatingto that particular foreign operation shall be recognized in the consolidated statementof income.  Our adoption of this standard increased our consolidated net incomeby Php1,779 million (Php1,226 million after tax effect) for the six monthsended June 30, 2004.

*** ***

***PAS27, “Consolidated and Separate Financial Statements”.*** PAS 27 supersedesSFAS 27/IAS 27, “Consolidated Financial Statements and Accounting for Investments in Subsidiaries”.Under PAS 27, the exclusion of a subsidiary from consolidation when there aresevere long-term restrictions that significantly impair a subsidiary’s abilityto transfer funds to the parent company under the superseded standard wasremoved.  Consequently, Pilipino Telephone Corporation, or Piltel, was requiredto be included in our unaudited consolidated financial statementsretrospectively.  Our adoption of this standard increased our consolidated netincome by Php840 million for the six months ended June 30, 2004.  

 

***PAS32, “Financial Instruments: Disclosure and Presentation”.***  PAS 32 covers the disclosure and presentation of allfinancial instruments.  This standard requires more comprehensive disclosuresabout a company’s financial instruments, whether recognized or unrecognized inthe financial statements.  New disclosure requirements include terms andconditions of financial instruments used, types of risks associated with bothrecognized and unrecognized financial instruments (market risk, price risk,credit risk, liquidity risk, and cash flow risk), fair value information ofboth recognized and unrecognized financial assets and financial liabilities,and our financial risk management policies and objectives.  This standard alsorequires financial instruments to be classified as liabilities or equity inaccordance with their substance and not their legal form.  Consequently, wehave designated PLDT’s Convertible Preferred Stock Series V, VI and VII ascompound instruments consisting of liability and equity components.  The total fair value of the Convertible PreferredStock Series V, VI and VII was determined at issue date, of which the aggregatefair value of the liability component of the Series V, VI and VII ConvertiblePreferred Stock as at issuance date is included as a financial liability under *Interest-bearingFinancial Liabilities*account in the unaudited consolidated balancesheets.  The residual amount was assigned as the equity component.  Our adoption of this standard reduced our consolidatednet income by Php897 million (Php647 million after tax effect) for the six monthsended June 30, 2004.

 

***PAS39, “Financial Instruments: Recognition and Measurement”.***PAS 39 establishes the accounting and reportingstandards for recognizing and measuring our financial assets and financialliabilities.  This standard requires a financial asset or financial liabilityto be recognized initially at fair value.  Subsequent to initial recognition,we are to continue to measure financial assets at their fair values, except forloans and receivables and held-to-maturity investments, which are measured atcost or amortized cost using the effective interest rate method.  Financialliabilities are subsequently measured at cost or amortized cost, except forliabilities classified as “at fair value through profit and loss” andderivatives, which are measured at fair value.

 

PAS39 also covers the accounting for derivative instruments.  This standard hasexpanded the definition of a derivative instrument to include derivatives(derivative-like provisions) embedded in non-derivative contracts.  Under thisstandard, every derivative instrument is recorded in the balance sheet aseither an asset or liability measured at its fair value.  Derivatives that arenot designated and do not qualify as hedges are adjusted to fair value throughincome.  If the derivative is designated and qualifies as a hedge, depending onthe nature of the hedge, changes in the fair value of derivatives are eitheroffset against the change in fair value of the hedged assets, liabilities, orfirm commitments through earnings, or recognized in equity until the hedgeditem is recognized in earnings.

 

Ouradoption of this standard decreased our consolidated net income by Php1,277million (Php830 million after tax effect) for the six months ended June 30, 2004. 

 

***PAS40, “Investment Property”.***  PAS40 prescribes the accounting treatment for investment properties which aredefined as land and/or building held to generate income or for capitalappreciation or both.  An investment property is initially recognized at cost.Subsequent to initial recognition, an investment property is either carried at(i) cost, less accumulated depreciation or any accumulated impairment losses,or (ii) fair value, wherein fair value movements are recognized as income orexpense.  Transfers to or from investment property classification are made onlywhen there is evidence of a change in use.

 

Ouradoption of this standard, where we opted to carry our investment properties atfair value subsequent to initial recognition, decreased our consolidated netincome by Php10 million (Php7 million after tax effect) for the six monthsended June 30, 2004.

 

***PFRS 2, “Share-Based Payment”.***  PFRS 2 requires an entity to recognize goods orservices received or acquired in a share-based payment transaction when itobtains the goods or as the services are received.  The entity shall recognizea corresponding increase in equity if the goods or services were received in anequity-settled share-based payment transaction, or a liability if the goods orservices were acquired in a cash-settled share-based payment transaction.  Inline with our adoption of PFRS 2, we recognized in our consolidated statementsof income the costs of employees’ and directors’ share options and othershare-based incentives by using an option-pricing model, further details ofwhich are given in *Note 21 – Employee Benefits*.

 

Ouradoption of this standard decreased our consolidated net income by Php127million (Php93 million after tax effect) for the six months ended June 30, 2004.

 

***PFRS 3, “BusinessCombinations”, PAS 36, “Impairment of Assets” and PAS 38, “Intangible Assets”.***  PFRS 3 requires all business combinations within itsscope to be accounted for by applying the purchase method.  In addition, thisstandard requires the acquirer to initially measure separately the identifiableassets, liabilities and contingent liabilities at their fair values, atacquisition date, irrespective of the extent of any minority interest.

 

PFRS 3 also requiresgoodwill in a business combination to be recognized by an acquirer as an assetfrom the acquisition date, initially measured as the excess of the cost of thebusiness combination over the acquirer’s interest in the net fair value of theacquiree’s identifiable assets and liabilities.  Further, the amortization ofgoodwill acquired in a business combination is prohibited; instead, goodwill isto be tested annually, or more frequently, if events or changes incircumstances indicate that the asset might be impaired.

 

Moreover,the useful lives of intangible assets are assessed at the individual assetlevel as having either a finite or indefinite life.  Where an intangible assethas a finite life, it will be amortized over its useful life.  Amortizationperiods and methods for intangible assets with finite useful lives are reviewedannually or earlier where an indicator of impairment exists.  Intangiblesassessed as having indefinite useful lives are not amortized, as there is noforeseeable limit to the period over which the asset is expected to generatenet cash inflows for the PLDT Group.  However, intangibles with indefiniteuseful lives are reviewed annually to ensure that their carrying values do notexceed the recoverable amounts regardless of any impairment indicators present.

 

Ouradoption of this standard decreased our consolidated net income by Php26million for the six months ended June 30, 2004.

 

***PFRS 5, “Noncurrent Assets Held-for-Sale andDiscontinued Operations”.***Underthe superseded SFAS 35/IAS 35, “Discontinuing Operations”, we would havepreviously recognized a discontinued operation at the earlier of when (a) weenter into a binding agreement; and (b) the Board of Directors have approvedand announced a formal disposal plan.  PFRS 5 now requires an operation to beclassified as discontinued when the criteria to be classified as held-for-salehave been met or we have disposed of the operation.

 

Inaddition to these standards referred to above, we have adopted the followingstandards during the period and comparative figures have been amended asrequired:

 

•        PAS   1  –  “Presentation ofFinancial Statements”;

•        PAS   2  –  “Inventories”;

•        PAS   8  –  “Accounting Policies,Changes in Accounting Estimates and Errors”;

•        PAS 10  –  “Events After theBalance Sheet Date”;

•        PAS 24  –  “Related PartyDisclosures”;

•        PAS 28  –  “Investments inAssociates”;

•        PAS 31  –  “Interests in JointVentures”; and

•        PAS 33  –  “Earnings Per Share”.

 

Following additional guidelines from PAS 16,“Property, Plant and Equipment”, we have recognized the initial settlement of the net present value oflegal and constructive obligations associated with the retirement of a tangiblelong-lived asset that resulted from the acquisition, construction ordevelopment and the normal operation of a long-lived asset in the period inwhich it is incurred.  The asset retirement obligations were recognized in theperiod in which they are incurred if a reasonable estimate of fair values canbe made.  The related asset retirement costs are capitalized as part of thecarrying amount of the corresponding property, plant and equipment which arebeing depreciated on a straight-line basis over the useful lives of the relatedassets or the contract periods, whichever is lower.

 

We are legally required under various lease agreementsto dismantle the installations and restore the leased sites to their originalstate at the end of the lease contract term.  Our adoption of certainprovisions of this standard reduced our consolidated net income by Php50million (Php34 million after tax effect) for the six months ended June 30, 2004.

 

Adoption of the above standards involved changes inaccounting policies and we have accordingly restated our comparative unauditedconsolidated financial statements retroactively in accordance with thetransitional provisions in these standards.  Reconciliation of the effects ofthese new standards, as they apply to us, on our net income for the six monthsended June 30, 2004 is set out below.

 

 

(in millions,  except per share amounts)

Net income, as previously reported

Php12,008

PAS 16 – Property, Plant and Equipment

(34)

PAS 17 – Leases

1

PAS 19 – Employee Benefits

(15)

PAS 21 – The Effects of Changes in Foreign Exchange Rates

1,226

PAS 27 – Consolidated and Separate Financial Statements

840

PAS 32 – Financial Instruments: Disclosure and Presentation

(647)

PAS 39 – Financial Instruments: Recognition and Measurement

(830)

PAS 40 – Investment Property

(7)

PFRS 2 – Share-Based Payment

(93)

PFRS 3 – Business Combinations, PAS 36 – Impairment of Assets and   PAS 38 – Intangible Assets

(26)

Net income, as restated
Php12,423

 

**Earnings per common share, as previously reported**

Php65.62

Earnings per share impact of restated items:

 

PAS 16 – Property, Plant and Equipment

(0.20)

PAS 17 – Leases

0.01

PAS 19 – Employee Benefits

(0.09)

PAS 21 – The Effects of Changes in Foreign Exchange Rates

7.17

PAS 27 – Consolidated and Separate Financial Statements

4.95

PAS 32 – Financial Instruments: Disclosure and Presentation

(3.04)

PAS 39 – Financial Instruments: Recognition and Measurement

(4.90)

PAS 40 – Investment Property

(0.04)

PFRS 2 – Share-Based Payment

(0.55)

PFRS 3 – Business Combinations, PAS 36 – Impairment of Assets and   PAS 38 – Intangible Assets

(0.15)

**Earnings per common share, as restated**

Php68.78

 

Wefully adopted PAS 16 in 2005, which requires us to determine the depreciationcharge separately for each significant part of an item of property, plant andequipment.  Consequently, we changed the estimated useful lives of certaincomponents of our property, plant and equipment and we recognized the effect ofthe change in accounting estimate prospectively, in accordance with PAS 8,“Accounting Policies, Changes in Accounting Estimates and Errors”.  Our fulladoption of this standard reduced our consolidated net income by Php698 million (Php475 millionafter tax effect) for the six months ended June 30, 2005.

 

**Basisof Consolidation**

 

Ourunaudited consolidated financial statements include the financial statements ofPLDT and those of the following subsidiaries (collectively, the PLDT Group),which were all incorporated in the Philippines except for PLDT GlobalCorporation, which was incorporated in the British Virgin Islands.

 

**Name of Subsidiary**

**Principal Activity**

**Percentage of Ownership**

** **

 

** **

**Wireless**

 

** **

Smart and subsidiaries 

Cellular mobile services

100.0

Piltel and subsidiaries

Cellular mobile and telecommunications services 

92.1

ACeS Philippines Cellular Satellite  Corporation, or ACeS Philippines

Satellite phone services

100.0

Telesat, Inc., or Telesat

Satellite communications services

94.4

Mabuhay Satellite Corporation, or  Mabuhay Satellite

Satellite communications services

67.0

** **

 

** **

**Fixed Line**

 

** **

PLDT Clark Telecom, Inc., or Clark Telecom

Telecommunications services

100.0

Subic Telecommunications Company, Inc.,  or Subic Telecom

Telecommunications services

100.0

PLDT Global Corporation, or  PLDT Global, and subsidiaries

Telecommunications services

100.0

Smart-NTT Multimedia, Inc., or SNMI

Data and network services

100.0

PLDT-Maratel, Inc., or Maratel

Telecommunications services

97.5

Bonifacio Communications Corporation, or BCC

Telecommunications, infrastructure and related value-added services

75.0

** **

 

** **

**Information and Communications Technology**

 

** **

ePLDT, Inc., or ePLDT, and subsidiaries

Information and communications infrastructure for internet-based services, e-commerce, call centers and IT-related services

100.0

 

Subsidiariesare consolidated from the date when control is transferred to the PLDT Groupand cease to be consolidated from the date when control is transferred out ofthe PLDT Group.

 

We prepareour unaudited consolidated financial statements using uniform accountingpolicies for like transactions and other events with similar circumstances.Intercompany balances and transactions, including intercompany profits andunrealized profits and losses, are eliminated.

 

Minorityinterests represent the equity interests in Telesat, Mabuhay Satellite,Maratel, BCC, Digital Paradise, Inc., or Digital Paradise, Digipar ThailandLtd., netGames, Inc., or netGames, and Infocom Technologies, Inc. not held bythe PLDT Group.

 

***Changes in Piltel’s Shareholding***

 

Tointegrate the PLDT Group’s wireless holdings, on July 2, 2004, Smart entered into a Sale and Purchase Agreement with PLDT to acquire PLDT’s 59.3 million sharesof Piltel Series K Class I Convertible Preferred Stock for a purchase price ofPhp2,066 million.  The payment was settled through an offset of amounts owed toSmart by PLDT arising from interconnection charges.  On July 9, 2004 and December 28, 2004, Smart converted a total of 4.8 million and 54.5 million shares,respectively, of Piltel Series K Class I Convertible Preferred Stock into10,080 million shares of common stock of Piltel, equivalent to 85.6% of theresulting total outstanding shares of common stock after such conversion.  On April 25, 2005, PLDT and Smart entered into a subscription and assignment agreementcovering the transfer and assignment to Smart of 767 million shares of Piltelcommon stock owned by PLDT.  As a result, Smart now owns 92.1% of the totaloutstanding common stock of Piltel, thereby consolidating the PLDT Group’swireless business under Smart.  Transactions of entities under common controlwere accounted for at historical cost.

 

***ePLDTInvestments in ePLDT Ventus, Inc., or Ventus, and netGames***

 

Inthe second half of 2004, ePLDT made investments in Ventus and netGames, whichare newly incorporated companies.

*** ***

Ventusis a wholly-owned call center subsidiary of ePLDT which was incorporated andregistered with the Securities and Exchange Commission, or SEC, on October 5, 2004.ePLDT subscribed to 100 million shares at a total par value of Php100 million.Ventus which owns a 400-seat call center facility located in Iloiloprovince and commenced commercial operations in March 2005.  Ventus will beexpanding in Metro Manila with a 270-seat call center facility in Makati and a 640-seatcall center facility in Ortigas, Pasig City to accommodate current and new client requirements.These facilities are expected to be completed by October 2005 and January 2006,respectively.

 

As at June 30, 2005, ePLDT owns 60% of netGames, a publisher for Massively Multi-player OnlineGame in the Philippines.  netGames is the Philippine licensee of Khan Online,the country’s first full 3D online game.  netGames was incorporated on June 21, 2004 and commenced full commercial operations in February 2005.  ePLDT sold 3% ofits share in netGames in April 2005.  In June 2005, ePLDT made an additionalcapital infusion amounting to Php11 million to netGames.

 

***Acquisitionof Meridian Telekoms, Inc. or******Meridian***

 

On July 5, 2004, Smartentered into a sale and purchase agreement, as amended and supplemented on August 11, 2004, toacquire 100% of Meridian, a company primarily engaged in providing wirelessbroadband and data services to small and medium-scale enterprises in the Philippines,for a total consideration of US$45 million.  Payments of US$11 million and US$7million for an equity interest of 40% in Meridian were made in 2004 andpayments of US$4 million for an additional equity interest of 9% was made inJanuary 2005.  The balance of US$23 million is payable on or before December 31, 2005 inrespect of the remaining 51% equity interest in Meridian.  The acquisition aimsto strengthen Smart’s position in the wireless data segment and is in line withSmart’s overall strategy of providing the widest range of innovative wirelessservices.  As at June 30, 2005, the net cash outflow on acquisition wasPhp1,285 million, representing cash payments of Php1,242 million, cash acquiredfrom Meridian of Php4 million and cost directly related to business combinationof Php51 million.

*** ***

***Investments in Associates***

 

Investmentsin associates in which we exercise significant influence and which are neithera subsidiary nor a joint venture of the PLDT Group are accounted for under theequity method of accounting.  Under the equity method, our investments inassociates are carried in the consolidated balance sheets at cost pluspost-acquisition changes in our share in net assets of the investees, lessimpairment in value, if any.  The consolidated statements of income reflect ourshare of the results of operations of the associates.  Where there has been achange recognized directly in the associates’ equity, we recognize our share ofany changes and disclose this, when applicable in the consolidated statementsof changes in equity.

 

***ForeignCurrency Translation***

*** ***

Thefunctional and presentation currency of the PLDT Group (except for MabuhaySatellite) is the Philippine peso.  Transactions in foreign currencies areinitially recorded in the functional currency rate ruling at the date of thetransaction.  Monetary assets and liabilities denominated in foreign currenciesare retranslated at the functional currency rate of exchange ruling at the balancesheet date.  All differences are taken to the consolidated statements of incomeexcept for foreign exchange losses that qualified as capitalizable borrowingcosts during construction period.  For income tax purposes, exchange gains orlosses are treated as taxable income or deductible expenses in the period suchare realized.

 

Thefunctional currency of Mabuhay Satellite is U.S. dollars.  As at the reportingdate, the assets and liabilities of this subsidiary are translated into thepresentation currency of the PLDT Group at the rate of exchange ruling at thebalance sheet date and, its income and expenses are translated at the weightedaverage exchange rate for the period.  The exchange differences arising onretranslation are taken directly to a separate component of equity ascumulative translation adjustments.  On disposal of this subsidiary, thedeferred cumulative amount of translation adjustments recognized in equityrelating to this particular subsidiary shall be recognized in the consolidatedstatements of income. 

** **

***Property,Plant and Equipment***

 

Property,plant and equipment, except for land, are stated at cost less accumulateddepreciation and amortization and any impairment in value.  Land is stated atcost less any impairment in value.

 

The initial cost of property, plant and equipmentcomprises its purchase price and any costs directly attributable in bringingthe asset to its working condition and location for its intended use.Expenditures incurred after the assets have been put into operation, such asrepairs and maintenance and overhaul costs, are normally charged to income inthe period the costs are incurred.  In situations where it can be clearlydemonstrated that the expenditures have resulted in an increase in the futureeconomic benefits expected to be obtained from the use of an item of property,plant and equipment beyond its originally assessed standard of performance, theexpenditures are capitalized as additional costs of property, plant andequipment.  Cost also includes asset retirement obligation, interest onborrowed funds used during the construction period and qualified borrowingcosts from foreign exchange losses related to foreign currency-denominatedliabilities used to acquire such assets.  When assets are sold or retired,their costs and accumulated depreciation, amortization and impairment losses,if any, are eliminated from the accounts and any gain or loss resulting fromtheir disposal is included in the consolidated statement of income of suchperiod.

 

Depreciationand amortization are calculated on a straight-line basis over the followingestimated useful lives of the assets:

 

** **

**Estimated Useful Lives**

 

 

Buildings

25 years

Cable and wire facilities 

20 – 25 years

Central office equipment

15 – 20 years

Information origination and termination equipment

5 – 15 years

Communications satellite

15 years

Vehicles and other work equipment

3 – 10 years

Furniture

3 – 10 years

Cellular facilities

10 years

Land improvements

10 years

 

The usefullives and depreciation and amortization method are reviewed periodically toensure that the periods and method of depreciation and amortization areconsistent with the expected pattern of economic benefits from items ofproperty, plant and equipment.  

 

Propertyunder construction is stated at cost.  This includes cost of construction,plant and equipment and other direct costs.  Property under construction is notdepreciated until such time that the relevant assets are completed and put intooperational use.

 

***BorrowingCosts***

 

Borrowingcosts are generally expensed as incurred.  Borrowing costs are capitalized ifthey are directly attributable to the acquisition, construction or productionof a qualifying asset.  Capitalization of borrowing costs commences when theactivities for use are in progress and expenditures and borrowing costs arebeing incurred.  Borrowing costs are capitalized until the assets are ready fortheir intended use.  If the resulting carrying amount of the asset exceedsits recoverable amount, an impairment loss is recognized.  Borrowing costsinclude interest charges and other costs incurred in connection with theborrowing of funds, as well as exchange differences arising from foreigncurrency borrowings used to finance these projects to the extent that they are regardedas an adjustment to interest cost.  Borrowing costs are treated as deductibleexpenses for income tax reporting purposes in the period they are incurred.

 

***Asset Retirement Obligations***

 

The netpresent value of legal obligations associated with the retirement of an item ofproperty, plant and equipment that resulted from the acquisition, constructionor development and the normal operation of property, plant and equipment isrecognized in the period in which it is incurred.

*** ***

***Investment Properties***

*** ***

Initially,investment properties are measured at cost including transaction costs.Subsequent to initial recognition, investment properties are stated at fairvalue.  Gains or losses arising from changes in the fair values of investmentproperties are included in the consolidated statements of income in the periodin which they arise.  

 

Investmentproperties are derecognized when they have either been disposed of or when theinvestment property is permanently withdrawn from use and no future benefit isexpected from its disposal.  Any gains and losses on the derecognition of aninvestment property are recognized in the consolidated statement of income inthe period of derecognition.

*** ***

***Goodwill***

 

Goodwill is initially measured at cost being theexcess of the acquisition cost over the fair value of identifiable assets,liabilities and contingent liabilities.  Following initial recognition,goodwill is measured at cost less any accumulated impairment losses.  Uponadoption of PFRS 3, goodwill is no longer amortized.  Goodwill is reviewed forimpairment, annually or more frequently if events or changes in circumstancesindicate that the carrying value may be impaired. 

 

As atacquisition date, any goodwill acquired is allocated to each of thecash-generating units expected to benefit from the combination’s synergies.Impairment is determined by assessing the recoverable amount of thecash-generating unit, to which the goodwill relates.  Where the recoverableamount of the cash-generating unit is less than the carrying amount, animpairment loss is recognized.  Where goodwill forms part of a cash-generatingunit and part of the operation within that unit is disposed of, the goodwillassociated with the operation disposed of is included in the carrying amount ofthe operation when determining the gain or loss on disposal of the operation.Goodwill disposed of in such circumstance is measured on the basis of therelative values of the operation disposed of and the portion of thecash-generating unit retained.

 

***IntangibleAssets***

 

Intangibleassets acquired separately are capitalized at cost while those acquired arisingfrom business combinations are initially recognized at fair value as at thedate of acquisition.  Subsequently, intangible assets are measured at cost.  Theuseful lives of intangible assets are now assessed at the individual assetlevel as having either a finite or indefinite life.  Where an intangible assethas a finite life, it is amortized over its useful life.  Periods and method ofamortization for intangible assets with finite useful lives are reviewedannually or earlier where an indicator of impairment exists.  Intangible assetsassessed as having indefinite useful lives are not amortized, as there is noforeseeable limit to the period over which the asset is expected to generatenet cash inflows for the Group.  However, intangibles with indefinite usefullives are reviewed annually to ensure the carrying value does not exceed therecoverable amount regardless of whether an indicator of impairment is present.

 

Gainsor losses arising from derecognition of an intangible asset are measured as thedifference between the net disposal proceeds and the carrying amount of theasset and are recognized in the consolidated statements of income when theasset is derecognized.

 

Intangibleassets created within the business are not capitalized and expenditure ischarged against profits in the period in which the expenditure is incurred.

 

***AssetImpairment***

 

Property, plant and equipment, investments, goodwilland other long-lived assets are reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable.  Whenever the carrying amount of an asset exceeds itsrecoverable amount, an impairment loss is recognized in the consolidatedstatements of income.  The recoverable amount is the higher of an asset’s netselling price or value in use.  The net selling price is the amount obtainablefrom the sale of an asset in an arm’s–length transaction while value in use isthe present value of estimated future cash flows expected to arise from thecontinuing use of an asset or from its disposal at the end of its useful life.Recoverable amounts are estimated for individual assets or, if it is notpossible, for the cash-generating unit to which the asset belongs.  Reversal ofimpairment losses recognized in prior periods is recorded when there is anindication that the impairment losses recognized for the asset no longer existor have decreased.  The reversal is recorded as income.  However, the increasedcarrying amount of an asset due to a reversal of an impairment loss isrecognized to the extent it does not exceed the carrying amount that would havebeen determined had the impairment loss not been recognized for that asset inprior periods.

*** ***

***Cashand Cash Equivalents***

*** ***

Cashincludes cash on hand and in banks.  Cash equivalents are short-term, highlyliquid investments that are readily convertible to known amounts of cash withoriginal maturities of three months or less from the date of acquisition andthat are subject to an insignificant risk of change in value.

*** ***

***AccountsReceivable***

*** ***

Accounts receivable arestated at face value, net of allowance for doubtful accounts.

*** ***

***Allowancefor Doubtful Accounts***

*** ***

We estimatethe allowance for doubtful accounts related to our trade receivables based ontwo methods.  The amounts calculated using each of these methods are combinedto determine the total amount we reserve.  First, we evaluate specific accountswhere we have information that certain customers are unable to meet theirfinancial obligations.  In these cases, we use judgment, based on the bestavailable facts and circumstances, including but not limited to, the length ofour relationship with the customer and the customer’s current credit statusbased on third party credit reports and known market factors, to recordspecific reserves for customers against amounts due to reduce our receivableamounts that we expect to collect.  These specific reserves are re-evaluatedand adjusted as additional information received affects the amounts estimated.Second, a provision is established as a certain percentage of age of status ofreceivables.  This percentage is based on a collective assessment of historicalcollection, write-off, experience and changes in our customer payment terms.Full allowance is provided for receivables from permanently disconnectedsubscribers.  Partial allowance is provided for active subscribers and carriersbased on the age status of receivables.

*** ***

***Inventories and Supplies***

*** ***

Inventories and supplies which include, among others,cellular phone units, materials, spare parts, terminal units and accessories,are valued at the lower of cost or net realizable value.

*** ***

Costis determined using the moving average method.  Net realizable value is thecurrent replacement cost.

*** ***

***Financial Assets and Liabilities***

*** ***

Werecognize a financial asset or a financial liability in our consolidatedbalance sheets when we become a party to the contractual provisions of the instrumentand derecognize a financial asset when we no longer control the contractualrights to the cash flows that comprise the financial instrument which isnormally the case when the instrument is sold, or all the cash flowsattributable to the instrument have already expired or are passed through to anindependent third party.  A financial liability (or a part of a financialliability) is derecognized when the obligation is extinguished.  In the case ofa regular way purchase or sale of financial assets, recognition andderecognition, as applicable, are done using settlement date accounting.

*** ***

Financialassets or financial liabilities are recognized initially at fair value.Transaction costs are included in the initial measurement of all financialassets and liabilities, except for financial instruments measured at fair valuethrough profit and loss.  Fair value is determined by reference to thetransaction price or other market prices.  If such market prices are notreliably determinable, the fair value of the consideration is estimated as thesum of all future cash payments or receipts, discounted using the prevailingmarket rates of interest for similar instruments with similar maturities.

 

Afterinitial recognition, the following financial assets and liabilities aremeasured at amortized cost using the effective interest rate method:  (a) loansand receivables; (b) held-to-maturity investments; and (c) financial liabilities other than liabilities measured at fair valuesthrough profit and loss.

 

Investmentsin unquoted equity securities and derivatives linked thereon are measured atcost.

 

Amortizationsof discounts and premiums are taken directly to net profit or loss for theperiod.  Changes in the fair value of financial assets and liabilities measuredat fair value of (a) all derivatives (except for those eligible for hedgeaccounting); (b) other items intended to be actively traded; and (c) any itemdesignated as held “at fair value through profit and loss” at origination, aretaken directly to net profit or loss for the period.  Changes in the fair valueof available-for-sale securities are recognized in equity, except for theforeign exchange fluctuations on available-for-sale debt securities and theinterest component which is taken directly to net profit or loss for the periodbased on the asset’s effective yield.

 

Financial assets and liabilities include financialinstruments which may be a primary instrument,such as receivables, payables and equity securities, or a derivativeinstrument, such as financial options, futures and forwards, interest rateswaps and currency swaps.

 

Financialinstruments are classified as a financial liability, or a financial asset or anequity in accordance with the substance of the contractual arrangement.Financial instruments that contain both liability and equity elements areclassified separately as financial liabilities, financial assets or equityinstruments.  Interest, dividends, gains and losses relating to a financialinstrument or a component that is a financial liability, are reported asexpense or income.  Distributions to holders of financial instrumentsclassified as equity are charged directly to equity net of any related incometax benefits.  Financial instruments are offset when we have a legally enforceableright to offset and we intend to settle either on a net basis or to realize theasset and settle the liability simultaneously. 

 

We usederivative financial instruments such as long-term currency swaps, foreigncurrency options, interest rate swaps and forward currency contracts to hedgeour risks associated with foreign currency and interest rate fluctuations.Such derivative financial instruments are stated at fair value.

 

Ourcriteria for a derivative instrument to be classified as a hedge include: (1)the hedge transaction is expected to be highly effective in achievingoffsetting changes in fair value or cash flows attributable to the hedged risk,(2) the effectiveness of the hedge can be reliably measured, (3) there isadequate documentation of the hedging relationships at the inception of thehedge, and (4) for cash flow hedges, the forecast transaction that is subjectof the hedge must be highly probable and must present an exposure to variationsin cash flows that could ultimately affect profit or loss.

 

Forpurposes of hedge accounting, hedges are classified as either fair value hedgeswhere they hedge the exposure to changes in the fair value of a recognizedasset or liability and firm commitment; or cash flow hedges where they hedgeexposure to variability in cash flows that is either attributable to aparticular risk associated with a recognized asset or liability or a forecastedtransaction.

 

Inrelation to fair value hedges which meet the conditions for special hedgeaccounting, any gain or loss from re-measuring the hedging instrument at fairvalue is recognized immediately in the consolidated statements of income.  Anygain or loss on the hedged item attributable to the hedged risk is adjustedagainst the carrying amount of the hedged item and recognized in theconsolidated statements of income.

 

Inrelation to cash flow hedges, the portion of the gain or loss on the hedginginstrument that is determined to be an effective hedge is recognized directlyin equity and the ineffective portion is recognized in net profit or loss.  Thegains or losses that are accumulated in equity are transferred to theconsolidated statement of income in the same period in which the hedged itemaffects the net profit or loss.

 

Forderivatives that do not qualify for hedge accounting, any gains or lossesarising from changes in fair value are taken directly to net profit or loss forthe period.

 

Hedgeaccounting is discontinued when the hedging instrument expires or is sold,terminated or exercised, or no longer qualifies for hedge accounting.  At thatpoint in time, any cumulative gain or loss on the hedging instrument recognizedin equity is kept in equity until the forecast transaction occurs.  If theforecast transaction is no longer expected to occur, any net cumulative gain orloss previously recognized in equity is transferred to net profit or loss forthe period.

 

***Provisions***

 

Werecognize provisions when we have obligations, legal or constructive, as aresult of past events, if it is probable that an outflow of resources embodyingeconomic benefits will be required to settle the obligation and a reliableestimate can be made of the amount of the obligation.  If the effect of thetime value of money is material, provisions are determined by discounting the expectedfuture cash flows at a pre-tax rate that reflects current market assessments ofthe time value of money and, where appropriate, the risks specific to theliability.  Where discounting is used, the increase in the provision due to thepassage of time is recognized as an additional provision.

 

***Retirement Benefits***

 

We havefunded, noncontributory retirement plans, administered by our respective Fund’sTrustees, covering permanent employees.  Retirement costs are actuariallydetermined using the projected unit credit of accrued benefit valuationmethod.  This method reflects services rendered by employees to the date ofvaluation and incorporates assumptions concerning employees’ projectedsalaries.  Retirement costs include current service cost plus amortization ofpast service cost, experience adjustments and changes in actuarialassumptions.  Past service cost is recognized as an expense on a straight-linebasis over the average period until the benefits become vested.  Actuarialgains and losses are recognized as income or expense when the net cumulativeunrecognized actuarial gains and losses at the end of the previous reportingperiod exceeded 10% of the higher of the defined benefit obligation and thefair value of plan assets at that date.  These gains and losses are recognizedover the expected average remaining working lives of the employeesparticipating in the plan.

 

***Share-BasedPayment Transactions***

 

Certainof our employees (including directors) receive remuneration in the form ofshare-based payment transactions, whereby employees render services in exchangefor shares or rights over shares (“equity-settled transactions”).

 

*Equity-settled transactions*

 

The cost of equity-settled transactions with employeesis measured by reference to the fair value of the stock options at the date atwhich they are granted.  Fair value is determined using an option-pricingmodel, further details of which are given in *Note 21 – Employee Benefits*.In valuing equity-settled transactions, no account is taken of any performanceconditions, other than conditions linked to the price of the shares of PLDT(“market conditions”).

 

Thecost of equity-settled transactions is recognized, together with acorresponding increase in equity, over the period in which the performanceconditions are fulfilled, ending on the date on which the relevant employeesbecome fully entitled to the award (“vesting date”).  The cumulative expenserecognized for equity-settled transactions at each reporting date until thevesting date reflects the extent to which the vesting period has expired andthe number of awards that will ultimately vest, in the opinion of PLDT’s Boardof Directors at that date, based on the best available estimate.

 

No expenseis recognized for awards that do not ultimately vest, except for awards wherevesting is conditional upon a market condition, which are treated as vestingirrespective of whether or not the market condition is satisfied, provided thatall other performance conditions are satisfied.

 

Wherethe terms of an equity-settled award are modified, an expense, as a minimum, isrecognized as if the terms had not been modified.  An expense is recognized forany increase in the value of the transactions as a result of the modification,as measured at the date of modification.

 

Where anequity-settled award is cancelled, it is treated as if it had vested on thedate of cancellation, and any expense not yet recognized for the award isrecognized immediately.  However, if a new award is substituted for thecancelled award, and designated as a replacement award on the date that it isgranted, the cancelled and new awards are treated as if they were amodification of the original award, as described in the previous paragraph.

 

Thedilutive effect of outstanding options is reflected as additional sharedilution in the computation of earnings per share, see *Note 7 – Earnings PerCommon Share*.

 

*Cash-settledtransactions*

 

OurLong-Term Incentive Plan, or LTIP, grants share appreciation rights, or SARs,to our eligible key executives and advisors.  Under the LTIP, we recognize theservices we receive from the eligible key executives and advisors, and ourliability to pay for those services, as the eligible key executives andadvisors render services during the vesting period.  We measure our liability,initially and at each reporting date until settled, at the fair value of theSARs, by applying an option valuation model, taking into account the terms andconditions on which the SARs were granted, and the extent to which the eligiblekey executives and advisors have rendered service to date.  We recognize anychanges in fair value at each reporting date until settled, in profit and lossfor the period.

 

***Leases***

 

Leaseobligations having provisions for bargain purchase options, ownership transferat the end of the lease term, or minimum lease payments, which approximate thefair market value of the property are capitalized.  The related obligations arerecognized as liabilities.  Finance lease payments are apportioned between thefinance charges and reduction of the lease liability so as to achieve aconstant rate of interest on the remaining balance of the liability.

 

A financelease gives rise to a depreciation expense for the asset as well as a borrowingcost for each period.  Finance charges are charged directly to currentoperations.  The depreciation policy for leased assets is consistent with thatfor depreciable assets that are owned.  

 

Leaseswhere the lessor retains substantially all the risks and benefits of ownershipof the asset are classified as operating leases.  Initial direct costs incurredin negotiating an operating lease are added to the carrying amount of theleased assets and liabilities over the lease term on the same bases as thelease income.  Operating lease payments are recognized as an expense in theconsolidated statements of income on a straight-line basis over the leaseterm.  For income tax reporting purposes, expenses that should have beenincurred under lease agreement are considered as deductible expenses.

 

***Revenue Recognition***

 

Revenuesfor services are stated at amounts invoiced to customers and excludevalue-added tax.  We provide wireless communication services, fixed linecommunication services, and information and communications technology services.We provide such services to mobile, business, residential and payphonecustomers.  Revenues, which exclude value-added tax, represent the value offixed consideration that have been received or are receivable.  Revenues arerecognized when there is evidence of an arrangement, collectibility isreasonably assured and the delivery of the product or service has occurred. 

 

*Service revenues*

* *

*Subscriptions*

 

We provide telephone and data communication services under prepaid andpostpaid payment arrangements.  Revenues include fees for installation andactivation are accrued upon subscription.

 

*Airtime, traffic and value-added services*

 

Prepaid service revenues collected in advance are deferredand recognized based on the earlier of actual usage or upon expiration of theusage period.  Interconnection revenues for call termination, call transit, andnetwork usage are recognized in the period the traffic occurs.  Revenuesrelated to local, long distance, network-to-network, roaming and internationalcall connection services are recognized when the call is placed or connectionis provided, net of amounts payable to other telecommunication carriers forterminating calls in their territories.  Revenues related to products andvalue-added services are recognized upon delivery of the product or service.

 

*Directory services.*

 

Revenue related to published directory services isrecognized on a pro rata basis over the period in which the publicationexpires, which is generally 12 months.  Telephone-based directory service revenueis recognized when the service is provided.

 

*Incentives.*

 

We record insignificant commission expense based onthe number of new subscriber connections initiated by certain dealers.  Allother cash incentives provided to dealers and customers are recorded as areduction from revenue.  Product-based incentives provided to dealers andcustomers as part of a transaction are accounted for as multiple elementarrangements and recognized when earned.

 

*Non-service revenues*

 

*Handset and equipment sales*

 

Salesof cellular handsets and communication equipment are recognized upon deliveryto the customer.

 

*Others*

 

Interestincome from cash deposits is recognized on a time proportion basis taking intoaccount the principal amount outstanding and the effective interest rate.

 

***Income Taxes***

 

Deferred income tax is provided, using the balancesheet liability method, on all temporary differences at the balance sheet datebetween the tax bases of assets and liabilities and their carrying amounts forfinancial reporting purposes.

 

Deferredincome tax liabilities and assets are recognized for all taxable temporarydifferences.  Deferred income tax assets are recognized for all deductible temporarydifferences, carryforward of unused tax credits from excess minimum corporate incometax, or MCIT, and unused tax losses, to the extent that it is probable thattaxable profit will be available against which the deductible temporarydifferences and carryforward of unused tax credits and unused tax losses can beutilized.  Deferred income tax, however, is not recognized when it arises fromthe initial recognition of an asset or liability in a transaction that is not abusiness combination and, at the time of the transaction, affects neither theaccounting profit nor taxable profit or loss.

 

Deferredtax liabilities are not provided on non-taxable temporary differencesassociated with investments in domestic subsidiaries and associates.  Withrespect to investments in other subsidiaries and associates, deferred taxliabilities are recognized except when the timing of the reversal of thetemporary difference can be controlled and it is probable that the temporarydifference will not reverse in the foreseeable future.

 

Thecarrying amount of deferred income tax assets is reviewed at each balance sheetdate and reduced to the extent that it is no longer probable that sufficienttaxable profit will be available to allow all or part of the deferred incometax asset to be utilized.

 

Deferredincome tax assets and liabilities are measured at the tax rate that areexpected to apply to the period when the asset is realized or the liability issettled, based on tax rate (and tax laws) that have been enacted orsubstantively enacted at balance sheet date.

 

Income taxrelating to items recognized directly in equity is recognized in equity and notin the consolidated statements of income.

 

***Earnings Per Common Share, or EPS***

 

Basic EPS is calculated by dividing the net income forthe period attributable to common shareholders (net income adjusted for dividendson all series of preferred shares except for dividends on preferred stocksubject to mandatory redemption) by the weighted average number of commonshares outstanding during the period, after giving retroactive effect to anystock dividend declarations.

 

DilutedEPS is calculated in the same manner assuming that, at the beginning of theperiod or at the time of issuance during the period, all outstanding optionsare exercised and convertible preferred shares are converted to common sharesand appropriate adjustments to net income are effected for the related expenseson preferred shares.  Outstanding stock options will have a dilutive effectunder the treasury stock method only when the average market price of theunderlying common share during the period exceeds the exercise price of theoption.  

 

Wherethe effect of the assumed conversion of the preferred shares and the exerciseof all outstanding options have an anti-dilutive effect, basic and diluted EPSare stated at the same amount.

 

Ifthe required dividends to be declared on each series of convertible preferredshares divided by the number of equivalent common shares, assuming suchconvertible preferred shares are converted to common shares, would decrease thebasic EPS, then such convertible preferred shares would be deemed dilutive.  Assuch, the diluted EPS will be calculated by dividing net income attributable tocommon shareholders (net income, adding back any dividends and/or other chargesrecognized in the period related to the dilutive convertible preferred sharesclassified as liability, less dividends on non-dilutive preferred shares exceptfor dividends on preferred stock subject to mandatory redemption) by theweighted average common shares including the common share equivalent arisingfrom the conversion of the dilutive convertible preferred shares.

 

 

 

**3.   Management’sUse of Estimates**

 

Ourunaudited consolidated financial statements prepared in Philippine GAAP requiremanagement to make estimates and assumptions that affect amounts reported inour unaudited consolidated financial statements and related notes.  Inpreparing our unaudited consolidated financial statements, we have made ourbest estimates and judgments of certain amounts, giving due consideration tomateriality.  We believe the following represent a summary of these significantestimates and judgments and related impact and associated risks in ourunaudited consolidated financial statements.
**
* *

*Estimatinguseful lives of property, plant and equipment*

 

Weestimate the useful lives of our property, plant and equipment based on theperiod over which our assets are expected to be available for use.  Theestimated useful lives of our property, plant and equipment are reviewedperiodically and are updated if expectations differ from previous estimates dueto physical wear and tear, technical or commercial obsolescence and legal orother limits on the use of our assets.  In addition, our estimation of theuseful lives of our property, plant and equipment is based on our collective assessmentof industry practice, internal technical evaluation and experience with similarassets.  It is possible, however, that future results of operations could bematerially affected by changes in our estimates brought about by changes infactors mentioned above.  The amounts and timing of recorded expenses for anyperiod would be affected by changes in these factors and circumstances.  Areduction in the estimated useful lives of our property, plant and equipmentwould increase our recorded operating expenses and decrease our noncurrentassets.  Property, plant and equipment amounted to Php190,176million and Php194,525 million as at June 30, 2005 and December 31, 2004, respectively.

 

*Assetimpairment*

 

PhilippineGAAP requires that an impairment review be performed when certain impairmentindicators are present.  In case of goodwill and intangible assets withindefinite life, such assets are subject to yearly impairment test and wheneverthere is an indication that such asset may be impaired.

 

Purchaseaccounting requires extensive use of accounting estimates and judgments toallocate the purchase price to the fair market values of the assets andliabilities purchased, including intangible assets and contingent liabilities.Our business acquisitions have resulted in goodwill.  Instead, goodwill issubject to a periodic impairment test.  

 

Determiningthe fair value of property, plant and equipment, investments and intangibleassets, which requires the determination of future cash flows expected to begenerated from the continued use and ultimate disposition of such assets,requires us to make estimates and assumptions that can materially affect ourunaudited consolidated financial statements.  Future events could cause us toconclude that property, plant and equipment, investments and intangible assetsassociated with an acquired business is impaired.  Any resulting impairmentloss could have a material adverse impact on our financial condition andresults of operations.

 

Thepreparation of the estimated future cash flows involves significant judgmentand estimations.  While we believe that our assumptions are appropriate andreasonable, significant changes in our assumptions may materially affect ourassessment of recoverable values and may lead to future additional impairmentcharges under Philippine GAAP.  

 

Totalgoodwill and intangible assets as at June 30, 2005 and December 31, 2004 amounted to Php3,727 million and Php3,864 million,respectively.

 

*Investment properties*

 

We haveadopted the fair value approach in determining the carrying value of ourinvestment properties.  While we have opted to rely on independent appraisersto determine the fair value of our investment properties, such fair value wasdetermined based on recent prices of similar properties, with adjustments to reflect any changes in economic conditions sincethe date of the transactions that occurred at those prices.  The amounts andtiming of recorded changes in fair value for any period would differ if we madedifferent judgments and estimates or utilized different basis for determiningfair value.

 

Totalinvestment properties as at June 30, 2005 and December 31, 2004 amounted to Php732 million and Php743 million, respectively.

 

*Deferredtax assets*

 

We reviewthe carrying amounts at each balance sheet date and reduce deferred tax assetsto the extent that it is no longer probable that sufficient taxable profit willbe available to allow all or part of the deferred tax assets to be utilized.However, there is no assurance that we will generate sufficient taxable profitto allow all or part of our deferred tax assets to be utilized.  

 

Unrecognizeddeferred tax assets as at June 30, 2005 and December 31, 2004 amounted to Php12,416 million and Php13,824 million, respectively.

 

*Financialassets and liabilities*

 

PhilippineGAAP requires that we carry certain of our financial assets and liabilities atfair value, which requires extensive use of accounting estimates and judgment.In addition, certain liabilities acquired through debt exchange andrestructuring are required to be carried at fair value at the time of the debtexchange and restructuring, see *Note**24 – Financial Assets andLiabilities*.  While significant components of fair value measurement weredetermined using verifiable objective evidence (i.e., foreign exchange rates,interest rates, volatility rates), the amount of changes in fair value woulddiffer if we utilized different valuation methodology.  Any changes in fairvalue of these financial assets and liabilities would affect directly ourprofit and loss and equity.

 

The fairvalue of financial assets and liabilities as at June 30, 2005 amounted to Php48,479 million and Php170,205 million, respectively.  

 

The fairvalue of financial assets and liabilities as at December 31, 2004 amounted to Php46,439 million and Php194,613 million, respectively.  

 

*Estimatingallowance for doubtful accounts*

 

Weestimate the allowance for doubtful accounts related to our trade receivablesbased on two methods.  The amounts calculated using each of these methods arecombined to determine the total amount we reserve.  First, we evaluate specificaccounts where we have information that certain customers are unable to meettheir financial obligations.  In these cases, we use judgment, based on the bestavailable facts and circumstances, including but not limited to, the length ofour relationship with the customer and the customer’s current credit statusbased on third party credit reports and known market factors, to recordspecific reserves for customers against amounts due to reduce our receivablesto amounts that we expect to collect.  These specific reserves are re-evaluatedand adjusted as additional information received affects the amounts estimated.Second, a general provision is established as a certain percentage of operatingrevenues based on the aging profile of receivables.  This percentage is basedon a collective assessment of historical collection, write-off experience,current economic trends, changes in our customer payment terms and otherfactors that may affect our ability to collect payments.  Full allowance isprovided for receivables from permanently disconnected subscribers andcarriers.  Such permanent disconnections generally occur within 105 days fromdue date.  Partial allowance is provided for active subscribers and carriersbased on the age status of receivables.

 

Theamounts and timing of recorded expenses for any period would differ if we madedifferent judgments or utilized different estimates.  An increase in ourallowance for doubtful accounts would increase our recorded operating expensesand decrease our current assets.  

 

Provisionfor doubtful accounts amounted to Php1,526 million andPhp1,875 million for the six months ended June 30, 2005 and 2004, respectively.  Trade and other receivables, net of allowance fordoubtful accounts, amounted to Php8,457 million andPhp10,404 million as at June 30, 2005 and December 31, 2004, respectively.

 

*Revenuerecognition*

 

Ourrevenue recognition policies require us to make use of estimates andassumptions that may affect the reported amounts of our revenues andreceivables.  

 

Ouragreements with domestic and foreign carriers for inbound and outbound trafficsubject to settlements require traffic reconciliations before actual settlementis done, which may not be the actual volume of traffic as measured by us.Initial recognition of revenues are based on our observed traffic adjusted byour normal experience adjustments, which historically are not material in ourunaudited consolidated financial statements.  Differences between the amountsinitially recognized and actual settlements are taken up in the accounts uponreconciliation.  However, there is no assurance that such use of estimates maynot result to material adjustments in future periods.

 

Revenuesunder a multiple element arrangement specifically applicable to our wirelessbusiness were split into separately identifiable components and recognized whenthe related components were delivered in order to reflect the substance of thetransaction.  The fair value of components was determined using verifiableobjective evidence.  Revenue for handset sales has been quantified andidentified separately using the residual value method from our cellular servicerevenue.  

 

*Pension and other retirement benefits*

 

Thedetermination of our obligation and cost for pension and other retirementbenefits is dependent on our selection of certain assumptions used by actuariesin calculating such amounts.  Those assumptions are described in *Note 21 –Employee Benefits* and include among others, discount rates, expectedreturns on plan assets and rates of compensation increase.  In accordance withPhilippine GAAP, actual results that differ from our assumptions areaccumulated and amortized over future periods and therefore, generally affectour recognized expense and recorded obligation in such future periods.  Whilewe believe that our assumptions are reasonable and appropriate, significantdifferences in our actual experience or significant changes in our assumptionsmay materially affect our pension and other retirement obligations.  

 

Unrecognizednet actuarial gain as at June 30, 2005 and December 31, 2004 amounted to Php176 million.

 

*Legal Contingencies*

 

We arecurrently involved in various legal proceedings.  Our estimate of the probablecosts for the resolution of these claims has been developed in consultationwith outside counsel handling our defense in these matters and is based upon ananalysis of potential results.  We currently do not believe these proceedingswill have a material adverse effect on our consolidated financial statements.It is possible, however, that future results of operations could be materiallyaffected by changes in our estimates or in the effectiveness of our strategiesrelating to these proceedings, see *Note 23 – Provisions and Contingencies.*

 

Outstandingprovisions to cover these contingencies amounted to Php4,767million and Php4,548 million as at June 30, 2005 and December 31, 2004, respectively.

 

 

 

**4.   Segment Information**

 

Operatingsegments are components of PLDT that engage in business activities from whichit may earn revenues and incur expenses (including revenues and expensesrelating to transactions with other components of PLDT), whose operatingresults are regularly reviewed by the enterprise’s chief operating decisionmaker to make decisions about resources to be allocated to the segment andassess its performance, and for which discrete financial information isavailable.  The accounting policies of the reportable segments are the same asthose described in *Note 2 – Summary of Significant Accounting Policies andPractices*.

 

We have organized ourbusiness into three main segments:

 

•        Wireless — wireless telecommunications services provided through our cellular serviceproviders, Smart and Piltel, and satellite and very small aperture terminal, orVSAT, operators, namely PLDT’s subsidiaries Mabuhay Satellite, ACeS Philippinesand Telesat;

 

•        Fixed Line — fixed line telecommunications services primarily provided throughPLDT.  We also provide fixed line services through PLDT’s subsidiaries ClarkTelecom, Subic Telecom, Maratel, Piltel and BCC which together account forapproximately 3% of our consolidated fixed lines in service, and PLDT Global;and

 

•        Information and CommunicationsTechnology — information and communications infrastructure andservices for internet applications, internet protocol-based solutions andmultimedia content delivery provided by PLDT’s subsidiary ePLDT; call centerservices provided by ePLDT’s subsidiaries Parlance Systems, Inc., or Parlance,Vocativ Systems, Inc., or Vocativ and Ventus; internet access and gamingservices provided by ePLDT’s subsidiaries Infocom Technologies, Inc., DigitalParadise and netGames; and e-commerce and IT-related services provided by otherinvestees of ePLDT, as described in *Note 9 – Investments in Associates*.

 

Thesegment assets and liabilities and results of operations of the segments in2004 have been restated to reflect the effects of the change in accounting policies.

 

Thesegment assets as at June 30, 2005 and December 31, 2004 and results of operations ofour reportable segments for the six months ended June 30, 2005 and 2004 reportedunder Philippine GAAP are as follows:

 

 

 

**Wireless**

**Fixed Line**

**Information and Communications Technology**

**Inter-segment Transactions**

**Total**

 

(in millions of pesos)

* *

* *

 

 

 

 

*As at and for the six months ended**June 30, 2005**(Unaudited)*

* *

 

 

 

**Revenues**

 

 

 

 

 

Service

36,703

24,214

1,328

(2,723)

59,522

Non-service

1,291

–

215

(84)

1,422

Others

57

122

44

(29)

 194

Segment revenues

38,051

24,336

1,587

(2,836)

61,138

 

 

 

 

 

 

**Result**

 

 

 

 

 

Income before income tax

17,592

4,850

69

–

22,511

Provision for income tax

4,217

1,471

6

–

5,694

Net income for the period

13,375

3,379

  63

–

16,817

** **

 

 

 

 

 

Assets

 

 

 

 

 

Segment assets

91,611

198,300

4,199

(43,212)

250,898

Deferred income tax assets

557

11,729

5

–

12,291

Total assets

92,168

210,029

4,204

(43,212)

263,189

 

 

 

 

 

 

Other segment information 

 

** **

** **

** **

** **

Capital expenditures

3,577

3,129

306

–

7,012

Depreciation and amortization

4,970

5,704

187

–

10,861

Provisions

437

1,531

–

–

1,968

Interest on loans and related items - net of capitalized interest

898

4,541

14

–

5,453

Interest income

(543)

(193)

(5)

–

(741)

* *

 

* *

* *

* *

* *

*As at**December 31, 2004**(Audited) and for the six months ended**June 30, 2005**(Unaudited)*

* *

**Revenues**

 

 

 

 

 

Service

33,983

24,108

953

(1,203)

57,841

Non-service

4,235

–

161

(85)

4,311

Others

135

107

13

(108)

 147

Segment revenues

38,353

24,215

1,127

(1,396)

62,299

 

 

 

 

 

 

**Result**

 

 

 

 

 

Income before income tax

15,298

908

53

–

16,259

Provision for income tax

3,529

284

(2)

–

3,811

Net income for the period

11,769

 624

  55

–

12,448

** **

 

 

 

 

 

**Assets**

 

 

 

 

 

Segment assets

94,623

198,090

3,716

(43,694)

252,735

Deferred income tax assets

8

12,721

9

–

12,738

Total assets

94,631

210,811

3,725

(43,694)

265,473

 

 

 

 

 

 

**Other segment information**

 

** **

** **

** **

** **

Capital expenditures

8,827

2,673

75

–

11,575

Depreciation and amortization

5,779

5,000

148

–

10,927

Provisions

608

1,568

–

–

2,176

Interest on loans and related items - net of capitalized interest

852

5,324

25

–

6,201

Interest income

(367)

(98)

(3)

–

(468)

 

 

 

**5.   Revenues and Expenses**

 

*Non-service Revenues*

* *

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Sale of handsets and SIM-packs

**1,291**

 

4,235

Point of product sales

**131**

 

76

 

**1,422**

 

4,311

* *

* *

*Compensation and Benefits*

* *

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Salaries and benefits

**5,455**

 

5,177

Incentive plans (Note 21)

**610**

 

269

Pension and other benefits (Note 21)

**384**

 

367

Manpower rightsizing program

**43**

 

183

 

**6,492**

 

5,996

 

*FinancingCosts*

* *

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Interest on loans and related items

**5,656**

 

6,503

Accretion on financial liabilities - net (Notes 2, 17 and 24)

**1,437**

 

1,496

Hedge costs (Note 24)

**557**

 

567

Dividends on preferred stock subject to mandatory redemption (Note 17)

**132**

 

117

Financing charges (Note 7)

**74**

 

86

Foreign exchange losses (gains) - net (Notes 17 and 24)

**(1,376)**

 

1,397

Loss (gain) on derivative transactions - net (Notes 2 and 24)

**(1,187)**

 

505

Interest income

**(741)**

 

(468)

Capitalized interest (Notes 2 and 8)

**(203)**

 

(302)

 

**4,349**

 

9,901

 

*Cost of Sales*

* *

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Cost of handsets and SIM-packs sold

**3,149**

 

6,478

Cost of satellite air time (Notes 20 and 22)

**122**

 

121

 

**3,271**

 

6,599

* *

*Provisions*

* *

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Doubtful accounts (Note 14)

**1,526**

 

1,875

Write-down of inventories at net realizable value (Note 15)

**325**

 

128

Onerous contracts (Notes 20 and 22)

**117**

 

173

 

**1,968**

 

2,176

* *

*Other Expenses*

* *

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Operating expenses

**1,507**

 

1,411

Equity in net losses of associates

**–**

 

36

Others

**233**

 

101

 

**1,740**

 

1,548

* *

* *

 

**6.   IncomeTaxes**

* *

The netcomponents of deferred income tax recognized in the consolidated balance sheetsare as follows:

* *

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Net assets

**12,291**

 

12,738

Net liabilities

**1,955**

 

1,943

* *

Thecomponents of net deferred tax assets and liabilities are as follows:

*** ***

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Net assets

** **

 

 

Unrealized foreign exchange losses

**9,904**

 

11,214

Allowance for doubtful accounts

**5,417**

 

4,068

Unearned revenues

**2,883**

 

1,939

Unamortized past service cost

**1,036**

 

1,130

Pension and other benefits

**899**

 

761

Provisions for unrealized assets

**451**

 

453

Derivative instruments

**346**

 

595

Accumulated write-down of inventories at net realizable value

**330**

 

190

Interest charges capitalized

**(4,885)**

 

(4,558)

Foreign exchange differential capitalized

**(1,995)**

 

(1,520)

Preferred stock subject to mandatory redemption

**(814)**

 

(1,042)

Taxes and duties capitalized

**(550)**

 

(582)

Excess of fair value over cost of investment properties

**(106)**

 

(106)

Net loss operating carryover, or NOLCO

**–**

 

3

Others

**(625)**

 

193

 

**12,291**

 

12,738

 

 

 

 

Net liabilities

** **

 

 

Unearned revenues

**545**

 

673

NOLCO

**257**

 

1,063

Provisions for unrealizable assets

**125**

 

13

Accumulated write-down of inventories at net realizable value

**31**

 

203

Gain on debt exchange and restructuring

**(1,802)**

 

(2,958)

Intangibles and fair value adjustment on assets acquired

**(1,157)**

 

(1,231)

Derivative instruments

**(46)**

 

20

Allowance for doubtful accounts

**–**

 

798

Foreign exchange differential capitalized

**–**

 

(644)

Interest charges capitalized

**–**

 

(485)

Unrealized foreign exchange losses

**–**

 

432

Others

**92**

 

173

 

**(1,955)******

 

(1,943)

 

Provisionfor income tax consists of:

*** ***

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Current

**5,003**

 

4,230

Deferred

**691**

 

(419)

 

**5,694**

 

3,811

*** ***

Thereconciliation between the provision for income tax at the applicable statutorytax rates and the actual provision for income tax follows:

 

 

**Six Months Ended June 30,**

 

**2005**

** **

2004

 

(Unaudited)

 

(in million pesos)

Provision for income tax at statutory tax rate

**7,203**

** **

5,203

Tax effects of:

** **

 

 

Non-deductible expenses 

**245**

** **

557

Income subject to lower tax rate

**113**

** **

(66)

Equity share in net losses of investees including provision  for decline in value of investments in associates

**1**

** **

10

Net reversal of deferred income tax assets

**(1,638)**

 

(172)

Income subject to final tax

**(228)**

** **

(246)

Income not subject to tax

**(2)**

** **

(1,475)

Actual provision for income tax

**5,694**

 

3,811

 

MabuhaySatellite and Subic Telecom are registered as Subic Bay Freeport Enterpriseswhile Clark Telecom is registered as a Clark Special Economic Zone Enterpriseunder R.A. No. 7227, otherwise known as the Bases Conversion and DevelopmentAct of 1992, or the Act.  As registrants, Mabuhay Satellite, Subic Telecom andClark Telecom are entitled to all the rights, privileges and benefitsestablished thereunder including tax and duty-free importation of capitalequipment and special income tax rate of 5% of gross income, as defined in theAct.

 

OnDecember 22, 2000, the Philippine Board of Investments, or BOI, approvedePLDT’s registration as a new information technology, or IT, service firm inthe field of services related to its internet data center on a pioneer status.As such, ePLDT enjoys, among other incentives, a six-year income tax holiday,or ITH, from January 2001.

 

Parlanceis registered with the BOI as a new IT export service firm in the field ofcustomer interaction center on a pioneer status.  Under this registration,Parlance shall be entitled to certain tax incentives like ITH for six yearsstarting June 2002.  Parlance is required to comply with specific terms andconditions stated in the BOI registration.

 

iPlusIntelligent Network, Inc., or iPlus, is registered with the BOI as a new ITservice firm in the field of application service provider on a pioneer status.Under such registration, iPlus is entitled to a six-year ITH incentive from theactual start of commercial operations until January 1, 2009.  Income derived from non-registered activities is subject to a normal income tax rate of32%.

 

Vocativ isregistered with the PEZA as an Ecozone Export Enterprise to develop and operatea call center business that serves overseas clients by providing customerrelationship management services.  As a registered enterprise, Vocativ isentitled to certain tax and nontax incentives which include, among others, taxand duty-free importations, exemption from local taxes and ITH for four yearsfrom start of commercial operations.  After the ITH period, Vocativ is liablefor a final tax, in lieu of all taxes after the expiration of its incentives.The final tax is computed at 5% of gross income less allowable deductions asdefined under R.A. No. 7916, “The Special Economic Zone Act of 1995,” and shallbe paid and remitted in accordance with the amendments contained in R.A. No.8748, as follows: (a) 3% to the National Government; and (b) 2% which shall bedirectly remitted by the business establishments to the treasurer’s office ofthe municipality or city where the enterprise is located.

 

mySecureSign,Inc., or mSSI, is registered with the BOI as a new IT service firm in the fieldof services related to public key infrastructure on a pioneer status. Undersuch registration, mSSI enjoys, among other incentives, a six-year ITH from August 1, 2001 or actual start of commercial operations, whichever comes first.  mSSIstarted commercial operations on January 1, 2002.

 

Ventus isregistered with the BOI as a new IT export service firm in the field ofcustomer interaction center on a pioneer status.  Under this registration,Ventus shall be entitled to certain tax incentives such as ITH for six yearsstarting March 2005.  In relation to this, Ventus is required to comply withspecific terms and conditions stated in the BOI registration.

 

On May 3, 2001, the BOI awarded Smart pioneer status for its GSM expansion projects entitlingit to a three-year ITH which expired on May 2, 2004.  The tax incentive wasutilized by Smart on the basis of incremental income generated from suchexpansion projects.  In addition, on July 12, 2001, the BOI awarded Smartpioneer status for its payment infrastructure projects, entitling it to enjoy asix-year ITH.  In this case, the tax incentive is availed for the entiretaxable income of the project.  The BOI registration for this project wascancelled effective September 14, 2004, which resulted in the termination ofall incentives granted to Smart by virtue of its registration.

 

WolfpacCommunications, Inc., or Wolfpac, is registered with the BOI as a new operatorof service provider applications.  Under the terms of its registration, it isentitled to certain tax and non-tax incentives which include, among others, anITH for four years from February 2004.

 

Meridianis registered with the BOI as a new operator of telecommunications systems(inter-exchange carrier for data services).  Under the terms of itsregistration, Meridian is entitled to certain tax and non-tax incentives whichinclude, among others, an ITH for six years from February 2001 or the actualstart of commercial operations, whichever comes first, and additional deductionfor labor expense for the first five years from the date of registration.  

 

Consolidatedtax incentives availed for the six months ended June 30, 2005 and 2004 amountedto Php43 million and Php1,554 million, respectively.

 

Smart’sdeferred income tax assets and liabilities as at June 30, 2005 and December 31, 2004 have been recorded to the extent that such deferred tax assets areexpected to be utilized against sufficient future taxable profit.

 

Certaindeferred income tax assets have not been recognized as it is not probable thattaxable profits will be sufficient against which they can be utilized.  Thecomponents of deductible temporary differences for which no deferred tax assetis recognized in the consolidated balance sheets are as follows:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Asset impairment

**9,493**

 

10,090

Unrealized foreign exchange losses

**1,711**

 

1,938

Allowance for doubtful accounts

**755**

 

746

MCIT

**383**

 

305

NOLCO

**27**

 

29

Unearned revenues on co-location fees

**–**

 

470

Provision for other assets

**–**

 

133

Unearned revenues on sale of prepaid cards

**–**

 

73

Others

**47**

 

40

 

**12,416**

 

13,824

 

Our consolidated unutilized NOLCO as at June 30, 2005 is detailed as follows:

 

**Year Incurred**

**Year Expiring**

**(in million pesos)**

2002

2005

775

2003

2006

5

2004

2007

72

 

 

 852

 

 

 

Tax benefit

 

284

Unrecognized deferred income tax assets as at June 30, 2005

 

(27)

 

 

 257

 

 

 

**7.   EarningsPer Common Share**

 

The following table presents information necessary tocalculate the earnings per common share:

 

** **

**Six Months Ended June 30,**

 

**2005**

 

2004

 

**Basic**

**Diluted**

 

Basic

Diluted

 

(Unaudited)

 

(in million pesos)

Net income 

**16,785**

**16,785**

 

12,423

12,423

Dividends on preferred shares

**(756)**

**(24)**

 

(765)

(25)

Dividend on preferred stock subject to mandatory redemption charged to interest expense for the period

**–**

**44**

** **

**–**

41

Accretion of preferred stock subject to mandatory redemption

**–**

**152**

** **

**–**

223

Foreign exchange gain on preferred stock subject to mandatory redemption

**–**

**(474)**

 

**–**

(32)

Net income applicable to common shares

**16,029**

**16,483**

** **

11,658

12,630

 

 

 

 

 

 

 

(in thousands, except per share amounts)

 

** **

 

 

 

 

Outstanding common shares, beginning

**170,214**

**170,214**

 

169,476

169,476

Effect of issuance of common shares during the period

**318**

**318**

 

28

28

Weighted average number of shares under ESOP during the period

–

**66**

 

–

49

Common shares equivalent of preferred shares deemed dilutive:

** **

** **

 

 

 

Preferred Stock Series A to FF (Note 16)

–

**3,218**

 

–

4,432

Global Depositary Stock Series III (Note 16)

–

**7,908**

 

–

7,907

Preferred Stock Series VII (Note 17)

–

**3,842**

 

–

3,842

Weighted average number of common shares, end

**170,532**

**185,566**

 

169,504

185,734

Earnings per common share

**Php94.00**

**Php88.83**

 

Php68.78

Php68.00

 

**Dividends Declared For the Six Months Ended****June 30, 2005**

*** ***

** **

**Date**

**Amount**

**Class**

**Approved**

**Record**

**Payable**

**Per Share**

**Total**

 

 

 

 

 

(in million pesos)

**Preferred Stock Subject to  Mandatory Redemption**

 

 

 

 

 

Series V

March 1, 2005

March 17, 2005

April 15, 2005

Php4.675

10

 

June 14, 2005

June 28, 2005

July 15, 2005

4.675

7

Series VI

March 1, 2005

March 17, 2005

April 15, 2005

US$0.09925

26

 

June 14, 2005

June 28, 2005

July 15, 2005

0.09925

20

Series VII

March 1, 2005

March 17, 2005

April 15, 2005

JPY10.179725

20

 

June 14, 2005

June 28, 2005

July 15, 2005

10.179725

26

Charged to income

 

 

 

 

 109

 

 

 

 

 

 

**10% Cumulative Convertible  Preferred Stocks**

 

 

 

 

 

Series DD

January 25, 2005

February 8, 2005

February 28, 2005

Php1.00

3

Series CC

January 25, 2005

February 24, 2005

March 31, 2005

1.00

17

Series A, I, R, W, AA  & BB

June 28, 2005

July 28,2005

August 31,2005

1.00

129

 

 

 

 

 

 149

 

 

 

 

 

 

**Convertible Preferred Stocks**

 

 

 

 

 

Series III

March 1, 2005

March 17, 2005

April 15, 2005

US$1.029412

260

 

June 14, 2005

June 28, 2005

July 15, 2005

1.029412

267

 

 

 

 

 

 527

 

 

 

 

 

 

**Cumulative Non-Convertible Redeemable Preferred Stock**

 

 

 

 

 

Series IV*

January 25, 2005

February 17, 2005

March 15, 2005

–

12

 

May 3, 2005

May 26, 2005

June 15, 2005

–

12

 

 

 

 

 

  24

 

 

 

 

 

 

**Common stock**

March 1, 2005

March 31, 2005

May 12, 2005

Php14.00

2,384

** **

May 5, 2005

June 3, 2005

July 14, 2005

21.00

3,598

** **

 

 

 

 

5,982

Charged to retained earnings

 

 

 

 

6,682

 

****Dividends aredeclared based on total amounts, not per share amounts.*

*** ***

Retainedearnings available for cash dividends amounted to Php23,564 million as at June 30, 2005.  Reconciliation of consolidated deficit to Parent Company retained earningsis shown below:

 

** **

** **

**(in million pesos)**

Deficit in the unaudited consolidated financial statements

 

(117)

Adjustments relating to:

 

 

PAS 27 – Consolidated and Separate Financial Statements

 

23,567

PAS 36 – Impairment of Assets

 

(2,025)

PAS 40 – Investment Property 

 

2,139

Retained earnings in the separate financial statements of the Parent Company

 

23,564

** **

 

 

**8.   Property, Plant and Equipment**

 

This account consists of:

** **

** **

**Cable and wire facilities**

**Central office equipment**

**Cellular facilities**

**Buildings**

**Vehicles, furniture, and other work equipment**

**Communications satellite**

**Information origination/ termination equipment**

**Land and**

**land improvements**

**Property under construction**

**Total**

 
(in million pesos)

** **

**At****December 31, 2004****(Audited)**

Cost

102,958

76,117

64,092

19,083

28,474

15,709

6,108

2,563

9,972

325,076

Accumulated depreciation, amortization and impairment

(30,091)

(36,126)

(31,080)

(4,911)

(16,859)

(8,907)

(2,151)

(341)

(85)

(130,551)

Net book value

72,867

39,991

33,012

14,172

11,615

6,802

3,957

2,222

9,887

194,525

** **

**Six Months Ended****June 30, 2005****(Unaudited)**

Net book value - beginning

72,867

39,991

33,012

14,172

11,615

6,802

3,957

2,222

9,887

194,525

Additions/Transfers - net

1,339

601

1,756

149

773

573

425

15

1,417

7,048

Disposals/Retirement

(69)

(4)

(149)

(16)

(84)

(54)

(11)

(7)

(144)

(538)

Depreciation and amortization

(1,991)

(2,206)

(2,860)

(1,214)

(1,723)

(437) 

(347)

(81)

–

(10,859)

Net book value - end

72,146

38,382

31,759

13,091

10,581

6,884

4,024

2,149

11,160

190,176

 

**At****June 30, 2005****(Unaudited)**

Cost

104,214

76,711

65,486

19,211

29,069

16,227

6,443

2,571

11,244

331,176

Accumulated depreciation, amortization and impairment

(32,068)

(38,329)

(33,727)

(6,120)

(18,488)

(9,343)

(2,419)

(422)

(84)

(141,000)

Net book value

72,146

38,382

31,759

13,091

10,581

6,884

4,024

2,149

11,160

190,176

** **

Substantially all our telecommunications equipment arepurchased from outside the Philippines.  Significant source of financing for such purchasesare foreign loans requiring repayment in currencies other than Philippine pesos,principally in U.S. dollars (see *Note 17 – Interest-bearing FinancialLiabilities*).  Interest, using an average capitalization rate of 8%, andnet foreign exchange losses capitalized to property, plant and equipmentqualified as borrowing costs for the six months ended June 30, 2005 and 2004 were as follows:

 

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Interest

**203**

 

302

Foreign exchange losses (gains)

**(156)**

 

55

 

As at June 30, 2005 and December 31, 2004, the undepreciated capitalized net foreign exchangelosses qualified as borrowing costs amounted to Php5,047 million and Php5,528million, respectively.

 

For the six months ended June 30, 2005, we recognizedadditional depreciation of Php578 million with our full adoption of PAS 16, see*Note 2 – Summary of Significant Accounting Policies*.

 

In2004, certain assets with net book values aggregating Php365 million wereretired.  These assets relate primarily to certain international facilityequipment of PLDT Global and Subic Telecom in relation to our strategicdirection to functionally integrate our international fixed line business.

 

Certainproperty, plant and equipment have been restated to include the followingamounts for capitalized leases as at June 30, 2005and December 31, 2004:

 

** **

**June 30, 2005****(Unaudited)**

December 31, 2004 (Audited)

 

**Central office equipment**

**Vehicles, furniture and other network equipment**

**Total**

Central office equipment

Vehicles, furniture and other network equipment

Total

 

(in million pesos)

Cost

**361**

**1,030**

**1,391**

361

863

1,224

Less accumulated depreciation

**282**

**577**

**859**

269

410

 679

 

**79**

**453**

**532**

  92

 453

 545

 

The following table describes all changes to theasset retirement obligations as at June 30, 2005 and December 31, 2004, respectively:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Asset retirement obligations at beginning of period

**638**

 

395

Additional liability recognized during the period

**37**

 

177

Settlement of obligations

**(4)**

 

–

Accretion expense

**38**

 

66

Asset retirement obligations at end of period (note 18)

**709**

 

 638

 

 

 

**9.   Investmentsin Associates**

 

This account consists of:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

ACeS International Limited, or AIL

**1,614**

 

1,614

Mabuhay Space Holdings Limited

**1,046**

 

1,077

Stradcom International Holdings, Inc.

**616**

 

616

Bayantrade Dotcom, Inc.

**97**

 

97

ePDS, Inc.

**6**

 

6

Airborne Access Corporation

**2**

 

2

 

**3,381**

 

3,412

Less accumulated impairment and equity in net losses of associates

**3,369**

 

3,404

Total cost and accumulated impairment and equity in net losses of associates

**12**

 

   8

 

***Investment of ACeS******Philippines******in AIL***

 

As at June 30, 2005, ACeS Philippines has a 20%investment in AIL, a company incorporated under the laws of Bermuda.  AILowns the Garuda I Satellite and the related system control equipment in Batam, Indonesia.

 

InDecember 1998, AIL and its 95% owned subsidiary, PT Asia Cellular Satellite,entered into an Amended and Restated Credit Agreement, or Amended Agreement, toamend the original Credit Agreement entered into by PT Asia Cellular Satelliteand its bank creditors in 1997.  Under the Amended Agreement, AIL has, amongothers, assigned to the banks as collateral all of its tangible properties,including the Garuda I Satellite, the system control facilities and systemcontrol equipment.  On September 30, 2002, PT Asia Cellular Satellite, AIL, asguarantor, P.T. Bank Internasional Indonesia, as security agent, and variousbanks signed the Rescheduling Agreement, which amended the terms of the Amendedand Restated Credit Agreement dated December 29, 1998, moving the principalrepayment dates to agreed periods with the final maturity date on January 31,2012, see *Note 20 – Related Party Transactions*.

 

AIL has incurred recurring significant operatinglosses, negative operating cash flows, and significant levels of debt.  Thefinancial condition of AIL was partly due to the National Service Providers’,or NSPs, inability to generate the amount of revenues originally expected asthe growth in subscriber numbers have been significantly lower than budgeted.These factors raise substantial doubt about AIL’s ability to continue as agoing concern.  On this basis, we recognized an impairment provision in respectof our investment in AIL amounting to Php1,614million in 2003.

 

***Investment of Mabuhay Satellite in Mabuhay SatelliteSpace Holdings Limited, or MSHL***

 

In 1996, MabuhaySatellite entered into a Joint Venture Agreement, or JVA, with SpaceSystems/Loral Inc., or SS/L, to form MSHL for the purpose of providinghigh-power Ku-Band satellite transmission services using the payload which wasadded by SS/L aboard Agila II.  Under the terms of the JVA, SS/L is required toconvey title to the additional payload service to MSHL in consideration forSS/L’s 35% equity interest in MSHL and Mabuhay Satellite is required to paySS/L US$19 million for a 65% equity interest in MSHL.

 

In 2000, SS/Lfiled a Notice of Default and Termination against Mabuhay Satellite arisingfrom the latter’s alleged failure to amicably resolve its unpaid obligation toSS/L under the JVA.  In 2002, the arbitration panel handed down its decisionand provided for payment by Mabuhay Satellite to SS/L of the principal amountof US$10 million plus accrued interest at 9% per annum.  On June 30, 2003,Mabuhay Satellite and SS/L concluded a US$15 million settlement agreement underwhich Mabuhay Satellite leased two transponders under a transponder agreementon a life-term basis to SS/L and had offset the lease charges due from SS/L andits receivables from Loral Skynet Network Services, Inc. (formerly known as theLoral Cyberstar, Inc.), among others, for a full and final settlement of thearbitration decision.  The agreement was subsequently approved by MabuhaySatellite’s creditors in March 2004.

 

In accordance with thesettlement agreement, Mabuhay Satellite and SS/L shall proceed to dissolve thejoint venture under a separate agreement, for which each of the parties shallreceive title over such number of transponders owned by the joint venture inproportion to their respective interests.  On the basis of the joint venturedissolution, we recognized an impairment provision in respect of our investmentin MSHL of Php423 million in 2004.

 

***Investment in Stradcom International Holdings, Inc.,or SIHI***

 

ePLDT has 22.5% interest inconvertible securities of SIHI, the parent company of Stradcom Corporation,which has an existing concession agreement with the Philippine Government forthe modernization of the Philippine Land Transportation Office, including thecomputerization of driver’s license issuance, vehicle registration and trafficadjudication systems.  SIHI has been incurring losses from the start of operationsdue to Stradcom Corporation’s continuous losses and consistent excess ofcurrent liabilities over current assets.  On this basis, we recognized animpairment provision in respect of our investment in SIHI of Php616 million in2004.

 

***Investmentin BayanTrade Dotcom, Inc., or BayanTrade***

*** ***

BayanTradewas incorporated and registered with the SEC on August 8, 2000 to provide:  (a)business-to-business electronic purchasing marketplace to link buyers andsuppliers of good services over the Internet; (b) electronic cataloguepurchasing facilities over the Internet to buyers and suppliers; (c) link-upwith similar horizontal markets and vertical markets across the Asia-PacificRegion and the world; and (d) such facilitating services incidental to thebusiness.  BayanTrade is an e-procurement joint venture established togetherwith six of the Philippines’ leading conglomerates.  ePLDT’s initial shareholdingin BayanTrade was originally 20.5%, which was subsequently diluted to 19.17% inAugust 2004 due to an equity call to which ePLDT did not subscribe.

*** ***

***Investment in ePDS, Inc., or ePDs***

*** ***

On June 30, 2003, ePLDT signed a Joint Venture Agreement with DataPostPte Ltd., or DataPost, a subsidiary of Singapore Post, and G3 Worldwide ASPAC,or Spring, pursuant to which the parties formed ePDS, a bills printing companywhich will do laser printing and enveloping services for statements, bills andinvoices, and other value-added services to companies in the Philippines.ePLDT has a 50% interest in ePDS, while DataPost has a 30% interest.  Spring,the largest international mail services provider, owns the remaining 20%.  ePDShas an initial paid-up capital of Php11 million.

*** ***

***Investment in Airborne Access Corporation, or AirborneAccess***

*** ***

On August 31, 2003, ePLDT signed a Memorandum of Agreement with Airborne Access to acquire a20% interest at a purchase price of Php2 million.  Airborne Access, apioneering wireless internet service provider, caters primarily to mobileprofessionals by delivering wireless internet access to its subsidiariesthrough more than 44 hotspots throughout Metro Manila.  In December 2004, ePLDThas recognized full provision in respect of its investment in Airborne Accessdue to its continuous losses which exceeded its paid-up capital.

 

 

 

**10. Investment Properties**

 

 

**June 30,   2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Balance at beginning of period

**743**

 

761

Additions (subsequent expenditures)

**–**

 

3

Disposal

**(11)**

 

–

Net loss from fair value adjustment

**–**

 

(21)

Balance at end of period

**732**

 

743

 

Investmentproperties are stated at fair values, which have been determined based onlatest valuations performed by an independent firm of appraisers.  Thevaluation undertaken was based on an open market value, supported by marketevidence in which assets could be exchanged between a knowledgeable willingbuyer and a knowledgeable willing seller in an arm’s-length transaction at thedate of valuation, in accordance with international valuation standards.

 

 

 

**11. Goodwilland Intangible Assets**

 

Thisaccount includes intangible assets – technology application arising from theacquisition of Wolfpac and intangible assets – franchise arising fromacquisition of Meridian.

 

Movements in the goodwill and intangible assets duringthe periods are as follows:

 

 

**June 30, 2005****(Unaudited)**

December 31, 2004 (Audited)

 

**Goodwill**

**Intangible assets**

**Total**

Goodwill

Intangible assets

Total

 

(in million pesos)

Cost:

 

 

 

 

 

 

Balance at beginning of period

**528**

**3,955**

**4,483**

498

317

 815

Additions

**–**

**15**

**15**

30

3,638

3,668

Balance at end of period

**528**

**3,970**

**4,498**

 528

3,955

4,483

 

** **

** **

** **

 

 

 

Accumulated amortization and impairment:

** **

** **

** **

 

 

 

Balance at beginning of period

**(438)**

**(181)**

**(619)**

(438)

(5)

(443)

Additions

**–**

**(152)**

**(152)**

–

(176)

(176)

Balance at end of period

**(438)**

**(333)**

**(771)**

(438)

(181)

(619)

Net balance

**90**

**3,637**

**3,727**

  90

3,774

3,864

 

 

 

**12. Notes Receivable**

*** ***

***Investment of ePLDT in Debt Securities of TechnologySupport Services, Inc., or TSSI (formerly First Advance Multi-MediaEntertainment Corp., or FAME)***

 

On June 1, 2004, ePLDT and TSSI entered an agreement whereby ePLDT would grant a seven-yearnon-interest bearing loan to TSSI amounting to US$3.1 million.  At the optionof ePLDT, the loan is convertible into 20% of the total outstanding capitalstock of TSSI at any time during the life of the outstanding loan.  

 

On August 20, 2004, FAMEchanged its corporate name into TSSI.

 

On September 14, 2004, ePLDT entered into a second agreement with TSSI whereby ePLDT wouldgrant another seven-year non-interest bearing loan to TSSI amounting to US$3.1million.  At the option of ePLDT, the loan is convertible into another 20% ofthe outstanding capital stock of TSSI at any time during the life of theoutstanding loan.  As at December 31, 2004, aggregate loans of ePLDT to TSSIamounted to US$5.1 million.  The remaining balance of the loans of US$1.1million was released to TSSI in February 2005.

 

ePLDT hasnot yet converted its investment in debt securities to TSSI’s shares of stockas at June 30, 2005.  TSSI is a systems integrator for the internet and mobiletelephone gaming project.

 

Thefair value of the debt instrument was computed as the present value ofestimated future cash flows.  The cost of the instrument approximates the fairvalue computed as at June 30, 2005.

 

 

 

**13. Cash and Cash Equivalents**

 

This account consists of:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Cash on hand and in banks

**2,241**

 

4,750

Temporary investments

**33,388**

 

22,571

 

**35,629**

 

27,321

 

Cash inbanks earns interest at prevailing bank deposit rates.  Temporary investmentsare made for varying periods of up to two months depending on our immediatecash requirements, and earn interest at the prevailing short-term depositrates.  Due to the short-term nature of such transactions, the carrying valueapproximates the fair value of our temporary investments.

 

 

 

**14. Trade and Other Receivables**

 

This account consists of receivables from:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Customers and carriers

**26,729**

 

27,280

Others (Notes 20, 22 and 23) 

**1,290**

 

1,192

 

**28,019**

 

28,472

Less allowance for doubtful accounts

**19,562**

 

18,068

 

**8,457**

 

10,404

 

Receivablesfrom carriers represent receivables arising from interconnection agreementswith other telecommunications carriers.  The aforementioned receivable balancesare shown net of related payables to the same telecommunications carriersbecause an established right of offset exists.  

 

On October10, 2002, PLDT entered into a Receivables Purchase Deed, or RPD, with a foreignfinancial institution, or the Purchaser, under which PLDT agreed (1) to sellits receivables from certain eligible foreign carriers for an advance paymentof US$50 million, of which, US$23 million remains outstanding as at June 30,2005, and (2) to service, administer and collect the receivables on behalf ofthe Purchaser.  Under the RPD, the Purchaser has no recourse against PLDTshould an eligible carrier fail or refuse to settle the assigned/purchasedreceivables, except when PLDT commits a breach of its representations andwarranties under the RPD.

 

Sale ofreceivables under the RPD amounted to US$6 million (Php338 million) and US$5million (Php297 million) for the six months ended June 30, 2005 and 2004, respectively.  Loss on sale of receivables under the RPD amounted to US$0.67 million(Php38 million) and US$0.65 million (Php37 million) for the six months ended June 30, 2005 and 2004, respectively.

 

 

 

**15. Inventoriesand Supplies**

 

This account consists of:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Terminal and cellular phone units:

** **

 

 

At net realizable value

**665**

 

1,357

At cost

**1,183**

 

1,895

Spare parts and supplies:

** **

 

 

At net realizable value

**443**

 

389

At cost

**1,034**

 

985

Others (At cost)

**1,147**

 

394

 

**2,255**

 

2,140

 

 

 

**16. Equity**

 

Themovement of PLDT’s capital account follows:

 

** **

**Preferred Stock** – Php10 par value

** **

** **

**Series  A to FF**

**III**

**IV**

** **

** **

** **

**Common Stock** –Php5 par value

** **

**No. of Shares**

**Total Preferred Stock**

**Amount**

**No. of Shares**

**Amount**

** **

(in million shares and pesos)

**Authorized**

 

 

** **

823

Php8,230

234

Php1,170

**Outstanding**

** **

 

** **

** **

** **

 

 

Balance at January 1, 2004

410

5

36

 451

Php4,505

169

Php847

Issuance

1

–

–

   1

9

–

2

Conversion

(2)

–

–

(2)

(17)

1

2

Balance at December 31, 2004 (Audited)

 409

   5

  36

 450

Php4,497

 170

Php851

 

 

 

 

 

 

 

 

Balance at January 1, 2005

 409

   5

  36

 450

Php4,497

 170

Php851

Issuance

–

–

–

–

1

–

1

Conversion

(1)

–

–

(1)

(11)

1

5

Balance at June 30, 20 05 (Unaudited)

 408

   5

  36

 449

Php4,487

 171

Php857

*** ***

***Preferred Stock***

 

The preferred stock is non-voting, except asspecifically provided by law, and is preferred as to liquidation.

 

The SeriesA to FF 10% Cumulative Convertible Preferred Stocks earn cumulative dividendsat an annual rate of 10%.  After the lapse of one (1) year from the last day ofthe year of issuance of a particular series of 10% Cumulative ConvertiblePreferred Stock, any holder of such series may convert all or any of the sharesof 10% Cumulative Convertible Preferred Stock held by him into fully paid andnon-assessable shares of Common Stock of PLDT, at a conversion price equivalentto 10% below the average of the high and low daily sales price of a share ofCommon Stock on the PSE, or if there shall have been no such sales on the PSEon any day, the average of the bid and the asked prices of a share of CommonStock of PLDT at the end of such day on such Exchange, in each such caseaveraged over a period of 30 consecutive trading days prior to the conversiondate, but in no case shall the conversion price be less than the price set bythe Board of Directors which, as at December 31, 2004, was Php5.00 per share.The number of shares of Common Stock issuable at any time upon conversion ofone share of subscriber investment plan, or SIP.  Cumulative ConvertiblePreferred Stock shall be determined by dividing Php10.00 by the then applicableconversion price.

 

In casethe shares of Common Stock at anytime outstanding shall be subdivided into agreater or consolidated into a lesser number of shares, then the minimumconversion price per share of Common Stock shall be proportionately decreasedor increased, as the case may be, and in the case of a stock dividend, suchprice shall be proportionately decreased, provided, however, that in every casethe minimum conversion price shall not be less than the par value per share ofCommon Stock.  In the event the relevant effective date for any suchsubdivision or consolidation of shares or stock dividend occurs during theperiod of 30 trading days preceding the presentation of any shares of 10%Cumulative Convertible Preferred Stock for conversion, a similar adjustmentshall be made in the sales prices applicable to the trading days prior to sucheffective date utilized in calculating the conversion price of the sharespresented for conversion.

 

Incase of any other reclassification or change of outstanding shares of CommonStock, or in case of any consolidation or merger of PLDT with or into anothercorporation, the Board of Directors shall make such provisions, if any, foradjustment of the minimum conversion price and the sales price utilized incalculating the conversion price as the Board of Directors, in it solediscretion, shall deem appropriate.

 

AtPLDT’s option, the Series A to FF 10% Cumulative Convertible Preferred Stockare redeemable at par value plus accrued dividends five years after the year ofissuance.

 

On January 27, 2004, theBoard of Directors designated 1 million shares of serial preferred stock asSeries EE 10% Cumulative Convertible Preferred Stock for issuance throughout2004, wich is an exempt transaction under Section 10.2 of the SRC as confirmedby SEC on March 22, 2004.

 

OnDecember 9, 2004, the Board of Directors designated 500,000 shares of serialpreferred stock as Series FF 10% Cumulative Convertible Preferred Stock forissuance throughout 2005 wherein exemption of these transactions under Section10.2 of the SRC is still awaiting confirmation from SEC.

 

TheSeries III Convertible Preferred Stock earns cumulative dividends at an annualrate of US$3.50 a share payable quarterly, free and clear of Philippinewithholding taxes.  It is convertible into Common Stock at the option of theholder at any time, at the conversion price of US$29.19 per share of CommonStock (equivalent to a conversion ratio of 1.7129 shares of Common Stock foreach share of Series III Convertible Preferred Stock, each share of Series IIIConvertible Preferred Stock being valued for this purpose at its referenceamount of US$50 a share), subject to adjustment in certain events; and are notredeemable.  Moreover, PLDT may require the mandatory conversion of some or allof the outstanding shares of Series III Convertible Preferred Stock into sharesof common stock at the above conversion price of US$29.19 per share of commonstock, if certain conditions are met, including that (i) the average of theclosing prices of the ADSs reported on the NYSE on each trading day during theperiod of 30 days ending on the seventh day prior to the date upon which noticeof the date of mandatory conversion is first given is greater than or equal tothe conversion price in effect on such seventh day, (ii) there are no dividendsin arrears on any shares of the Series III Convertible Preferred Stock, and(iii) PLDT has sufficient distributable reserves to pay the fixed preferentialdividends on the shares of Series III Convertible Preferred Stock, calculateddown to and including the mandatory conversion date.  Upon liquidation of PLDT,holders of the Series III Convertible Preferred Stock will be entitled toreceive liquidating distributions equivalent to Php11 per share, plus accruedand unpaid dividends to the date of distribution, subject to the prior rightsof creditors.

 

TheSeries IV Cumulative Non-Convertible Redeemable Preferred Stock earnscumulative dividends at an annual rate of 13.5% based on the paid-upsubscription price.  It is redeemable at the option of PLDT at any time oneyear after subscription and at the actual amount paid for such stock, plusaccrued dividends.  On February 26, 2002, the Board of Directors called for the payment of aportion of the balance of the subscription price of the Series IV CumulativeNon-Convertible Redeemable Preferred Stock amounting to Php72 million, whichwas paid on March 5, 2002.  On March 22, 2002, PLDT redeemed 60 million sharesout of the 360 million subscribed shares of its Series IV CumulativeNon-Convertible Preferred Stock and paid Php72 million, representing theredemption price plus unpaid dividends up to the date of redemption.

 

Theprovisions of certain subscription agreements involving preferred stock have aneffect on the ability of PLDT to, without written consent, sell certain assetsand pay cash dividends unless all dividends for all past quarterly dividendperiods have been paid and provision has been made for the currently payabledividends.

 

 

 

**17. Interest-bearingFinancial Liabilities**

 

Thisaccount consists of the following:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

**Long-term portion of interest-bearing financial liabilities - net of current portion:**

** **

 

 

Long-term debt

**102,675**

 

121,012

Obligations under capital lease (Note 8)

**516**

 

601

Preferred stock subject to mandatory redemption

**13,611**

 

14,375

 

**116,802**

 

135,988

 

** **

 

 

**Current portion of interest-bearing financial liabilities:**

** **

** **

** **

Long-term debt maturing within one year

**28,880**

 

28,018

Obligations under capital lease maturing within one year (Note 8)

**527**

 

425

Notes payable

**56**

 

58

 

**29,463**

 

28,501

 

Unamortizeddebt discount, representing debt issuance costs and any difference between thefair value of consideration given or received on initial recognition, includedin following financial liabilities are as follows:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Long-term debt

**9,913**

 

10,440

Obligations under capital lease (Note 8)

**699**

 

741

Preferred stock subject to mandatory redemption

**4,758**

 

6,182

Total unamortized debt discount

**15,370**

 

17,363

 

The following table describes all changes tounamortized debt discount as at June 30, 2005 and December 31, 2004.

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Unamortized debt discount at beginning of period

**17,363**

 

16,390

Additions during the period

**157**

 

7,765

Accretion during the period charged to financing costs (Note 5)

**(1,430)**

 

(3,452)

Revaluations

**473**

 

474

Settlement and conversions during the period

**(1,193)**

 

(3,814)

Unamortized debt discount at end of period

**15,370**

 

17,363

** **

**Long-termDebt**

 

Long-term debt consists of:

 

** **

** **

**June 30, 2005**

December 31, 2004

**Description**

**Interest Rates**

**(Unaudited)**

(Audited)

 

 

(in millions)

*U.S. Dollar Debt:*

** **

** **

** **

** **

** **

Export Credit Agencies-Supported Loans:

** **

** **

** **

** **

** **

Kreditanstalt für Wiederaufbau, or KfW

5.65% - 8.03% and US$ LIBOR + 0.55% - 2.5%

**US$306**

**Php17,201**

US$351

Php19,793

Finnish Export Credit or Finnvera

6.36% - 7.75% and US$ LIBOR + 0.5% - 1.425%

**136**

**7,657**

159

8,964

Nippon Export and Investment Insurance  of Japan, or NEXI

US$ LIBOR +1%

**61**

**3,445**

74

4,179

Japan Bank for International Cooperation,  or JBIC/Co-financing Banks

6.56% - 7.95% and US$ LIBOR + 0.65% - 1.55%

**29**

**1,627**

44

2,459

Others

5.83% - 7.89% and US$ LIBOR + 0.15% - 4.30% and GOVCO’s cost + 0.20%

**51**

**2,872**

104

5,871

 

 

**583**

**32,802**

732

41,266

Fixed Rate Notes

7.85% - 11.375%

**1,176**

**66,043**

1,220

68,795

Term Loans:

 

** **

** **

 

 

Debt Exchange Facility

2.25% and US$ LIBOR + 1%

**160**

**8,976**

155

8,721

GSM Network Expansion Facilities

4.49% and US$ LIBOR + 1%-3.25%

**110**

**6,195**

125

7,046

Nederlandse Financierings-Maatschappij Voor

Ontwikkelingslanden N.V., or FMO

US$ LIBOR + 1.95% - 2.05%

** **

** **

51

2,862

Others

5.83% and LIBOR + 0.40% - 3.625%

**23**

**1,295**

33

1,863

Restructured Loans

US$ LIBOR + 1%

**88**

**4,917**

85

4,815

Satellite Acquisition Loans

US$ LIBOR + 1.75% and 5.6%

**65**

**3,635**

72

4,064

 

 

**US$****2,205**

**123,863**

US$2,473

139,432

 

 

 

 

** **

** **

 

 

*Japanese Yen Debt:*

 

** **

** **

 

 

JBIC’s Overseas Investment Loan, or OIL

2.125%

**JP¥****8,364**

**4,238**

JP¥9,760

5,363

Export Credit Agency-Supported Loan –  NEXI Supported Loan

JP¥ LIBOR + 1.70%

**1,887**

**956**

2,205

1,212

** **

 

**JP¥****10,251**

**5,194**

JP¥11,965

6,575

** **

** **

 

** **

** **

 

 

*Philippine Peso Debt:*

 

** **

** **

 

 

Peso Fixed Rate Corporate Notes

14% - 15.816%

**–**

**1,575**

–

1,675

Term Loans:

 

** **

** **

 

 

JBIC 4 Program

11.18%

**–**

**340**

–

680

Secured Term Loans

11% - 24%

**–**

**212**

–

305

Restructured Loans

91-day T-Bill + 1%

**–**

**371**

–

363

 

 

**–**

**2,498**

–

3,023

 

 

** **

**131,555**

 

149,030

Less portion maturing within one year

 

** **

**281,880**

 

28,018

Total long-term debt 

 

** **

**Php102,675**

 

Php121,012

 

*Note:Amounts presented are net of unamortized debt discount and debt issuance costs.*

 

The scheduled maturities of our outstanding unauditedconsolidated long-term debt at nominal values as at June 30, 2005 are as follows:

 

*** ***

**U.S. Dollar Loans**

**JP****Y Loans**

**Php Loans**

**Total**

** **

**In U.S. Dollar**

**In Php**

**In JP****Y**

**In Php**

**In Php**

**In Php**

** **

(in millions)

**Year**

 

 

 

 

 

 

2005(1)

238

13,389

1,709

866

368

14,623

2006

337

18,947

3,418

1,732

847

21,526

2007

443

24,882

3,418

1,732

73

26,687

2008

118

6,630

1,709

866

61

7,557

2009

271

15,219

–

–

52

15,271

2010 and onwards

972

54,590

–

–

1,214

55,804

 

*(1)**July 1, 2005**through**December 31, 2005**.*

 

***U.S. Dollar Debt:***

* *

*Export Credit Agencies-Supported Loans*

 

In order to obtain imported components for our networkinfrastructure in connection with our expansion and service improvementprograms, we obtained loans extended and/or guaranteed by various export creditagencies.  These financings account for a significant portion of ourindebtedness.

 

*Kreditanstalt für Wiederaufbau, or KfW*

 

KfW, a German state-owned development bank, is PLDT’slargest single creditor.  As at June 30, 2005, we owed US$306 millionaggregate principal amount of debt to KfW, as follows:

 
- US$227 million provided under various export credit agency-backed facilities, of which US$117 million was in connection with our expansion and service improvement programs and US$110 million in connection with the US$149 million refinancing facility discussed below; and

 
- US$79 million provided for the 15% downpayment portion and credit facilities without guarantee/insurance cover from the export credit agencies, of which US$30 million was in connection with the US$149 million refinancing facility discussed in the following paragraphs.

 

On January 25, 2002, PLDT signed two loan agreementswith KfW, which provided PLDT with a US$149 million facility to refinance inpart the repayment installments under its existing loans from KfW due fromJanuary 2002 to December 2004.  The facility is composed of a nine-year loan,inclusive of a three-year disbursement period and a two-year grace periodduring which no principal is payable.  It partly enjoys the guarantee ofHERMES, the export credit agency of the Federal Republic of Germany.  We havedrawn US$140 million (Php7,862 million) under this facility as at June 30, 2005.  PLDTwaived further disbursements under this refinancing facility effective September 1, 2004.Thus, the undrawn portion of US$9 million was cancelled.

 

Ofthe amounts outstanding under these KfW loans, US$38 million ofour KfW loans will mature in 2005, US$57 million in 2006, US$78 million in 2007, US$58 million in2008, US$44 million in 2009 and US$31 million in 2010.  Principal amortizations on theseloans are generally payable in equal semi-annual installments.

 

*Finnish**Export Credit, plc, or Finnvera*

 

As at June 30, 2005, US$139 million aggregate principalamount of Smart’s debts were provided by various banks under export creditagency-backed facilities in connection with Smart’s GSM expansion programs.These facilities are covered by guarantees from Finnvera, the Finnish exportcredit agency, for 95% of political risk and 50% of commercial risk for GSMPhase 1 to 4 loan facilities and 100% of political and commercial risk for therefinancing facility of GSM Phase 5A and 5B.  The US$100 million refinancingfacility was obtained on February 11, 2005 in relation to Smart’s GSM Phase 5Aand 5B loans which were prepaid last March 1, 2005 with outstanding balances ofUS$60million and US$41 million, respectively, at the time of prepayment.This refinancing facility is payable semi-annually over five years startingSeptember 1, 2005 with final repayment due in March 2010.  The principalbenefit of refinancing the Phase 5 loan was the savings from a lower interestmargin on the refinancing facility.

 

Of the amounts outstanding under these Finnveraguaranteed loans, US$32 million will mature in 2005, US$37 million in2006, US$20 million in 2007, US$20 million in 2008, US$20 million in 2009 and US$10 million in2010.  Principal amortization on these loans are generally payable in equalsemi-annual installments.

 

*Nippon**Export and**Investment**Insurance of**Japan**, or NEXI*

 

On November 28, 2002,Smart signed a US$100 million term loan facility supported by NEXI, of whichUS$60 million was drawn on November 28, 2003 and US$40 million on April 5, 2004.  Thisloan is payable semi-annually over four years in eight equal installmentsstarting May 28, 2004 with final repayment due in November 2007.  Outstandingbalance as at June 30, 2005 is US$63 million.

 

*JapanBank for International Cooperation, or JBIC/Co-financing Banks*

 

Asat June 30, 2005, PLDT owed US$29 million aggregate principal amount of debt to JBIC (formerly the Export-Import Bank of Japan) and itsco-financing banks under variousfacilities.  Of the amounts outstandingunder these loans, US$5 million will mature in 2005, US$10 million in2006, US$8 million in 2007, US$3 million in 2008 and US$3 million in 2009.

 

*Other Export Credit Agency Supported Loans*

 

PLDT has also obtained loans extended and/orguaranteed by other export credit agencies, including the Export-Import Bank ofthe United States, and the respective export credit agencies of France, Italy, Israel, Sweden, Canada, Australia and Singapore, inthe aggregate outstanding principal amount of US$45 million as at June 30, 2005.Smart, likewise, obtained loans guaranteed by export credit agencies of Norway and Italyamounting to US$6 million.  Of the amounts outstanding under theseloans, US$12 million will mature in 2005, US$19 million in2006, US$13 million in 2007, US$4 million in 2008, US$2 million in 2009 and US$1 million in2010.

* *

*FixedRate Notes*

 

PLDThas the following non-amortizing fixed rate notes outstanding as at June 30, 2005 and December 31, 2004:

 

**Principal Amount**

**Interest Rate**

**Maturity Date**

**June 30, 2005****(Unaudited)**

December 31, 2004  (Audited) 

** **

** **

** **

(in millions)

US$300,000,000

8.350%

March 6, 2017

**US$296**

**Php16,616**

US$296

Php16,658

US$250,000,000

11.375%

May 15, 2012

**243**

**13,640**

242

13,661

US$161,799,000

7.850%

March 6, 2007

**161**

**9,057**

183

10,315

US$175,000,000

10.500%

April 15, 2009

**174**

**9,756**

174

9,777

US$119,389,000

9.250%

June 30, 2006

**119**

**6,691**

129

7,289

US$110,557,000

9.875%

August 1, 2005

**111**

**6,210**

110

6,223

US$ 73,766,000

10.625%

May 15, 2007

**72**

**4,073**

86

4,872

 

 

 

**US$****1,176**

**Php66,043**

US$1,220

Php68,795

* *

*Term**Loans*

* *

*US$283Million**Term**Loan Facility, or Debt Exchange Facility*

* *

On July 2, 2004, Smart acquired from Piltel’s creditors approximately US$289 million, or69.4%, in the aggregate of Piltel’s outstanding restructured debt at that time,in exchange for Smart debt and a cash payment by Smart.  In particular, Smartpaid an amount in cash of US$1.5 million, or Php84 million and issued new debtof US$283.2 million, or Php15,854 million, at fair value of Php8,390 million,net of debt discount amounting to Php7,464 million.  As at June 30, 2005, unamortized discount amounted to Php85 million.

* *

Thebreakdown of the total amount of Smart debt issued to participating Piltelcreditors is as follows:

* *

•        2007 Facility in the amount ofUS$0.2 million payable in full in December 2007;

•        2008 Facility in the amount ofUS$2.9 million payable in full in December 2008; and

•        2014 Facility in the amount ofUS$280.1 million payable in full in June 2014.

* *

Interestfor the above facilities is payable every quarter at a floating rate of threemonths US$ LIBOR plus 1.00% for the 2007 and 2008 facilities, and a fixed rateof 2.25% per annum for the 2014 facility.  Furthermore, a portion of the 2014facility amounting to US$144 million has a variable yield option whereby thecreditors have an option to elect for an early repayment at a discount eitherin December 2007 at 52.5% of the relevant debt amount or in December 2008 at57.5% of the relevant debt amount.

* *

*GSM**NetworkExpansion Facilities*

* *

On September 13, 2004, Smart signed a US$104 million 5-year term loan facility supported byFinnish Export Credit Ltd. as the lender with ABN AMRO Bank, Banque National deParibas, Calyon, DBS Bank and Sumitomo Mitsui Banking Corporation as the LeadArrangers.  The full amount of the facility was drawn in November 22, 2004, of which US$94 million remained outstanding as at June 30, 2005.  The loan is payable over five years in ten equal payments starting May 2005 with finalrepayment in November 2009.  

 

On June 8,2001, Smart signed its GSM Phase 5A financing comprised of US$195 millionloans, of which US$30 million is owed to Nordic Investment Bank, or NIB, US$15million to Nederlandse Financierings-Maatschappij Voor OntwikkelingslandenN.V., or FMO, of the Netherlands and US$150 million to Finnvera.  Of theamounts owed to FMO and NIB, US$18 million remained outstanding as at June 30, 2005 with final repayments due in March 2007 and June 2007.  

 

*Local**ExchangeTransfer Loans*

 

Inconnection with the transfer to PLDT of Smart’s local exchange business, PLDTentered into loan agreements with Nederlandse Financierings-Maatschappij VoorOntwikkelingslanden N.V., or FMO, of the Netherlands, Exportkreditnamden, orEKN, of Sweden and Export Credits Guarantee Department, or ECGD, of the UnitedKingdom for loans in the principal amounts of US$135 million, US$36 million andUS$27 million, respectively.  The FMO loan with original final maturity of September 1, 2007 wasprepaid in full on March 1, 2005.  The ECGD and EKN loans, both with original finalmaturity on December 31, 2007, were prepaid in full effective June 30, 2005.

 

*Restructured Loans*

 

On June 4,2001, Piltel completed the restructuring of approximately Php41 billion ofindebtedness and other claims owed to banks, trade creditors, bondholders andpreferred shareholders, representing 98% of its total liabilities as at thatdate.

 

Asa result of the restructuring:

 
- 50% of the financial debt of each participating creditor was released in consideration for the allotment of Piltel Series K Class I Convertible Preferred Stock.  One (1) Piltel Series K Class I Convertible Preferred Stock was exchanged for every Php340 worth of debt (converted into Pesos at an exchange rate of Php47.05 = US$1.00 for dollar-denominated debt and Php1.00 = JP¥2.39522 for yen-denominated debt), which shares were immediately and mandatorily converted into PLDT Convertible Preferred Stock.  One PLDT Series V, VI or VII convertible preferred share was issued for every five (5) Piltel Series K Class I Convertible Preferred Stock.

 
- Approximately half of the remaining 50% of all participating creditors’ (except for bondholders and preferred shareholders) financial debt became their participation in a Tranche B Loan in the same currency as their previous financial debt and the other half became their participation in a Tranche C Loan also in the same currency as their previous financial debt.  In the case of bondholders and preferred shareholders, the remaining 50% of their financial debt became a participation in the Conversion Notes Facility and in a single Tranche Peso loan, or the Term Notes Facility, respectively.

 

On July 2,2004, Smart acquired from Piltel’s creditors US$289 million, or 69.4%, in theaggregate of Piltel’s total outstanding restructured debt at that time, inexchange for US$283.2 million in new debt of Smart and US$1.5 million in cash.A gain on debt exchange transaction amounting to Php4,419 million was recognizedin our consolidated statement of income representing the difference between thefair value of Piltel’s debt cancelled and/or exchanged amounting to Php12,893million (net of debt discount of Php3,359 million) and Smart’s considerationfor the debt exchange including cash of Php84 million (US$1.5 million) and fairvalue of newly issued debt amounting to Php8,390 million (net of debt discountof Php7,464 million).  This portion of Piltel’s debt has been eliminated inconsolidation as at June 30, 2005.

 

Piltel’s residual long-term debt to third partiesconsists of:

 

** **

**June 30, 2005**

December 31, 2004

**Description**

**(Unaudited)**

(Audited) 

** **

(in millions)

**Restructured debts**

** **

** **

** **

** **

Philippine Pesos

** **

** **

** **

 

10 year Tranche B

** **

**Php****186**

 

Php182

15 year Tranche C

** **

**185**

 

181

 

** **

**371**

 

363

U.S. Dollars

** **

** **

 

 

10 year Tranche B

**US$****7**

**414**

US$7

406

15 year Tranche C

**7**

**408**

7

400

15 year Conversion Notes Facility

**74**

**4,095**

71

4,009

 

**US$****88**

**4,917**

US$85 

4,815

Total

** **

**5,288**

 

5,178

**Unrestructured debt**

** **

** **

 

 

U.S. Dollars

** **

** **

 

 

Convertible bonds

**US$****1**

**52**

US$1

52

Total

** **

**5,340**

 

5,230

Less current portion

** **

**75**

 

59

 

** **

**Php****5,265**

 

Php5,171

 

Thefollowing is a summary of the key economic terms relating to the restructuringof the financial debt taking the form of Tranche B Loan, Tranche C Loan, TermNotes Facility and Conversion Notes Facility.

 

 

**Tranche B Loans**

**Tranche C Loans**

**Term Notes Facility**

**Conversion Notes Facility**

Final maturity

10 years from June 4, 2001

15 years from June 4, 2001

15 years plus 10 days from June 4, 2001

15 years from June 4, 2001

Amortization

Years 1 and 2  –  0.00%

Years 1 and 2  –  0.00%

Years 1 and 2  –  0.00%

Years 1 and 2  –  0.00%

Years 3 to 9  –  0.10%

Years 3 and 4  –  0.10%

Years 3 to 14  –  0.10%

Years 3 and 4  –  0.10%

 

Year 10  –  99.30%

Year 5  –  2.00%

Year 15  –  98.80%

Year 5  –  1.05%

 

 

Years 6 to 14  –  10.00%

 

Years 6 to 9  –  5.05%

 

 

Year 15  –  7.80%

 

Year 10  –  54.65%

 

 

 

 

Years 11 to 14  –  5.00%

 

 

 

 

Year 15  –  3.90%

Interest rate

 

**Peso facility** – Philippine 91-day treasury bill rate, or T-Bill Rate, or the average of the 91-day T-Bill Rate and the 90-day Philippine inter-bank offered rate, or PHIBOR, if 90-day PHIBOR is different from the T-Bill Rate by more than 2.50%, plus 1.00% p.a.

 

**U.S. dollar facilities** – London interbank rate for U.S. dollar deposits, or LIBOR, for three-month U.S. dollar deposits plus 1.00% p.a.

 

**Yen facility** – LIBOR interbank rate for Yen deposits for three-month deposits plus 1.00% p.a.

181-day T-Bill Rate or the average of the 181-day T-Bill Rate and the 6-months PHIBOR, if 6-months PHIBOR is different from the T-Bill Rate by more than 2.50%, plus 1.00% p.a.

LIBOR for three-month deposits plus 1.00% p.a.

 

Interest payment dates

Quarterly in arrears

Semi-annually

 

Under theterms of Piltel’s debt restructuring plan, PLDT issued a Letter of Support, orLOS, for the benefit of Piltel and its creditors under which PLDT has agreed tocover any funding shortfalls of Piltel up to a maximum amount of US$150 millionless all amounts paid or committed to be paid to or on behalf of Piltel or anyof its subsidiaries or affiliates on or after March 23, 2000. Under the LOS,PLDT is required to provide funding to Piltel in the event that the cash flowfrom Piltel’s operations falls short of the amount required by it to dischargein full its obligations to any creditor of Piltel and all its operating andfinancing subsidiaries and affiliates.  PLDT is subject to contractual restrictionslimiting the amount of financial support it can provide to Piltel up to US$150million.  As at June 30, 2005 and December 31, 2004, the remaining undrawnbalance available under the PLDT LOS is US$50 million, approximately Php2,823million and Php2,831 million, respectively, due to prior investments made fromMarch 23, 2000 to December 31, 2002 aggregating to US$100 million throughPLDT’s subscription to Series J Class I preferred shares of Piltel.  There wasno drawdown under the LOS in 2004.

 

Piltel’srestructured obligations are secured by substantially all present and futureassets of Piltel under the mortgage trust indenture, or MTI, dated June 4, 2001 betweenPiltel and Chase Manhattan Bank as security agent for the creditors, whichestablished the security arrangements relating to the restructured debts.  Theparticipating creditors (other than the participating holders of the Peso TermNote Facility) will share equally in first ranking security, whilenon-participating creditors and the participating holders of the Peso Term NoteFacility will share equally in second ranking security created under the MTI.Such mortgage was approved by at least two-thirds of Piltel’s stockholders atits annual meeting on April 18, 2001 and the NTC on May 18, 2001.

 

*Satellite**Acquisition Loans*

 

MabuhaySatellite has an existing Credit Agreement with the Export-Import Bank of the United States, or Ex-Im Bank, to finance a portion of the cost of purchasing theAgila II Satellite.  In 2003, Ex-Im Bank of the United States approved, inprinciple, the re-profiling of Mabuhay Satellite’s US$42 million debt with themby extending the maturity of the loan by 11⁄2 years to July 15, 2007 and reducing the interest rate by 1% to 5.6%.  The revised repayment terms have beenapproved by the majority of the local creditor banks.

 

Mabuhay Satellite also has an existing OmnibusAgreement with a syndicate of local banks, or the Banks, which includesissuance of irrevocable standby Letters of Credit with an aggregate statedvalue not exceeding US$39 million (Php2,171 million) in favor of U.S. Ex-ImBank, as security under the Credit Agreement and a term loan to MabuhaySatellite in the aggregate amount of US$26 million (Php1,465 million), whichwill mature on various dates from 2005 to 2007. 

 

MabuhaySatellite has constituted in favor of the Banks: (a) a first mortgage on itsleasehold rights under a lease agreement entered into with the Subic BayMetropolitan Authority and the components of the satellite system; (b) anassignment of its rights under its purchase contract for the satellite system;(c) an assignment of its rights under the transponder lease contracts to beentered into with its shareholders and other parties and the revenuestherefrom; and (d) an assignment of the applicable proceeds of insurance to betaken on the satellite system.

* *

***Japanese Yen Debt:***

* *

*JBIC JP¥9,760 Million Overseas**Investment**Term Loan*

 

On July 26, 2002, PLDTsigned a loan agreement with JBIC for a credit facility of JP¥9,760 millionunder JBIC’s OIL program.  The loan, which was drawn on July 31, 2002, isbeing amortized semi-annually beginning March 21, 2005and will mature on March 21, 2008.

 

*NEXI**Supported****JP**¥5,615 Million**Syndicated**Term**Loan**Facility*

 

On June 11, 2003, PLDTsigned a JP¥5,615 million syndicated term loan facility supported by NEXI, ofwhich JP¥2,520 million was drawn and JP¥1,890 million was outstanding as atJune 30, 2005.  The undrawn balance of JP¥3,095 million was cancelled at theend of the Availability Period on December 3, 2004.  This loan is beingamortized semi-annually beginning December 2004 and will mature in June 2008.

 

***PhilippinePeso Debt:***

* *

*Php2,**770**Million Peso Fixed Rate Corporate Notes*

 

Inconnection with PLDT’s service improvement and expansion programs, PLDT hasentered into two loan agreements, pursuant to each of which PLDT issued fixedrate corporate notes in three tranches.  Interest on each tranche is payablesemi-annually.

 

Underthe first loan agreement, PLDT borrowed an aggregate amount of Php1,500 million, of which Php230million matured on November 11, 2002, Php500 millionmatured on November 9, 2004 and Php770 millionwill mature on November 9, 2006.

 

Underthe second loan agreement, PLDT borrowed an aggregate amount of Php1,270 million, of which Php360million matured on June 9, 2003, Php100 millionmatured on June 9, 2005 and Php810 millionwill mature on June 9, 2010.

* *

*Term Loans*

* *

*JBIC 4 Program of the Development Bank of the**Philippines*

 

Inconnection with the Asia Pacific Cable Network 2 project, PLDT entered into aloan agreement on September 28, 2000 with Citibank, N.A., as facility agent,and a syndicate of banks in the aggregate principal amount of Php1,700 million, of which about Php340 million was outstanding as at June 30, 2005.  Theloan, which was funded under the JBIC Facility for Private Sector Developmentof the Development Bank of the Philippines, matures on October 26, 2005and since April 2002 is payable in quarterly installments as set forth below:

 

**Quarterly Payment Number**

**Percentage of Principal Payable on Each Quarterly Payment Date**

 

 

Payments 1–7 

3.500%

Payments 8–11

8.875%

Payments 12–15

10.000%

* *

*Secured**Term Loans*

* *

*Php150 Million**Term Loan Facility*

 

On March 4, 2002, ePLDTentered into a three-year loan facility with Philippine Bank of Communicationsamounting to Php150 million.  The loan facility was fully drawn on December 31, 2002 and payable in seven quarterly installments, with agrace period of one year, beginning year 2003.  The quarterly principalpayments of Php15 million started in June 2003 with a balloon payment of Php45million in March 2005.  Interest on this loan was equivalent to 91-day T-billrate plus 4% per annum payable quarterly in arrears.  The loan was secured byePLDT’s deed of assignment of receivables of a subsidiary from a foreigncustomer and an investment in an associate with an original cost of Php629million.  This loan was fully paid as at March 31, 2005.

 

*Php100 Million Term Loan Facility*

 

On March 15, 2004, ePLDT entered into anotherthree-year term loan facility with Asia United Bank amounting to Php100 millionfor the payment of its outstanding short-term bank loan facility and for otherworking capital requirements.  The loan facility was fully drawn as at December 31, 2004.The loan is to be repaid in nine equal quarterly installments starting March2005 with final repayment in March 2007.  Interest on the loan is equivalent to90-day PHIBOR plus 3% per annum payable quarterly in arrears.  The loan issecured by a Mortgage Trust Indenture Agreement, or MTIA, on a parcel of landwith a carrying value of Php279 million as at December 31, 2004.  As at June 30, 2005, theoutstanding balance of this loan amounted to Php78 million, of which Php22million will mature in 2005.

 

*Php149 Million Term Loan Facility*

 

Asat June 30, 2005, Vocativ, a wholly-owned call center subsidiary of ePLDT, hadan outstanding five-year term loan facility of Php129 million with Asia UnitedBank for the payment of its additional capital expenditures and working capitalrequirements.  The loan is to be repaid in 14 equal quarterly installmentsstarting April 2006 with final repayment in July 2009.  Interest on the loan isequivalent to 90-day PHIBOR plus 3% per annum payable quarterly in arrears.The loan is secured by a Mortgage Participation Certificate against the MTIAbetween ePLDT and Asia United Bank Corporation – Trust and Investments Groupdated March 15, 2004 on a parcel of land, which excludes the buildings andimprovements.  In April 2005, Php20 million of the loan was pre-terminated.

 

*DebtCovenants*

 

Ourdebt instruments contain restrictive covenants, including covenants that couldprohibit us from paying dividends on common stock under certain circumstances,and require us to comply with specified financial ratios and other financialtests, calculated in conformity with accounting principles generally acceptedin the Philippines, at relevant measurement dates, principally at theend of each quarterly period.  We have complied with all of our maintenancefinancial ratios as required under our loan covenants and other debtinstruments.  In addition, we are required to comply with certain financialratios for the incurrence of capital expenditures in excess of US$10 millionand incurrence of indebtedness.

 

Theprincipal factors that can negatively affect our ability to comply with thesefinancial ratios and other financial tests are depreciation of the Philippinepeso relative to the U.S. dollar, poor operating performance of PLDT and itsconsolidated subsidiaries, impairment or similar charges in respect ofinvestments or other long-lived assets that may be recognized by PLDT and itsconsolidated subsidiaries and increases in our interest expenses.  Interestexpense may increase as a result of various factors including issuance of newdebt, the refinancing of lower cost indebtedness by higher cost indebtedness,depreciation of the Philippine peso, the lowering of PLDT’s credit ratings orthe credit ratings of the Philippines, increase in reference interest rates, and generalmarket conditions.  Since approximately 98% of PLDT’s total consolidated debtsare denominated in foreign currencies, principally in U.S. dollars, many ofthese financial ratios and other tests are negatively affected by any weakeningof the peso.

 

PLDT’sdebt instruments contain a number of other negative covenants that, subject tocertain exceptions and qualifications, restrict PLDT’s ability to take certainactions without lenders’ approval, including: (a) incurring additionalindebtedness; (b) prepaying other debt; (c) making investments; (d) extendingloans; (e) extending guarantees or assuming the obligations of other persons;(f) paying dividends or other distributions or redeeming, repurchasing orotherwise acquiring shares of PLDT’s capital stock; (g) disposing of all orsubstantially all of its assets or of assets in excess of specified thresholdsof its tangible net worth; (h) entering into management contracts providing forthe management of its business or operations by a third party; (i) creating anylien or security interest; (j) permitting set-off against amounts owed to PLDT;(k) merging or consolidating with any other company; (l) entering intotransactions with stockholders and affiliates; and (m) entering into sale andleaseback transactions. 

 

Further, certain of PLDT’s debt instruments containprovisions wherein PLDT may be required to repurchase or prepay certainindebtedness in case of change in control of PLDT or if the ownership of ourshares of common stock held by NTT Communications falls below a certainthreshold.

 

PLDT’sdebt instruments also contain customary and other default provisions thatpermit the lender to accelerate amounts due or terminate their commitments toextend additional funds under the debt instruments. These default provisionsinclude: (a) cross-defaults and cross-accelerations that permit a lender todeclare a default if PLDT is in default under another debt instrument; in somecases, the cross-default provision is triggered upon a payment or other defaultpermitting the acceleration of PLDT’s debt, whether or not the defaulted debtis accelerated.  In other cases, the cross-default provision requires thedefaulted loan to be accelerated.  In some debt instruments, the cross-defaultprovision will be triggered only if the principal amount of the defaultedindebtedness exceeds a threshold amount specified in these debt instruments;(b) failure by PLDT to meet certain financial ratio covenants referred toabove; (c) the occurrence of any material adverse change in circumstances thata lender reasonably believes materially impairs PLDT’s ability to perform itsobligations under its debt instrument with the lender; (d) the revocation,termination or amendment of any of the permits or franchises of PLDT in any mannerunacceptable to the lender; (e) the abandonment, termination or amendment ofthe project financed by a loan in a manner unacceptable to the lender; (f) thenationalization or sustained discontinuance of all or a substantial portion ofPLDT’s business; and (g) other typical events of default, including the commencement of bankruptcy,insolvency, liquidation or winding up proceedings by PLDT.

 

Smart’sdebt instruments contain certain restrictive covenants, including covenantsthat prohibit Smart from paying dividends, redeeming preferred stock, makingdistributions to PLDT or otherwise providing funds to PLDT or any affiliatewithout the consent of its lenders under its Phases 1, 2 and 3 facilities.Also, Smart’s debt instruments contain certain restrictive covenants thatrequire Smart to comply with specified financial ratios and other financialtests at semi-annual measurement dates.  The financial tests under Smart’s loanagreements include compliance with a debt to equity ratio of not more than 1.50:1and a debt service coverage ratio of not less than 1.50:1.  Smart hasmaintained compliance with all of its financial covenants.  The agreements alsocontain customary and other default provisions that permit the lender toaccelerate amounts due under the loans or terminate their commitments to extendadditional funds under the loans.  These default provisions include: (a)cross-defaults and cross-accelerations that permit a lender to declare adefault if Smart is in default under another loan agreement.  Thesecross-default provisions are triggered upon a payment or other defaultpermitting the acceleration of Smart debt, whether or not the defaulted debt isaccelerated; (b) failure by Smart to comply with certain financial ratiocovenants; (c) any reduction in PLDT’s ownership of Smart’s shares below 51%;(d) any reduction in First Pacific’s and Metro Pacific Corporation’s collectivedirect and/or indirect ownership of PLDT’s common stock below 17.5% of thetotal common stock outstanding; and (e) the occurrence of any material adversechange in circumstances that the lender reasonably believes materially impairsSmart’s ability to perform its obligations under its loan agreements.

 

Asat June 30, 2005, Piltel was not in compliance with the terms ofconvertible bonds with principal amount of US$0.7 million (approximately US$0.9 millionredemption price at the option of the holders).  Piltel may not be able torestructure or otherwise pay the claims of its unrestructured debt.  However,default on and acceleration of Piltel’s unrestructured indebtedness does notcreate a cross-default under Piltel’s restructured indebtedness or anyindebtedness of PLDT or Smart.

 

The Creditand Omnibus Agreements of Mabuhay Satellite imposes several negativecovenants.  In particular, these covenants, among others, restrict materialchanges in Mabuhay Satellite’s nature of business and ownership structure, anylien upon or with respect to any of its assets or to any right to receiveincome, acquisition of capital stock, declaration and payment of dividends,merger, consolidation and sale with another entity and incurring orguaranteeing additional long-term debt beyond prescribed amounts.

 

ePLDT’sloan agreement imposes negative covenants which, among other things, restrictePLDT in regard to payment of cash dividends or any other income or any capitaldistribution to PLDT, voluntary suspension of its entire business operationsfor a period of 60 consecutive days, dissolution of its legal existence, andcreation of any encumbrances on the shares pledged.  One of ePLDT’s loanagreements also requires ePLDT to comply with specified financial ratios andother financial tests at quarterly measurement dates.  The agreement alsocontains customary and other default provisions that permit the lender toaccelerate amounts due under the loan or terminate their commitments to extendadditional funds under the loan.  As at June 30, 2005, ePLDT has complied withall of its financial covenants.

 

**ObligationsUnder Capital Lease**

 

The future minimum payments forcapitalized leases are as follows as at June 30, 2005:

 

**Year**

**(Unaudited)**

** **

(in million pesos)

2005(1)

535

2006

431

2007

317

2008

8

2009

7

2010 and onwards

444

Total minimum lease payments

1,742

Less amount representing interest

699

Present value of net minimum lease payments

1,043

Less capital lease maturing within one year

527

Long-term portion of obligations under capital lease

 516

 

*(1)**July 1, 2005**through**December 31, 2005**.*

* *

*MunicipalTelephone Projects*

 

In 1993,PLDT entered into two lease agreements with the Philippine Department ofTransportation and Communications, or DOTC, covering telecommunicationsfacilities in Bohol and Batangas established under the Municipal TelephoneAct.  Under these agreements, PLDT was granted the exclusive right to performtelecommunications management services, to expand services, and to promote theuse of the DOTC-contracted facilities in certain covered areas for a period of15 years.  Title to the properties shall be transferred to PLDT upon expirationof the lease term.  As at June 30, 2005, PLDT’s aggregate remaining obligationunder this agreement was approximately Php858 million.  In case ofcancellation, PLDT is liable to pay Php100 million under each of the twocontracts as liquidated damages.

 

On June 1,2004, PLDT served the DOTC a notice of termination of the lease agreement inrespect of the telecommunications system in Bohol which state of deterioration,obsolescence and disrepair have made it impossible for PLDT to continuemanaging, operating, and maintaining the system.  Since 2002, PLDT has beenadvising the DOTC of the need to review the viability of the system as it has infusedmore than Php200 million for upgrades and maintenance to keep the systemoperable.  Further, the enactment of Public Telecommunications Policy Act, orR.A. No. 7925, which negated the DOTC’s warranty to grant PLDT the exclusiveright to provide telecommunication services in the areas stipulated, preventedPLDT from achieving the originally projected profitability thereby rendering itimpossible for PLDT to continue fulfilling its obligation under the leaseagreement.  Although several discussions have been held since then to seek amutually acceptable agreement, no amenable arrangement has been reached.  On June 30, 2004, the DOTC advised PLDT that the request for termination of the leaseagreement in Bohol has been referred to the Department of Justice, or DOJ, asgovernment agencies are required to refer all interpretation of contracts andagreements to the DOJ secretary as attorney-general of the nationalgovernment.  On May 5, 2005, PLDT received a letter from the DOTC stating thatPLDT is in default for failure to remit to the DOTC the quarterly installmentsunder the lease agreement.  PLDT is intending to bring the matter toArbitration for the Financial Lease Agreement due to clearing opposingpositions of the parties.  As at June 30, 2005, the net book value of thetelecommunications system in Bohol, including PLDT’s additional capitalexpenditure relating to the telecommunications system, and correspondingcapital lease obligation amounted to Php35 million and Php735 million,respectively.

 

*Other Long-term Capital Lease Obligations*

 

The PLDT Group has various long-term lease contractsfor a period of three years covering various office equipment.  In particular,Smart and Piltel have capital lease obligations aggregating Php469 million asat June 30, 2005 in respect of office equipment and facilities.

 

Underthe terms of certain loan agreements and other debt instruments, PLDT may notcreate, incur, assume or permit or suffer to exist any mortgage, pledge, lienor other encumbrance or security interest over the whole or any part of itsassets or revenues or suffer to exist any obligation as lessee for the rentalor hire of real or personal property in connection with any sale and leasebacktransaction.

 

**Preferred Stock Subject to Mandatory Redemption**

 

The movements of PLDT’s preferred stock subject tomandatory redemption follow:

 

 

**June 30, 2005****(Unaudited)**

December 31, 2004 (Audited)

 

**Series V**

**Series VI**

**Series VII**

**Total**

Series V

Series VI

Series VII

Total

 

(in million pesos)

Balance at beginning of period

**2,104**

**6,242**

**6,029**

**14,375**

2,053

5,435

5,247

12,735

Conversion

**(945)**

**(80)**

**–**

**(1,025)**

(339)

(18)

–

(357)

Accretion

**180**

**413**

**152**

**745**

390

751

457

1,598

Revaluation

**–**

**(11)**

**(473)**

**(484)**

–

74

325

399

Balance at end of period

**1,339**

**6,564**

**5,708**

**13,611**

2,104

6,242

6,029

14,375

 

As at June 30, 2005, PLDT hadissued 3 million shares of Series V Convertible Preferred Stock, 5 millionshares of Series VI Convertible Preferred Stock and 4 million shares of SeriesVII Convertible Preferred Stock in exchange for Series K Class I ConvertiblePreferred Stock of Piltel, pursuant to the debt restructuring plan of Pilteladopted in June 2001.  Shares of Series V, VI and VII Convertible PreferredStock are entitled to receive annual dividends of Php18.70 per share, US$0.397per share and JP¥40.7189 per share, respectively.  Each share of Series V, VIand VII Convertible Preferred Stock is convertible at any time at the option ofthe holder into one PLDT common share.  On the date immediately following theseventh anniversary of the issue date of the Series V and Series VI ConvertiblePreferred Stock and on the eighth anniversary of the issue date of the SeriesVII Convertible Preferred Stock, the remaining outstanding shares under theseseries will be mandatorily converted to PLDT common shares.  Under a put optionexercisable for 30 days, holders of common shares received on mandatoryconversion of the Series V, VI and VII Convertible Preferred Stock will be ableto require PLDT to purchase such PLDT common shares for Php1,700 per share, US$36.132 per share, and JPY4,071.89 per share,respectively.

 

TheSeries V, VI and VII Convertible Preferred Stock were designated as compoundinstruments consisting of liability and equity components.  The total fair valueof the Series V, VI and VII Convertible Preferred Stock was determined at issuedate, of which the aggregate fair value of the liability component of theissued Series V, VI and VII Convertible Preferred Stock as at date of issuanceis included under the “Interest-bearing Financial Liabilities” account in theconsolidated balance sheets.  The residual amount was assigned as the equitycomponent.

 

Thedifference between the aggregate fair value of the Series V, VI and VIIConvertible Preferred Stock at issue date and the aggregate redemption value isaccreted over the period up to the put option date using the effective interestrate method.  Accretions added to “Preferred Stock Subject to MandatoryRedemption” and charged to interest for the six months ended June 30, 2005 and2004 amounted to Php745 million and Php756 million, respectively.

 

“PreferredStock Subject to Mandatory Redemption” amounted to Php13,611 million andPhp14,375 million as at June 30, 2005 and December 31, 2004, respectively, after revaluation of Series VI and VII Convertible Preferred Stock to theexchange rates at balance sheet dates and after giving effect to the aboveaccretions, conversions and additional issuances.  As at June 30, 2005 and December 31, 2004, 2,040,354 shares and 1,060,940 shares, respectively, of theConvertible Preferred Stock have been converted into PLDT common shares.  Theoutstanding shares of Series V, VI and VII Convertible Preferred Stock as at June 30, 2005 were 1,285,535, 4,690,655 and 3,842,000, respectively.  The aggregateredemption value of the outstanding Series V, VI and VII Convertible PreferredStock amounted to Php19,633 million and Php22,016 million as at June 30, 2005 and December 31, 2004, respectively.

 

Thecorresponding dividends on these shares charged as interest expense amounted toPhp132 million and Php117 million for the six months ended June 30, 2005 and 2004, respectively.

 

**NotesPayable**

 

Parlance,a wholly-owned call center subsidiary of ePLDT, has availed of a local bank’sExport Packing and Credit Loan facility amounting to US$950,000 in December2004 and another in June 2005 amounting to US$1 million.  The said facilitiescan be availed by an export Letter of Credit with an 80% loan value.  It has a90-day term from the date it was granted by the bank and is supported by a Deedof Assignment of Receivables.  Interest is based on the prevailing bank rate tobe collected in arrears on a monthly basis.  The US$950,000 loan facility wasfully paid in March 2005.

 

 

 

**18. Other Noncurrent Liabilities**

 

This account consists of:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Capital expenditures under long-term financing

**5,786**

 

3,970

Prepayment received under receivable purchase facility (Note 14)

**1,269**

 

1,644

Asset retirement obligations (Note 8)

**709**

 

638

Unearned revenues

**86**

 

85

Others

**791**

 

822

 

**8,641**

 

7,159

 

 

 

**19. AccruedExpenses and Other Current Liabilities**

 

This account consists of:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Accrued utilities and related expenses

**5,727**

 

4,457

Accrued taxes and related expenses

**2,582**

 

2,886

Accrued interest on various loans (Notes 17 and 20)

**2,142**

 

2,235

Accrual for payment for unused sick leave and other employee benefits

**1,663**

 

1,624

Payable in installment purchase of equity investment

**1,343**

 

1,561

Others

**2,647**

 

2,048

 

**16,104**

 

14,811

 

 

 

**20. Related Party Transactions**

 

*a.   Air Time Purchase Agreementbetween PLDT and AIL and Related Agreements*

 

In March 1997, PLDTentered into a National Service Provider, or Founder NSP, Air Time PurchaseAgreement with PT Asia Cellular Satellite, as amended in December 1998 and asassigned and transferred to AIL, under which PLDT was granted the exclusiveright to sell ACeS services in the Philippines.  In exchange, the Air Time Purchase Agreementrequired PLDT to purchase from PT Asia Cellular Satellite at least US$5 millionworth of air time annually over ten years, commencing on January 1, 2002, thedate of commercial operations.

 

In the event that PTAsia Cellular Satellite’s aggregate billing revenue is less than US$45 millionin any given year, the Air Time Purchase Agreement states that PLDT has to makesupplemental air time purchase payments not to exceed US$15 million per yearduring the ten-year term.

 

PLDT and the otherfounder NSPs are endeavoring to amend the Air Time Purchase Agreement due tothe occurrence of partial satellite loss, changes in the primary business ofACeS and other events affecting the business.

 

In March 2003, PLDT,together with the other founder NSPs, entered into a Standstill Agreement withAIL suspending the application and enforcement of the minimum and supplementalair time payments under the original Air Time Purchase Agreement.  The partiesagreed that AIL shall provide PLDT and the other founder shareholders, withunlimited use of air time for the year 2003 in exchange for a fixed fee in theamount of US$3.8 million for PLDT.  Moreover, PLDT was also obliged to purchasefrom AIL 13,750 satellite phone units in 2003 at US$395 F.O.B. per unit,subject to quarterly price adjustments.  The parties to the StandstillAgreement also agreed to negotiate in good faith and use their best efforts toreach an agreement on a revised Air Time Purchase Agreement before November 15,2003 that will cover, among other things, the amended minimum and supplementalair time payment provisions subject to the approval of AIL’s creditors.

 

On February 10, 2004, notwithstanding the ongoingnegotiations, AIL advised PLDT of the termination of the Standstill Agreementand the reinstatement of the terms under the original Air Time PurchaseAgreement effective January 1, 2002, following the lapse of the November 15,2003 deadline set in the Standstill Agreement for the negotiation of a revisedAir Time Purchase Agreement.  Negotiations are continuing with the relevantparties towards an amicable settlement of this matter.  As at June 30, 2005, PLDT’soutstanding payables under the original Air Time Purchase Agreement wasPhp4,068 million.  See *Note 22 – Contractual Obligations and CommercialCommitments* and *Note 23 – Provisions and Contingencies*for further discussion.

 

PLDT also entered into a Founder NSP OperatingAgreement with PT Asia Cellular Satellite on March 12, 1997,under which PLDT may:

 

•        authorize distributors to resellACeS services in the Philippines upon prior approval from PT Asia Cellular Satellite;and

 

•        appoint agents to solicit and billPLDT’s or its authorized distributors’ subscribers for ACeS services and tosell terminals on behalf of PLDT.

 

Underan Assignment and Assumption Agreement dated December 29, 1998, PT AsiaCellular Satellite agreed to assign and transfer to AIL of PT Asia CellularSatellite’s rights under the Founder NSP Air Time Purchase Agreement andFounder NSP Operating Agreement.

 

Under an Acknowledgment of the Assignment of Air TimePurchase Agreement entered into on December 29, 1998, by and among PLDT, P.T.Bank Internasional Indonesia and AIL, PLDT consented to the assignment by AILof the Founder NSP Air Time Purchase Agreement to P.T. Bank InternasionalIndonesia, as security agent, for the benefit of the secured parties under theSecurity Agreement dated December 29, 1998, which was executed in connectionwith the Amended and Restated Credit Agreement dated December 29, 1998 among PTAsia Cellular Satellite, AIL, P.T. Bank Internasional Indonesia and variousbanks.

 

OnSeptember 30, 2002, PT Asia Cellular Satellite, AIL, as guarantor, P.T. BankInternasional Indonesia, as security agent, and various other banks signed aRescheduling Agreement, which amended the terms of the Amended and RestatedCredit Agreement dated December 29, 1998, moving the principal repayment datesto agreed periods with the final maturity date on January 30, 2012.

 

*b.   Transactions with MajorStockholders, Directors and Officers*

 

Transactionsto which PLDT or its subsidiaries is a party, in which a director or keyofficer or owner of more than 10% of the common stock of PLDT, or any member of theimmediate family of a director or key officer or owner of more than 10%of the common shares of PLDT had a direct or indirect material interest in PLDTor its subsidiary, as at June 30, 2005 and December 31, 2004 and for the sixmonths ended June 30, 2005 and 2004 are as follows:

 

*1.   Agreements with NTT Communications and/or itsAffiliates*

 

PLDTis a party to the following agreements with NTT Communications and/or itsaffiliates:

 

•        *Advisory Services Agreement*.   On March 24, 2000, PLDT entered into an agreementwith NTT Communications, as amended on December 31, 2003, under which NTTCommunications provides PLDT with technical, marketing and other consultantsfor various business areas of PLDT starting April 1, 2000;

 

•        *Domestic Fiber Optic NetworkSubmerged Plant Maintenance Agreement*.On July 4, 2000, PLDT entered into an agreement with NTT WorldEngineering Marine Corporation, or NTT WEMC, for submarine cable repair andother related services for the maintenance of PLDT’s domestic fiber-opticnetwork, or DFON, submerged plant for a period of five years up to July 4, 2005.  Thisagreement has been extended up to the end of 2005.  Under the agreement, PLDTis required to pay NTT WEMC a fixed annual standing charge of US$2 million,excluding cost for the use of a remotely operated submersible vehicle atUS$5,000 for every day of use and repair cost computed at US$19,000 per day ofactual repair;

 

•        *Arcstar Licensing Agreement andArcstar Service Provider Agreement.*OnMarch 24, 2000, PLDT entered into an agreement with NTT WorldwideTelecommunications Corporation under which PLDT markets managed data and otherservices under NTT Communications’ “Arcstar” brand to its corporate customersin the Philippines.  PLDT also entered into a Trade Name and TrademarkAgreement with NTT Communications under which PLDT has been given the right touse the tradename “Arcstar” and its related trademark, logo and symbols, solelyfor the purpose of PLDT’s marketing, promotional and sales activities for theArcstar services within the Philippines; and

 

•        *Conventional InternationalTelecommunications Services Agreement*.On March 24, 2000, PLDT entered into an agreement with NTT Communicationsunder which PLDT and NTT Communications agreed to cooperative arrangements forconventional international telecommunications services to enhance theirrespective international businesses.

 

Total fees under these agreements amounted to Php114 million andPhp146 million for the six months ended June 30, 2005and 2004, respectively.  As at June 30, 2005 and December 31, 2004, outstandingobligations of PLDT amounted to Php55 million and Php49 million, respectively.

 

*2.   Agreement between Smart and**Asia**Link B.V., or ALBV.*Smart has anexisting Technical Assistance Agreement with ALBV for the latter to providetechnical support services and assistance in the operations and maintenance ofcellular business for a period of five years, subject to renewal upon mutualagreement between the parties.  The agreement provides for quarterly paymentsof technical service fees equivalent to 2% of the net revenues of Smart.  InJanuary 2004, the agreement was amended, reducing the technical service fees tobe paid by Smart to ALBV to 1% of net revenues effective January 1, 2004.  On February 18, 2004,Smart and ALBV entered into a renewal of the technical service agreementextending the effectivity of the terms of the agreement to February 23, 2008.Furthermore, in view of the acquisition by Smart of Piltel Series K Class IConvertible Preferred Stock held by PLDT, the parties agreed to make theconsolidated net revenues of Smart the basis for the computation of the 1%royalty payable by Smart to ALBV, effective from January 1, 2005.  

 

Smart also has an existing ServicesAgreement with ALBV for a period of 25 years starting January 1, 1999, which shallautomatically expire unless renewed by mutual agreement of both parties.  Underthe agreement, ALBV provides advice and assistance to Smart in sourcing capitalequipment and negotiating with international suppliers, arranging internationalfinancing and other services therein consistent with and for the furtherance ofthe objectives of the services.  Service agreement fees were paid for the whole25-year period.

 

ALBVis a subsidiary of the First Pacific Group.

 

Total fees under these agreements amounted to Php278million and Php239 million for the six months ended June 30, 2005 and 2004,respectively.  Outstanding obligations of Smart under the Technical ServiceAgreement amounted to Php284 million and Php267 million as at June 30, 2005 and December 31, 2004,respectively.

 

*3.   Agreements relating to insurance companies.*  Gotuaco del Rosario and Associates, or Gotuaco, actsas the broker for certain insurance companies to cover certain properties ofthe PLDT Group.  Insurance premiums are remitted to Gotuaco and the broker’sfees are settled between Gotuaco and the insurance companies.  In addition,PLDT has an insurance policy with Malayan Insurance Co., Inc., or Malayan,wherein premiums are directly paid to Malayan.  Total insurance expenses underthese agreements amounted to Php268 million and Php238 million for the six months ended June 30, 2005 and2004, respectively.  Two directors of PLDT have a direct/indirect interests inor serve as director/officer of Gotuaco and Malayan.

 

***Compensationof Key Management Personnel of the PLDT Group***

 

Theaggregate compensation and benefits paid to the chief executive officer and otherkey officers and advisors, as a group, for the six months ended June 30, 2005and 2004 amounted to approximately Php403 million and Php307 million,respectively.

 

Each of the directors, including the members of theadvisory board of PLDT, is entitled to a director’s fee in the amount ofPhp125,000 for each meeting of the board attended, except Manuel V. Pangilinan,who has waived his right to receive a director’s fee.  Each of the members oradvisors of the audit, executive compensation, governance and nomination andfinance committees is entitled to a fee in the amount of Php50,000 for eachcommittee meeting attended.

 

There are no agreements between PLDT and any of itsdirectors and key officers and advisors providing for benefits upon terminationof employment, except for such benefits to which they may be entitled underPLDT’s retirement plan.

 

 

 

**21. Employee Benefits**

 

***Executive Stock Option Plan, or ESOP***

 

On April 27, 1999 and December 10, 1999, the Board of Directors and stockholders, respectively, approved the establishment of an ESOPand the amendment of the Seventh Article of the Articles of Incorporation ofPLDT denying the pre-emptive right of holders of common stock to subscribe forany issue of up to 1,289,745 common stock pursuant to the ESOP.  The ESOPcovers management executives, which include officers with rank of VicePresident up to the President, executives with the rank of Manager up toAssistant Vice President, and advisors/consultants engaged by PLDT.  The ESOPseeks to motivate option holders to achieve PLDT’s goals, reward option holdersfor the creation of shareholder value, align the option holders’ interests withthose of the stockholders of PLDT and retain the option holders to serve thelong-term interests of PLDT.  The ESOP is administered by the ExecutiveCompensation Committee of the Board of Directors.  About 1.3 million commonstock of PLDT have been reserved as underlying shares of options under the ESOPin 1999. 

 

Movements in the number of stock option planoutstanding are as follows:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

Balance at beginning of period

**536,589**

 

900,118

Exercised shares*

**(168,961)**

 

(336,745)

Cancelled

**–**

 

(26,784)

Balance at end of period

**367,628**

 

536,589

 

****Based on date ofpayment of exercised shares.*

 

As at June 30, 2005, 505,706 shares were exercised by certain officers and executives at anexercise price of Php814 per share.  Of the 505,706 exercised shares, 7,798shares were unissued as at June 30, 2005.

 

Thefair value of the ESOP plan was estimated at the date of grant using an optionpricing model, which considered annual volatility of 40%, risk-free interestrate, expected life of option, exercise share price of Php814 and weightedaverage share price Php870 for the 1999 Grant and Php315 for the 2002 Grant asat valuation date.  Total fair value of shares granted amounted to Php359million as at June 30, 2005 and December 31, 2004.  The fair value of the options recognized as an expensefor the six months ended June 30, 2005 amounted to Php8 million and none for the six monthsended June 30, 2005.

*** ***

***LTIP***

 

On August 3, 2004,PLDT’s Board of Directors approved the establishment of the LTIP for eligiblekey executive officers and advisors of PLDT and its subsidiaries, which isadministered by the Executive Compensation Committee.  The LTIP is a four-yearcash plan covering the period January 1, 2004 to December 31, 2007.  The LTIPawards payment at the end of the four-year period (without interim payments) iscontingent upon the achievement of an approved target increase in PLDT’s commonshare price by the end of the plan period and a cumulative consolidated netincome target for the plan period.  The target increase in the PLDT base shareprice, which is the average of the closing prices of PLDT shares ten tradingdays before or after December 31, 2003, is approximately 15% per annum compounded for theplan period.

 

The fairvalue of the LTIP was estimated using an option pricing model, which consideredannual stock volatility, risk-free interest rate, expected life of option offour years and weighted average share price Php1,620 as at valuation date.  Thefair value of the options recognized as an expense for the six months endedJune 30, 2005 and 2004 amounted to Php610 million and Php269 million,respectively.

 

***Pension***

 

*Defined Benefit Plans*

 

We have defined benefit pension plans, coveringsubstantially all of our permanent and regular employees, except Smart, whichrequire contributions to be made to separate administrative fund.

 

Ouractuarial valuation is done on an annual basis.  Based on the latest actuarialvaluation, the actual present value of accrued liability, net of pension costand average assumptions used in developing the valuation are as follows:

 

 

(in million pesos)

Benefit obligation as at December 31, 2004

6,925

Fair value of plan assets as at December 31, 2004

4,449

Funded status

2,476

Unrealized net transition obligation

(120)

Unrecognized net actuarial gain

(176)

Accrued benefit cost as at December 31, 2004

2,180

Accrual of pension cost during the period

384

Contributions

(157)

Accrued benefit cost as at June 30, 2005

2,407

 

Net pension cost was computed as follows:

 

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Components of net periodic benefit cost:

** **

 

 

Service cost

**223**

 

213

Interest cost

**345**

 

269

Actual return on plan assets

**(238)**

 

(188)

Amortizations of unrecognized net transition obligation

**28**

 

28

Recognition of transitional liability

**2**

 

2

Net periodic benefit cost

**360**

 

 324

 

The weighted average assumptions used to determinepension benefits are as follows:

 

Discount rate

** **

 

9%

Rate of increase in compensation

** **

 

7%

Rate of return on plan assets

** **

 

9%

 

Asat June 30, 2005, our plan assets include investments in shares ofstock of PLDT and Piltel with fair values aggregating Php1,488 million,which represent about 23% of our beneficial trust fund’s net assets availablefor plan benefits.

 

*Defined Contribution Plan*

 

Smartmaintains a trustee-managed, tax-qualified, multi-employer plan coveringsubstantially all permanent and regular employees.  The plan has a definedcontribution format wherein Smart’s obligation is limited to specifiedcontribution to the plan.  It is being financed by the participating companies(Smart and its subsidiary, I-Contacts, Inc.) and employees’ contribution isoptional.

 

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

 

(in million pesos)

Expense recognized for defined benefit plans

**360**

 

324

Expense recognized for defined contribution plan

**24**

 

43

 

**384**

 

 367

 

 

 

**22. Contractual Obligations and CommercialCommitments**

 

***Contractual Obligations***

 

The following table discloses our contractualobligations outstanding as at June 30, 2005:

 

 

**Payments Due by Period**

 

**Total**

**Within 1 year**

**2****-3**

**years**

**4****-5**

**years**

**After 5 years**

 

(in million pesos)

 

 

 

 

 

 

Long-term debt(1)

141,468

29,036

38,385

21,173

52,874

Long-term lease obligations: 

 

 

 

 

 

Operating lease

3,704

624

1,103

843

1,134

Capital lease

1,742

760

524

13

445

Unconditional purchase obligations(2)

11,861

4,556

2,249

2,247

2,809

Other long-term obligations

19,633

–

5,853

13,780

–

**Total contractual obligations**

**178,408**

**34,976**

**48,114**

**38,056**

**57,262**

 

*(1)**Beforededucting unamortized debt discount and debt issuance costs.*

*(2)**Basedon the original Air Time Purchase Agreement with AIL.*

*** ***

*Long-termDebt*

*** ***

For a discussion of our long-term debt, see *Note 17*– *Interest-bearing Financial Liabilities*.

 

*Long-termOperating Lease Obligations*

 

*DomesticFiber Optic Network Submerged Plant Maintenance Agreement*.   As discussed in *Note 20 – Related Party Transactions*,PLDT entered into an agreement with NTT World Engineering Marine Corporation,or NTT WEMC, on July 4, 2000, for submarine cable repair and other relatedservices in relation to the maintenance of PLDT’s DFON submerged plant for aperiod of five years up to July 4, 2005.  This agreement has been extended up to the end of2005.  Under this agreement, PLDT is required to pay NTT WEMC a fixed annualstanding charge of US$2 million, excluding cost for the use of aremotely-operated submersible vehicle at US$5,000 for every day of use andrepair cost computed at US$19,000 per day of actual repair.  As at June 30, 2005, PLDT’saggregate remaining obligation under this agreement was approximately Php39million.

 

*Digital Passage Service Contracts*.   PLDT hasexisting Digital Passage Service Contracts with foreign telecommunicationadministrations for several dedicated circuits to various destinations for tento 25 years expiring at various dates.  As at June 30, 2005, PLDT’s aggregateremaining obligation under these contracts amounted to approximately Php24 million.

* *

*LicenseAgreement with Mobius Management Systems (**Australia**) Pty Ltd., orMobius.*PLDT entered into a licenseagreement with Mobius pursuant to which Mobius has granted PLDT anon-exclusive, non-assignable and non-transferable license for the use ofcomputer software components.  Under this agreement, Mobius is also required toprovide maintenance services for a period of one year at no additionalmaintenance charge.  PLDT may purchase maintenance services upon expiration ofthe first year for a fee of 15% of the current published license fee.  As at June 30, 2005, PLDT’saggregate remaining obligation under this agreement was approximately Php40 million.

 

*Other Long-term Operating Lease Obligations*.   The PLDT Group has various long-term leasecontracts for periods ranging from two to ten years covering certain offices,warehouses, cell sites telecommunication equipment locations and various officeequipment.  In particular, Smart has lease obligations aggregating Php3,325 million asat June 30, 2005 in respect of office and cell site rentals with over3,000 lessors nationwide, PLDT has lease obligations aggregating Php96  millionas at June 30, 2005, and ePLDT has lease obligations aggregating Php180million as at June 30, 2005 in respect of certain office space rentals.

 

*Long-termCapital Lease Obligations*

 

For a discussion of our long-term capital leaseobligations, see *Note 17 – Interest-bearing Financial Liabilities*.

 

*UnconditionalPurchase Obligations*

 

*AirTime Purchase Agreement with AIL.*Asdiscussed in *Note 20 – Related Party Transactions*, PLDT is a party to aFounder NSP Air Time Purchase Agreement with AIL in March 1997, which wasamended in December 1998, under which PLDT is granted the exclusive right tosell AIL services in the Philippines.  In exchange, the Air Time PurchaseAgreement required PLDT to purchase from AIL a minimum of US$5 million worth ofair time annually over ten years commencing on January 1, 2002, the date ofcommercial operations of the Garuda I Satellite.

 

Inthe event that AIL’s aggregate billing revenue is less than US$45 million inany given year, the Air Time Purchase Agreement also states that PLDT has tomake supplemental air time purchase payments not to exceed US$15 million peryear during the ten-year term.

 

PLDTand the other founder NSPs are endeavoring to amend the Air Time PurchaseAgreement due to the occurrence of partial satellite loss, changes in theprimary business of ACeS and other events affecting the business.

 

InMarch 2003, PLDT, together with the other founder NSPs, entered into aStandstill Agreement with AIL suspending the application and enforcement of theminimum and supplemental air time payments under the original Air Time PurchaseAgreement.  The parties agreed that AIL shall provide PLDT and the otherfounder shareholders, with unlimited use of air time for the year 2003 inexchange for a fixed fee in the amount of US$3.8 million for PLDT.  Moreover,PLDT is also obliged to purchase from AIL 13,750 satellite phone units in 2003at US$395 F.O.B. per unit, subject to quarterly price adjustments.  The partiesto the Standstill Agreement also agreed to negotiate in good faith and usetheir best efforts to reach an agreement on a revised Air Time PurchaseAgreement before November 15, 2003 that will cover, among other things, theamended minimum and supplemental air time payment provisions subject to theapproval of AIL’s creditors.

 

OnFebruary 10, 2004, notwithstanding the ongoing negotiations, AIL advised PLDTof the termination of the Standstill Agreement and the reinstatement of theterms under the original Air Time Purchase Agreement effective January 1, 2002following the lapse of the November 15, 2003 deadline set in the Standstill Agreementfor the negotiation of a revised Air Time Purchase Agreement.  Negotiations arecontinuing with the relevant parties towards an amicable settlement of thismatter.  See *Note 20 – Related Party Transactions* and *Note 23 –Provisions and Contingencies*for further details relating to the Air TimePurchase Agreement with AIL.

 

As at June 30, 2005, PLDT’s aggregate remaining minimumobligation under the original Air Time Purchase Agreement was approximately Php11,857 million.

 

*International Affiliate Agreement with VeriSign, Inc.,or VeriSign*.   On September 15, 2000,ePLDT entered into an agreement with VeriSign for the non-exclusive,non-transferable right and license to use the VeriSign software, brand andCertification Practice Statement for the purpose of approving, issuing,suspending or revoking digital certificates for users of the internet orsimilar open systems in the Philippines for a period of seven years.  Under this agreement,ePLDT is required to pay VeriSign a certain percentage of the revenue derivedfrom the services subject to minimum annual royalty payments aggregating toUS$11 million, which was subsequently reduced to US$1 million, for theseven-year contract period.  In addition, ePLDT was required to pay an annualsupport fee of US$0.5 million during the first year and US$0.3 million in eachyear thereafter.  

 

EffectiveJuly 1, 2003, VeriSign has agreed to amend the Agreement and issued Addendum 6to write-off all past due invoices and payments owed to VeriSign, which wereinvoiced or scheduled to be invoiced under the agreement prior to this Addendum6.  All royalty payments and annual support fees due through June 2003 werepart of the write-off in the amount of US$0.8 million.  For contract year 4(September 2003 to August 2004), the annual support fee was reduced from US$0.3 million to US$40,000 andfor contract years 5 to 7 (September 2004 to August 2007) from US$0.3 millionto US$0.16 million.  In addition, VeriSign agreed to reduce the affiliaterevenue sharing rates from 50% of suggested retail price to 25% of suggestedretail price for both enterprise and internet products for 12 months startingJuly 2003 and negotiable thereafter.  

 

Moreover,effective July 1, 2004, VeriSign has agreed to amend the Agreement andissued Addendum 8 as an extension of Addendum 6.  Under this amendment, annualsupport fee for year 5 (September 2004 to August 2005) will remain at US$40,000and affiliate revenue sharing rates will remain at 25%.  As at June 30, 2005,ePLDT’s aggregate remaining minimum obligation under this agreement wasapproximately Php4 million pertaining to annual support fee.

 

*LicensePurchase Agreement with I-Contact Solutions Pte. Ltd.*  On April 2, 2003, iPlus is a wholly-owned subsidiaryof ePLDT and the Philippines’ pioneer in IP-based IT response center, entered intoan Application Services Provider, or ASP, and Reseller Contract with I-ContactSolutions Pte. Ltd., or I-Contact, of Singapore.  Under the agreement, iPlus will purchase licensesof the CosmoCall Universe TM IP-based contact center solution.  CosmoCallUniverse supports multi-channel customer interactions including telephone, webchat, web voice, web video, web collaboration, e-mail and voicemail in one highcapacity, high availability, multi-tenant platform.  CosmoCall Universe is acomplete, unified contact center suite that includes ACD, IVR, CTI, predictivedialing, multimedia recording and a complement of other managementapplications.  The aggregate value of these licenses is US$2.1 million andthese licenses will be delivered quarterly over a two-year period.  Further tothe agreement, I-Contact will appoint iPlus as the exclusive reseller and ASPfor the Philippine market and will provide iPlus with all the necessary supportin terms of sales, marketing, and technical services.  Effective March 30, 2004,I-Contact has agreed to amend the agreement and waived all financialobligations and committed seats requirement over the two-year period.  iPluswill pay all its remaining obligations pertaining only to the 300 seatsdelivered by I-Contact.  In June 2005, iPlus committed to purchase additional50 predictive dialer and Cosmocorder licenses in the amount of Php18 million.

 

*Other Long-term Obligations*

 

*Mandatory Conversion and Purchase of Shares*.   As discussed in *Note 9 – Investments inAssociates*and *Note 17 – Interest-bearing Financial Liabilities*, asat June 30, 2005, PLDT had issued a total of 3 million shares of Series VConvertible Preferred Stock, 5 million shares of Series VI ConvertiblePreferred Stock and 4 million shares of Series VII Convertible Preferred Stockin exchange for a total of 58 million shares of Series K Class I ConvertiblePreferred Stock of Piltel, pursuant to the debt restructuring plan of Pilteladopted in June 2004.

 

Eachshare of Series V, VI and VII Convertible Preferred Stock is convertible at anytime at the option of the holder into one PLDT common share.  On the dateimmediately following the seventh anniversary of the issue date of the Series Vand Series VI Convertible Preferred Stocks and on the eighth anniversary of theissue date of the Series VII Convertible Preferred Stock, the remainingoutstanding shares under these series will be mandatorily converted to PLDTcommon shares.  Under a put option exercisable for 30 days, holders of commonshares received on mandatory conversion of the Series V, VI and VII ConvertiblePreferred Stock will be able to require PLDT to purchase such PLDT commonshares for Php1,700 per share, US$36.132 per share, and JPY4,071.89 per share,respectively.  

 

As at June 30, 2005, 1,435,905 shares of Series V Convertible Preferred Stock and 604,449 sharesof Series VI Convertible Preferred Stock had been converted to PLDT commonshares.  The aggregate value of the put option based on outstanding shares asat June 30, 2005 was Php19,633 million, of which Php11,706 million is payableon June 4, 2008 and Php7,927 million on June 4, 2009, if all of the outstandingshares of Series V, VI and VII Convertible Preferred Stock were mandatorilyconverted and all the underlying common shares were put to PLDT.  As at June 30, 2005, 1,285,535 shares of Series V, 4,690,655 shares of Series VI and 3,842,000shares of Series VII Convertible Preferred Stock remain outstanding.  Themarket value of the underlying shares of common stock was Php13,549 million,based on the market price of PLDT common shares of Php1,620 per share as at June 30, 2005.

 

***Commercial Commitments***

 

As at June 30, 2005, our outstanding commercialcommitments, in the form of letters of credit, amounted to Php947 million.These commitments will expire within one year.

 

 

 

**23. Provisionsand Contingencies**

 

Wehave made a reasonable estimate of the amount necessary to pay or settle thecontested assessment in the event of an unfavorable judgment against us andhave made the appropriate provisions in our unaudited consolidated financialstatements as at June 30, 2005 aggregating Php5,854 million in respect of thefollowing:

 

*NTCsupervision and regulation fees, or SRF*

 

Since1976, PLDT has received assessments from NTC for permit, SRF and other chargespursuant to Section 40 of Commonwealth Act 146, otherwise known as the PublicService Act.  As at June 30, 2005, PLDT has paid, since 1994, a total amount ofPhp1,718 million in SRF, of which Php1,508 million was paid under protest.

 

PLDTis contesting the manner by which these assessments were calculated and thebasis for such calculations.  The case is now with the Supreme Court and uponthe rules and practice of court, stands submitted for decision.

 

Smartand Piltel have similarly received assessments from NTC for permit, SRF andother charges which were paid under protest.  Total payments amounted to Php122million each in 2004 and 2003.  Morever, on February 11, 2005,Piltel paid under protest the amount of Php559 million in respect of NTC feesfor the period from 1992 to 2004.

 

*Local business andfranchise tax assessments*

 

PLDTis presently a party to several cases involving the issue of exemption of PLDTfrom local franchise and business taxes.  PLDT believes, based on the opinionof its legal counsel, that it is exempt from payment of local franchise andbusiness taxes. 

 

The LocalGovernment Code of 1991, or R.A. No. 7160, which took effect on January 1, 1992, extended to local government units, or LGUs, power to tax businesseswithin their territorial jurisdiction granted under Batas Pambansa No. 337 andwithdrew tax exemptions previously granted to franchise grantees under Section12 of R.A. No. 7082. 

 

PLDTbelieves, based on the opinion of its legal counsel, that R.A. No. 7925 whichtook effect on March 16, 1995, and the grant of local franchise and businesstaxes exemption privileges to other franchise holders subsequent to theeffectivity of R.A. No. 7160, implicitly restored its local franchise and businesstaxes exemption privilege under Section 12 of R.A. No. 7082, or the PLDTFranchise pursuant to Section 23 thereof or the quality of treatment clause. 

 

Toconfirm this position, PLDT sought and obtained on June 2, 1998 a ruling from theBureau of Local Government Finance, or BLGF, of the Philippine Department ofFinance, which ruled that PLDT is exempt from the payment of local franchiseand business taxes imposable by LGUs under R.A. No. 7160.

 

By virtueof the BLGF Ruling, PLDT stopped paying local franchise and business taxesstarting with the fourth quarter of 1998 and has filed with certain LGUs claimsfor tax refund covering the period from the second quarter of 1995 to the thirdquarter of 1998.  PLDT has received assessments for local franchise andbusiness tax from several cities and provinces following PLDT’s decision tostop payment of local franchise and business taxes.  

 

Followinga decision of the Supreme Court on March 25, 2003, a judgment in the amount ofPhp4 million against PLDT involving the City of Davao became final andexecutory on April 9, 2003, pursuant to which PLDT was declared not exempt fromthe local franchise tax.  Although PLDT believes that it is not liable to paylocal franchise and business taxes, PLDT has entered into compromisesettlements with several LGUs in order to maintain and preserve its goodstanding and relationship with these LGUs.  Under these compromise settlements,which have been approved by the relevant courts, PLDT has paid a total amountof Php55 million as at June 30, 2005 for local franchise tax covering up to endof 2004.

 

PLDTcontinues to contest the remaining assessments amounting to Php3.7 million asat June 30, 2005, a number of which were based on the gross revenues of PLDTderived from its operations within the entire Philippines.  PLDT claims thatassuming that it is liable for local franchise tax, R.A. No. 7160 provides thatlocal franchise tax shall be based on the gross receipts of the preceding yearreceived or collected for services rendered within the jurisdiction of thetaxing authority.  Therefore, the use by some LGUs of gross revenues as thebasis for computation of franchise tax is in gross violation of the law becauseit pertains to all income earned regardless of whether it was received or not,unlike gross receipts which are essentially the amount of money or itsequivalent actually or constructively received.  Moreover, gross revenues referto all income earned by PLDT within and outside the jurisdiction of the localtaxing authority; thus, the use thereof as a basis of computation willexceptionally overstate the franchise tax.

 

In apetition recently filed with the Supreme Court involving another LGU, PLDT hasappealed to the Supreme Court for a re-examination of its decision in the Cityof Davao case in light of the strong dissenting opinion in that case concurredin by four other Justices of the Supreme Court.  PLDT currently expects thatgoing forward it will pay local franchise and business taxes on an annual basisand based on the gross receipts received or collected for services renderedwithin the jurisdiction of the respective taxing authority.

 

Smart has,likewise, received assessments for local franchise and business taxes fromcertain cities and provinces in the aggregate amount of Php313 million, whichSmart continues to contest.  Smart believes, based on the opinion of its legalcounsel, that Smart is not liable to pay the local franchise and business taxesby virtue of (i) the opinion issued by the BLGF dated August 13, 1998; and (ii)Smart’s exemption under its legislative franchise which took effect after theeffective date of R.A. No. 7160.

 

Smart hasrecently been declared exempt from payment of local franchise tax to the Cityof Makati in a decision dated August 3, 2004 by the Regional Trial Court ofMakati.  The City of Makati has filed their motion for reconsideration andSmart has filed its opposition to that motion for reconsideration.  The RTC ofMakati has denied Makati’s Motion for Reconsideration on November 12, 2004.  They have filed a Motion for Extension to file a Petition for Review with theCourt of Appeals.  However, on June 9, 2005, the Court of Appeals has dismissedthe appeal filed by the City of Makati.

 

TheRTC of Iloilo has likewise ruled in a decision dated January 19, 2005 thatSmart is exempt from payment of local franchise tax to the City of Iloilo.  TheCity of Iloilo has filed an appeal directly with the Supreme Courtbut the Court has yet to give it due course.

 

*Piltel’s Bureau of Internal Revenue, or BIR,Assessment*

 

Piltel received the following assessment noticesfrom the BIR:

 

**Year**

**Tax Assessment Type**

**Basic**

**Interest**

**Total**

 

 

(in million pesos)

1998

Value Added Tax, or VAT

85.7

68.7

 154.4

 

Overseas Communications Tax

31.8

25.5

  57.3

 

Income Tax

12.4

9.4

  21.8

 

Administrative Penalties

0.1

–

   0.1

 

 

 

 

 

1999

VAT

82.8

67.8

 150.6

 

Income Tax

17.8

13.8

  31.6

 

 

 

 

 

2001

VAT

56.1

35.1

  91.2

 

Income Tax

13.4

8.9

  22.3

 

Piltelfiled applications for compromise settlement with the BIR for the deficiencytax assessments of 1998 and 1999, citing as basis for the compromise settlementits financial incapacity on account of networth and earnings deficit.  LastJune 22, 2005, however, Piltel received a letter from the BIR dated May 9, 2005 denyingthe applications for compromise settlements for the 1998 and 1999 taxassessments.  Piltel intends to file a request for reconsideration with the BIRby presenting its latest audited and unaudited financial statements, whichindicate that Piltel would still have networth and earnings deficit.  Ifreconsidered, Piltel would be permitted to settle its deficiency taxliabilities by paying 10% to 40% of the assessed deficiency taxes.

 

Piltelfiled last June 20, 2005 an administrative protest in connection with the 2001tax assessment.  Last July 1, 2005, Piltel received a tax verification notice,which granted a request for reinvestigation for the 2001 tax assessment.  Piltelalso intends to pursue an application for compromise settlement with the BIRonce the reinvestigation is concluded and the tax assessment finalized.

 

*AirTime Purchase Agreement with AIL*

*** ***

InMarch 1997, PLDT entered into a Founder NSP Air Time Purchase Agreement with PTAsia Cellular Satellite as amended in December 1998 and as assigned andtransferred to AIL, under which PLDT was granted the exclusive right to sellACeS services in the Philippines.  The Air Time Purchase Agreement required PLDT topurchase from PT Asia Cellular Satellite at least US$5 million worth of airtime annually over ten years, commencing on January 1, 2002, the date ofcommercial operations and has to make supplemental air time purchase paymentsnot to exceed US$15 million per year during the ten-year term in the eventrevenues generated are less than US$45 million in any given year.  The air time payment obligations shall remain ineffect until all indebtedness incurred by AIL have been fully repaid.  See *Note 20 – Related Party Transactions* and *Note22 – Contractual Obligations and Commercial Commitments* for detaileddiscussion of the terms of the agreement.

 

PLDT andthe other founder NSPs are endeavoring to amend the Air Time Purchase Agreementdue to the occurrence of partial satellite loss, changes in the primarybusiness of ACeS and other events affecting the business.

 

In March2003, PLDT, together with the other founder NSPs, entered into a StandstillAgreement with AIL.  Payments made to AIL under the Air Time Purchase Agreementbased on billings of actual usage and the Standstill Agreement amounted to US$2million and US$1 million for the second quarters of 2005 and 2004,respectively.

 

OnFebruary 10, 2004, notwithstanding the ongoing negotiations, AIL advised PLDTof the termination of the Standstill Agreement and the reinstatement of theterms under the original Air Time Purchase Agreement effective January 1, 2002following the lapse of the November 15, 2003 deadline set in the StandstillAgreement for the negotiation of a revised Air Time Purchase Agreement.  As at June 30, 2005, PLDT’s outstanding payables under the original Air Time Purchase Agreementwas approximately Php4,068 million.  Negotiations are continuing with therelevant parties towards an amicable settlement of this matter.  Prior tofurther negotiation of definitive transaction agreement among the parties, PLDTdeposited US$21.5 million in an escrow account on March 28, 2005 which was tobe disbursed upon the execution and delivery of mutually agreeable definitivetransaction agreement on or before April 29, 2005.  The parties involved hadnot reached an agreement and on May 2, 2005, PLDT formally requested for thereturn of amount deposited which was returned on May 12, 2005.

 

On June21, 2004, AIL also sent PLDT a letter citing PLDT in default under the Air TimePurchase Agreement for non-payment of outstanding amounts and for repudiationof its obligations thereunder.  PLDT maintains, however, that the terminationof the Standstill Agreement and reinstatement of the terms under the originalAir Time Purchase Agreement are premature, considering that the discussions ornegotiations on the terms of the proposed revised Air Time Purchase Agreementwere still pending between the parties, such that it is highly inequitable forAIL to have unilaterally decided to invoke the provisions of the StandstillAgreement and declared PLDT in default.  Furthermore, PLDT maintains itsposition that the Air Time Purchase Agreement has been rendered ineffective byvarious events, circumstances and technical problems encountered in theoperation of the business of AIL.  The substantial changes in the circumstancesunder which AIL must operate, changes which were not contemplated by theparties at the time the commitments were made, have rendered the commitmentsunder the Air Time Purchase Agreement unrealistic and the performance of thesame impossible.

 

Asat June 30, 2005, PLDT’s aggregate remaining minimum obligation underthe original Air Time Purchase Agreement was approximately Php11,857 million.

 

Wemade a reasonable estimate of the amount necessary in the event such obligationwould be settled and have made the appropriate provisions in our unauditedconsolidated financial statements as at June 30, 2005 with due consideration ofAIL’s existing indebtedness and of PLDT’s share as one of the founder NSPs.  

 

 

 

**24. Financial Assets and Liabilities**

 

Ourfinancial assets and liabilities are recognized initially at fair value.Transaction costs (debt issuance costs) are included in the initial measurementof all financial assets and liabilities except for financial instrumentsmeasured at fair value through profit and loss.  Subsequent to initialrecognition, assets and liabilities are either valued at amortized cost usingthe effective interest rate method or at fair value depending onclassification.

 

Thefollowing table sets forth the carrying values and estimated fair values of ourfinancial assets and liabilities recognized as at June 30, 2005 and December 31, 2004.  There are no material unrecognized financial assets and liabilities asat June 30, 2005 and December 31, 2004.

 

** **

**Carrying Value**

**Fair Value**

** **

**June 30,  2005****(Unaudited)**

December 31,  2004 (Audited)

**June 30,  2005****(Unaudited)**

December 31,  2004 (Audited)

 

(in million pesos)

**Noncurrent Financial Assets**

** **

 

 

 

Investments-available-for-sale

**109**

104

**109**

104

Derivative assets

**3,694**

4,116

**3,694**

4,116

Notes receivable

**346**

286

**346**

286

Total noncurrent financial assets

**4,149**

4,506

**4,149**

4,506

**Current Financial Assets**

** **

 

 

 

Cash and cash equivalents

**35,629**

27,321

**35,629**

27,321

Short-term investments

**27**

3,873

**27**

3,873

Trade and other receivables

**8,457**

10,404

**8,457**

10,404

Derivative assets

**217**

335

**217**

335

Total current financial assets

**44,330**

41,933

**44,330**

41,933

**Total Financial Assets**

**48,479**

46,439

**48,479**

46,439

** **

** **

 

 

 

**Noncurrent Financial Liabilities**

** **

 

 

 

Long-term debt - net of current portion*

**102,675**

121,012

**112,214**

132,803

Obligations under capital lease*

**516**

601

**516**

601

Preferred stock subject to mandatory redemption*

**13,611**

14,375

**16,994**

18,237

Derivative liabilities

**4,755**

5,903

**4,755**

5,903

Total noncurrent financial liabilities

**121,557**

141,891

**134,479**

157,544

**Current Financial Liabilities**

** **

 

** **

 

Notes payable*

**56**

58

**56**

58

Current portion of long-term debt*

**28,880**

28,018

**29,614**

29,083

Obligations under capital lease*

**527**

425

**527**

425

Accounts payable

**5,300**

7,029

**5,300**

7,029

Derivative liabilities

**229**

474

**229**

474

Total current financial liabilities

**34,992**

36,004

**35,726**

37,069

**Total Financial Liabilities**

**156,549**

177,895

**170,205**

194,613

 

*    *Included under “Interest-bearing Financial Liabilities”in the consolidated balance sheets.*

 

Thefollowing methods and assumptions were used to estimate the fair value of eachclass of financial instrument for which it is practicable to estimate suchvalue:

 

Interest-bearing Financial Liabilities:

 

*Long-term debt:*Fair value is based on the following:

 

**Debt Type**

**Fair Value Assumptions**

Fixed Rate Loans:

U.S. dollar notes/convertible debt

Other loans in all other currencies

 

Quoted market price.

Estimated fair value is based on the discounted value of future cash flows using the applicable rates for similar types of loans.

Variable Rate Loans

The carrying value approximates fair value because of recent and regular repricing based on market conditions.

 

*Preferredstock subject to mandatory redemption:*The fair values were determined using an independent third party valuationmodel.

 

Derivative instruments:

 

*Forward foreign exchange contracts and bifurcatedforeign currency forwards:* The fairvalues were determined using forward exchange market rates at the balance sheetdate.

 

*Foreigncurrency options:*  The fair valueswere computed using an option pricing model.

 

*Foreigncurrency and interest rate swaps:*  The fair values were computed as thepresent value of estimated future cash flows.

 

Due to theshort-term nature of the transactions, the fair value of cash and cashequivalents, short-term investments, trade and other receivables, notes payableand accounts payable approximate amount of consideration at the time of initialrecognition.

 

*Financialassets and liabilities carried at amortized cost*

 

Unamortizeddebt discount, representing debt issuance cost and any difference between thefair value of consideration given or received on initial recognition, includedin following financial liabilities amounted to Php15,370 million and Php17,363million as at June 30, 2005 and December 31, 2004, respectively, see *Note 17– Interest-bearing Financial Liabilities*.

 

*Financialassets and liabilities carried at fair value*

 

Thefollowing financial assets and liabilities carried at fair value as at June 30, 2005 and December 31, 2004.

 

 

**June 30,  2005****(Unaudited)**

December 31, 2004 (Audited)

 

(in million pesos)

Investments-available-for-sale

**109**

104

Derivative instruments

**(1,073)**

(1,926)

 

**(964)**

(1,822)

 

*DerivativeFinancial Instruments*

 

Ourderivative financial instruments are accounted for as either cash flow hedgesor transactions not designated as hedges.  Cash flow hedges refer to thosetransactions that hedge our exposure to variability in cash flows attributableto a particular risk associated with a recognized asset or liability. Changesin the fair value of these instruments are recognized as cumulative translationadjustments in equity until the hedged item is recognized in earnings.  Fortransactions that are not designated as hedges, any gains or losses arisingfrom the changes in fair value are recognized directly to income for theperiod.

 

The tablebelow sets out the information about our derivative financial instruments as at June 30, 2005 and December 31, 2004:

 

** **

**June 30, 2005****(Unaudited)**

December 31, 2004 (Audited)

 

** **

 

**Maturity**

**Notional Amount**

**Mark-to-market Gain (Loss)**

Notional Amount

Mark-to-market Gain (Loss)

 

 

(in millions)

***PLDT***

** **

** **

 

 

 

** **

** **

 

 

Cash flow hedges:

** **

** **

 

 

Long-term currency swaps

** **

** **

 

 

 

2017

**US$****300**

**Php****624**

US$300

Php748

 

2012

**250**

**(361)**

250

282

 

** **

** **

 

 

Long-term foreign currency options

2009

**175**

**915**

175

672

 

 

** **

** **

 

 

Short-term foreign currency options

**76**

**(156)**

76

(198)

 

** **

** **

 

 

Transactions not designated as hedges:

** **

** **

 

 

Long-term foreign currency options

**175**(1)

**76**

175(1)

(22)

 

** **

** **

 

 

Short-term currency options

**88**(3)

**76**

76(2)

117

 

**JPY****655**

**(12)**

JPY–

–

 

** **

** **

 

 

Interest rate swap

**US$125**

**(2,315)**

US$125

(3,468)

 

** **

** **

 

 

Forward foreign exchange contracts

**87**

**92**

87

6

 

**JPY****879**

**(19)**

JPY14

1

 

** **

** **

 

 

Bifurcated embedded derivatives

**US$****–**

**–**

US$1

(1)

 

** **

**(1,080)**

 

(1,863)

***Smart***

 

** **

 

* *

 

** **

** **

 

 

Transactions not designated as hedges:

** **

** **

 

 

Forward foreign exchange contracts

**US$****–**

**(1)**

US$69

(77)

Bifurcated embedded derivatives

**9**

**8**

19

14

 

** **

**7**

 

(63)

Net liabilities

** **

**(Php****1,073)**

 

(Php1,926)

 

*(1)**Non-hedged portion of 2009 long-term foreigncurrency options based on the same notional amount as the hedged portion.*

*(2)**Non-hedged portion of short-term foreign currencyoptions based on the same notional amount as the hedged portion.*

*(3)**Non-hedged portion of short-term foreign currencyoptions is inclusive of the same notional amount as the hedged portion andadditional short-term foreign currency options not designated as hedges.*

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Presented as:

** **

 

 

Noncurrent assets

**3,694**

 

4,116

Current assets

**217**

 

335

Noncurrent liabilities

**(4,755)**

 

(5,903) 

Current liabilities

**(229)**

 

(474)

Net liabilities

**(1,073)**

 

(1,926)

 

Cumulative translation adjustments as at June 30, 2005 and December 31, 2004 consists of:

 

 

**June 30,  2005****(Unaudited)**

 

December 31, 2004 (Audited)

 

(in million pesos)

Cumulative translation adjustments – beginning

**362**

 

549

Movements of cumulative translation adjustments:

** **

 

 

Currency translation differences

**(2)**

 

17

Net loss on cash flow hedges

**(867)**

 

(159)

Net gain (loss) on available-for-sale financial assets

**6**

 

(5)

Net gain (loss) on cash flow hedges removed from cumulative translation adjustments and taken to profit or loss

**131**

 

(133)

Deferred income tax effects on cash flow hedge

**236**

 

93

 

**(496)******

 

(187)

Cumulative translation adjustments – ending

**(134)**

 

 362

 

Analysisof gain (loss) on derivative transactions for the six months ended June 30, 2005 and 2004 are as follows:

 

 

**Six Months Ended June 30,**

 

**2005**

 

2004

 

(Unaudited)

Net mark-to-market loss – ending

**(1,073)**

 

(1,664)

Net mark-to-market loss – beginning

**(1,926)**

 

(1,060)

Net change

**853**

 

(604)

Net loss charged to cumulative translation adjustments

**867**

 

–

Gain (loss) on contracts entered into and terminated during the period

**(533)**

 

99

Net gain (loss) on derivative transactions

**1,187**

 

(505)

 

***PLDT***

*** ***

***CashFlow Hedges***

 

*Long-termCurrency Swaps*

*** ***

PLDTentered into long-term principal-only currency swap agreements with variousforeign counterparties to hedge the currency risk on its fixed rate notesmaturing in 2009, 2012 and 2017.  As at June 30, 2005 and December 31, 2004, these long-term currency swaps have an aggregate notional amount of US$550million.  Under the swaps, PLDT effectively exchanges the principal of its U.S.dollar-denominated fixed rate notes into peso-denominated loan exposures atagreed swap exchange rates.  The agreed swap exchange rates are reset to thelowest U.S. dollar/Philippine peso spot exchange rate during the term of theswaps, subject to a minimum exchange rate.  In March and April 2004, PLDT enteredinto amendments to keep the lowest reset exchange rate and unwind the downwardresettable feature of US$550 million of its long-term principal-only currencyswap agreements in order to lower the running hedging cost of the swaps.  As at June 30, 2005 and December 31, 2004, the outstanding swap contracts have anagreed average swap exchange rate of Php50.76.

 

In orderto manage hedge costs, these swaps included credit-linkage feature with PLDT asthe reference entity.  The specified credit events include bankruptcy, failureto pay, obligation acceleration, moratorium/repudiation, and restructuring ofPLDT bonds or all or substantially all of PLDT’s obligations.  Upon theoccurrence of any of these credit events, subject to agreed threshold amountswhere applicable, the obligations to both PLDT and its counterparty under theswap contracts terminate without further settlements to either party, includingany mark-to-market value of the swaps.  In March 2004, PLDT amended anadditional US$150 million of the long-term currency swaps to include thiscredit-linkage feature.  As at June 30, 2005 and December 31, 2004, US$725 million of PLDT’s long-term currency swaps/options have been structured to includecredit-linkage with PLDT as the reference entity.  The semi-annual fixed orfloating swap cost payments that PLDT is required to make to its counterpartiesaveraged about 3.79% and 2.95% per annum as at June 30, 2005 and December 31, 2004, respectively.  As cash flow hedges, any movements in the fair value ofthese instruments will be taken as a cumulative translation adjustment underequity in our consolidated balance sheets.

 

*Long-termForeign Currency Options*

 

To managehedging costs, the currency swap agreement relating to the 2009 fixed ratenotes has been structured to include currency option contracts.  If thePhilippine peso to U.S. dollar spot exchange rate on maturity date settlesbeyond Php90.00 to US$1.00, PLDT will have to purchase U.S. dollar at anexchange rate of Php52.50 to US$1.00 plus the excess above the agreed thresholdrate.  On the other hand, if on maturity, the Philippine peso to US$1.00 spotexchange rate is lower than the exchange rate of Php52.50 to US$1.00, PLDT willhave the option to purchase at the prevailing Philippine peso to U.S. dollarspot exchange rate.  In July 2004, PLDT and its counterparty, agreed tore-document and re-classify the transaction into long-term currency optioncontracts.  The net semi-annual floating hedge cost payments that PLDT isrequired to pay under these transactions was approximately 4.72% and 3.94% perannum as at June 30, 2005 and December 31, 2004, respectively.

 

The optioncurrency contract relating to PLDT’s option to purchase U.S. dollar at Php52.50to US$1.00 or prevailing spot rate at maturity whichever is lower, qualifies asa cash flow hedge.  The option currency contract relating to the counterparty’soption to purchase foreign currency from PLDT at Php90.00 to US$1.00 is notdesignated as a hedge.  Please refer to discussion below (under transactionsnot designated as hedges).

 

*Short-termForeign Currency Options*

 

PLDTutilized structures incorporating currency options to hedge the maturingprincipal on its fixed rate notes due June 2004 and August 2005.  Under theterms of the contracts, PLDT will have the option to purchase U.S. dollar at anagreed Philippine peso to U.S. dollar spot exchange rate or prevailing spotrate at maturity whichever is lower.

 

***Transactions Not Designated as Hedges***

 

Due to the amounts of PLDT’s foreign currency hedging requirementsand the large interest differential between the Philippine peso and the U.S.dollar, the costs to book long-term hedges can be significant.  In order tomanage such hedging costs, PLDT utilizes structures that include currencyoption contracts, and fixed-to-floating coupon-only swaps that may not qualifyfor hedge accounting. 

 

*Long-termForeign Currency Options*

 

Withreference to the above-mentioned hedge on the PLDT’s 2009 fixed rate notes,PLDT simultaneously sold a currency option contract with the same notionalamount of US$175 million with the same maturity that gives the counterparty aright to purchase foreign currency at Php90.00 to US$1.00.  Together with thelong-term currency option contract classified under cash flow hedges, PLDT hasthe obligation to purchase U.S. dollar at an exchange rate of Php52.50 toUS$1.00 plus the excess above the agreed threshold rate.  In exchange for thiscondition, the overall net hedging cost for the transaction is reduced.

 

*Short-termCurrency Options*

 

Inorder to manage hedge costs, currency option contracts that hedge PLDT’s fixedrate notes due June 2004 and August 2005 have features similar to that of thelong-term currency option contracts.  PLDT simultaneously sold currency optioncontracts with the same notional amounts with same maturity.  Together with theother short term currency option contracts classified under cash flow hedges,PLDT has the obligation to buy U.S. dollar at the agreed strike price plus theexcess above the agreed threshold rate should the Philippine peso to U.S.dollar spot exchange rate on maturity date settle beyond that agreedthreshold.  In exchange for this condition, the overall net hedging cost forthe transactions is reduced.

* *

PLDT also entered into short-term U.S. dollarsubsidized forwards and Japanese yen currency option contracts to hedge othershort-term foreign currency obligations.

* *

*InterestRate Swap*

 

A portionof PLDT’s currency swap agreements to hedge its 2017 fixed rate notes carryfixed rate swap cost payments.  To effectively lower the running cost of suchswap agreements, PLDT, in April 2003, entered into an agreement to swap thecoupon on US$125 million of its 2012 fixed rate notes into a floating rateJapanese yen amount.  Under this agreement, PLDT is entitled to receive a fixedcoupon rate of 11.375%, provided the Japanese yen to U.S. dollar exchange ratestays above JP¥99.90/US$1.00.  Below this level, a reduced fixed coupon rate of3% will be due to PLDT.  In order to mitigate the risk of the Japanese yenstrengthening below the agreed threshold, PLDT, in December 2003, entered intoan overlay swap transaction to effectively lower the portion of the couponindexed to the U.S. dollar to Japanese yen rate to 3%.  Both swap agreementsinclude a credit-linkage feature with PLDT as the reference entity.

 

*ForwardForeign Exchange Contracts*

 

PLDTentered into short-term U.S. dollar and Japanese yen forward foreign exchangecontracts to hedge short-term foreign currency obligations.

 

*BifurcatedEmbedded Derivatives*

 

Derivativeinstruments include derivatives (or derivative-like provisions) embedded innon-derivative contracts.  PLDT’s outstanding bifurcated embedded derivativetransactions as at December 31, 2004 covered service contracts denominated inU.S. dollars paid out to a Japanese company in April 2005.  There are nooutstanding bifurcated embedded derivative transactions as at June 30, 2005.

 

***Smart***

 

Smart’sembedded derivatives were bifurcated from service and purchase contracts.  Asat June 30, 2005 and December 31, 2004, outstanding contracts includeda service contract with foreign equipment supplier and various supplierscovering handset and equipment importations payable in U.S. dollars.

 

Embeddedderivatives were also bifurcated from prepaid forwards.  The relatedprepayments amounting to Php27 million and Php3,873 million as at June 30, 2005 and December 31, 2004,respectively, are presented under “Short-term investments.”  The embeddedforeign currency derivatives bifurcated from these prepaid forwards arepresented as derivative assets or derivative liabilities.

** **

**Financial Risk Management Objectives and Policies**

 

The mainpurpose of our financial instruments is to fund our operations.  We also enterinto derivative transactions, the purpose of which is to manage the currencyrisks and interest rate risks arising from our operations and our sources offinancing.  It is, and has been throughout the year under review, our policythat no trading in financial instruments shall be undertaken.

 

Themain risks arising from our financial instruments are liquidity risk, foreigncurrency risk, interest rate risk and credit risk.  Our Board reviews andagrees with policies for managing each of these risks and they are summarizedbelow.  We also monitor the market price risk arising from all financialinstruments.  Our accounting policies in relation to derivatives are set out in*Note 2 – Summary of Significant Accounting Policies*.

 

***Liquidity Risk***

 

We seek tomanage our liquidity profile to be able to finance our capital expenditures andservice our maturing debts.  To cover our financing requirements, we intend touse internally generated funds and proceeds from debt and equity issues andsales of certain assets. 

 

As part ofour liquidity risk management program, we regularly evaluate our projected andactual cash flow information and continuously assess conditions in thefinancial markets for opportunities to pursue fund-raising initiatives.  Theseinitiatives may include bank loans, export credit agency-guaranteed facilities,and debt capital and equity market issues.

 

***ForeignCurrency Risk***

 

Thefollowing table shows our consolidated foreign currency-denominated monetaryassets and liabilities and their peso equivalents as at June 30, 2005 and December 31, 2004:

 

** **

**June 30, 2005****(Unaudited)**

December 31, 2004 (Audited)

** **

**U.S. Dollar**

**Php Equivalent**(1)

U.S. Dollar

Php Equivalent(2)

 

(in millions)

**Noncurrent Financial Assets**

** **

 

** **

** **

Derivative assets

**US$****61**

**Php3,435**

US$73

Php4,113

Notes receivable

**6**

**346**

5

286

Total noncurrent financial assets

**67**

**3,781**

  78

4,399

**Current Financial Assets**

** **

** **

 

 

Cash and cash equivalents

**315**

**17,668**

251

14,142

Short-term investments

**1**

**68**

69

3,888

Trade and other receivables

**141**

**7,938**

146

8,226

Derivative assets

**21**

**476**

6

338

Total current financial assets

**478**

**26,150**

 472

26,594

**Total Financial Assets**

**US$****545**

**Php29,931**

US$550

Php30,993

** **

** **

** **

 

 

**Noncurrent Financial Liabilities**

** **

** **

 

 

Interest-bearing financial liabilities

**US$****2,022**

**Php113,578**

US$2,330

Php131,275

Derivative liabilities

**85**

**4,755**

105

5,916

Total noncurrent financial liabilities

**2,107**

**118,333**

2,435

137,191

** **

** **

**Current Financial Liabilities**

** **

** **

 

 

Accounts payable

**20**

**1,124**

46

2,592

Accrued expenses and other current liabilities

**54**

**3,017**

77

4,338

Derivative liabilities

**4**

**229**

8

451

Interest-bearing financial liabilities

**511**

**28,644**

483

27,213

Total current financial liabilities

**589**

**33,014**

 614

34,594

**Total Financial Liabilities**

**US$****2,696**

**Php****151,347**

US$3,049

Php171,785

 

*(1)**The exchangerate used was Php56.177 to US$1.00.*

*(2)**The exchangerate used was Php56.341 to US$1.00.*

 

Intranslating the foreign currency-denominated monetary assets and liabilitiesinto peso amounts, the exchange rates used were Php56.177 to US$1.00 andPhp56.341 to US$1.00, the Philippine peso-U.S. dollar exchange rates as at June 30, 2005 and December 31, 2004, respectively.

 

As at August 3, 2005, the peso–dollar exchange rate was Php56.106 to US$1.00.  Using thisexchange rate, our consolidated net foreign currency–denominated liabilities asat June 30, 2005 would have decreased by Php153 million.

 

While acertain percentage of our revenues is either linked to or denominated in U.S.dollars, substantially all of our indebtedness and related interest expense, asubstantial portion of our capital expenditures and a portion of our operatingexpenses are denominated in foreign currencies, mostly in U.S. dollars.

 

As at June 30, 2005, approximately 98% of our totalconsolidated debts were denominated in foreign currencies principally in U.S.dollars.  Of our foreign currency-denominated debts, 4% are inJapanese yen and the balance in U.S. dollars.  Thus, a weakening of thePhilippine peso against the U.S. dollar or Japanese yen will increase both theprincipal amount of our unhedged foreign currency-denominated debts(representing 62% of our consolidated foreign-currency debts), and interestexpense on our debt in peso terms.  In addition, many of our financial ratiosand other financial tests will be negatively affected.  If, among other things,the value of the Philippine peso against the U.S. dollar substantially dropsfrom its current level, we may be unable to maintain compliance with theseratios, which could result in acceleration of some or all of our indebtedness.For further information on our loan covenants, see *Note 17 –Interest-bearing Financial Liabilities*.

 

To manageour foreign exchange risks, stabilize cash flows, and improve investment andcash flow planning, we enter into foreign exchange forward contracts, foreigncurrency swap contracts, currency options and other hedging products aimed atreducing and/or managing the adverse impact of changes in foreign exchangerates on our operating results and cash flows.  However, these hedges do notcover all of our exposure to foreign exchange risks.

 

Specifically,we use forward foreign exchange contracts, foreign currency swap contracts andcurrency option contracts to manage the foreign exchange risk associated withour foreign currency-denominated loans.  

 

***InterestRate Risk***

 

On alimited basis, we enter into interest rate swap agreements in order to manageour exposure to interest rate fluctuations.  We make use of hedging instrumentsand structures solely for reducing or managing financial risks associated withour liabilities and not for trading or speculative purposes.

 

Thefollowing tables set out the carrying amount, by maturity, of our financialinstruments that are exposed to interest rate risk:

 

SixMonths Ended June 30, 2005 (Unaudited)
 

** **

 

 

 

 

 

 

 

**Discount/**

** **

 

** **

** **

 

 

 

 

 

 

 

**Debt**

** **

** **

** **

 

 

 

 

**Over 5**

**In****U.S.******

 

**Issuance Cost**

**Carrying Value**

**Fair Value**

**In****U.S.**

** **

** **

**Below 1 year**

**1-2 years**

**2 – 3 years**

**3-5 years**

**years**

**Dollar**

**In Php**

**In Php**

**In Php**

**Dollar**

**In Php**

** **

 

 

 

 

 

 

 

**(in millions)**

**Liabilities:**

 

 

 

 

 

 

 

** **

** **

 

** **

Long-term Debt

 

 

 

 

 

 

 

** **

** **

 

 

*Fixed Rate*

 

 

 

 

 

 

 

 

 

 

 

US$ Notes (in millions)

230

236

–

175

550

1,191

66,879

837

66,042

1,293

72,650

Interest rate

9.25% to  9.875%

7.85% to 10.625%

–

10.50%

8.35% to 11.375%

–

–

–

–

–

–

US$ Fixed Loans (in millions)

101

52

42

39

280

514

28,861

7,000

21,861

414

23,193

Interest rate

4.49% to 7.95%

4.49% to 7.95%

4.49% to 7.58%

4.49% to 6.66%

2.25%

–

–

–

–

–

–

Japanese Yen (in millions)

25

25

25

–

–

75

4,238

–

4,238

76

4,280

Interest rate

2.125%

2.125%

2.125%

–

–

–

–

–

–

–

–

Philippine Peso (in millions)

6

14

–

14

–

34

1,926

5

1,921

38

2,141

Interest rate

11.18% to 24%

15.816% to 24%

–

15.00%

–

–

–

–

–

–

–

*Variable Rate*

 

 

 

 

 

 

 

 

 

 

 

U.S. Dollar (in millions)

149

160

115

147

104

675

37,917

1,958

35,959

675

37,917

Interest rate

GOVCO’s Cost + 0.20%; 0.15% to 4.30% over  LIBOR

GOVCO’s Cost + 0.20%; 0.15% to 4.30% over LIBOR

GOVCO’s Cost + 0.20%; 0.15% to 4.30% over LIBOR

0.15% to 2.50% over LIBOR

0.5% to 2.5% over LIBOR

–

–

–

–

–

–

Japanese Yen (in millions)

6

6

5

–

–

17

958

2

956

17

958

Interest rate

1.70% over LIBOR

1.70% over LIBOR

1.70% over LIBOR

–

–

–

–

–

–

–

–

Philippine Peso (in millions)

–

2

2

1

7

12

689

111

 578

12

689

Interest rate

1% over 91-day T-bill rate; 11% to 11.25%

1% over 91-day T-bill rate; 11% to 11.25%

1% over 91-day T-bill rate; 11% to 11.25%

1% over 91-day T-bill rate

1% over 91-day T-bill rate

–

–

–

–

–

–

 

 

 

 

 

 

**2,518**

**141,468**

**9,913**

**131,555**

**2,525**

**141,828**

 

 

 

 

 

 

 

 

 

 

 

 

*Interest rate swap (fixed to floating)*

 

 

 

 

 

 

 

 

 

 

 

U.S. Dollar (US$125 million)

–

–

–

–

–

(41)

(2,315)

–

–

(41)

(2,315)

Japanese Yen (JPY15,037 million)

 

 

 

 

–

–

–

–

–

–

–

Fixed Rate on US$ notional 

11.375%

11.375%

11.375%

11.375%

11.375%

–

–

–

–

–

–

Variable Rate on JPY notional

8.11% over LIBOR

8.11% over LIBOR

8.11% over LIBOR

8.11% over LIBOR

8.11% over LIBOR

–

–

–

–

–

–

 

YearEnded December 31, 2004 (Audited)
 

** **

 

 

 

 

 

 

 

**Discount/**

** **

 

** **

** **

 

 

 

 

 

 

 

**Debt**

** **

** **

** **

 

 

 

 

**Over 5**

**In****U.S.**

 

**Issuance Cost**

**Carrying Value**

**Fair Value******

**In****U.S.**

** **

** **

**Below 1 year**

**1-2 years**

**2-3 years**

**3-5 years**

**years**

**Dollar**

**In Php**

**In Php**

**In Php**

**Dollar**

**In Php**

** **

 

 

 

 

 

 

 

**(in millions)**

**Liabilities:**

 

 

 

 

 

 

 

** **

** **

 

** **

Long-term Debt

 

 

 

 

 

 

 

** **

** **

 

 

*Fixed Rate*

 

 

 

 

 

 

 

 

 

 

 

US$ Notes (in millions)

110

130

272

175

550

1,237

69,725

930

68,795

1,307

73,662

Interest rate

9.875%

9.250%

7.85% to 10.625%

10.50%

8.35% to 11.375%

–

–

–

–

–

–

US$ Fixed Loans (in millions)

125

93

51

58

280

 607

34,190

7,340

26,850

576

32,452

Interest rate

4.49% to 8.03%

4.49% to 7.95%

4.49% to 7.95%

4.49% to 7.58%

2.25%

–

–

–

–

–

–

Japanese Yen (in millions)

27

27

27

14

–

  95

5,363

 

5,363

96

5,414

Interest rate

2.125%

2.125%

2.125%

2.125%

–

–

–

–

–

–

–

Philippine Peso (in millions)

14

14

–

–

14

  42

2,371

5

2,366

45

2,537

Interest rate

11.18% to 24%

11.6% to 24%

–

–

15%

–

–

–

–

–

–

*Variable Rate*

 

 

 

 

 

 

 

 

 

 

 

U.S. Dollar (in millions)

212

213

139

117

132

 813

45,832

2,045

43,787

814

45,832

Interest rate

0.15% to 4.3% over LIBOR

0.15% to 4.3% over LIBOR

0.15% to 4.3% over LIBOR

0.15% to 4.3% over LIBOR

0.5% to 2.5% over LIBOR

–

–

–

–

–

–

Japanese Yen (in millions)

6

6

6

4

–

  22

1,212

–

1,212

  22

1,212

Interest rate

1.7% over JPY LIBOR 

1.7% over JPY LIBOR 

1.7% over JPY LIBOR 

1.7% over JPY LIBOR

–

–

–

–

–

–

–

Philippine Peso (in millions)

2

2

2

1

7

  14

777

120

 657

13

777

Interest rate

1.0% over 91-day T-bill rate; 11% to 11.25%

1.0% over 91-day T-bill rate; 11% to 11.25%

1% over 91-day T-bill rate; 11% to 11.25%

1% over 91-day T-bill rate

1% over 91-day T-bill rate

–

–

–

–

–

–

 

 

 

 

 

 

**2,830**

**159,470**

**10,440**

**149,030**

**2,873**

**161,886**

 

 

 

 

 

 

 

 

 

 

 

 

*Interest rate swap (fixed to floating)*

 

 

 

 

 

 

 

 

 

 

 

U.S. Dollar (US$125 million)

–

–

–

–

–

(62)

(3,468)

–

–

(62)

(3,468)

Fixed Rate on US$ notional 

11.375%

11.375%

11.375%

11.375%

11.375%

–

–

–

–

–

–

Variable Rate on JPY notional

8.11% over LIBOR

8.11% over LIBOR

8.11% over LIBOR

8.11% over LIBOR

8.11% over LIBOR

–

–

–

–

–

–

 

Fixed ratefinancial instruments are subject to fair value interest rate risk whilefloating rate financial instruments are subject to cash flow interest raterisk.  

 
Repricingof floating rate financial instruments is mostly done on intervals of threemonths or six months.  Interest on fixed rate financial instruments is fixeduntil maturity of instrument.  Financial instruments that are not subject tointerest rate risk were not included in the above tables.

 
***Credit Risk***

 

We tradeonly with recognized, creditworthy third parties.  It is our policy that allcustomers who wish to trade on credit terms are subject to credit verificationprocedures.  In addition, receivable balances are monitored on an ongoing basisto reduce our exposure to bad debts.

 

Withrespect to credit risk arising from our other financial assets, which comprisecash and cash equivalents, certain derivative instruments, our exposure tocredit risk arises from default of the counterparty, with a maximum exposureequal to the carrying amount of these instruments.

 

We have nosignificant concentrations of credit risk.

 

 

 

**25. OtherMatters**

 

a.   Interconnection Agreements

 

PLDT hasexisting interconnection agreements with nine International Gateway Facilities,or IGF operators, six Inter Exchange Carriers, or IXCs, six Cellular MobileTelephone Systems, or CMTS operators, 70 LECs (including members of thePhilippine Association of Private Telephone Companies, Inc.), and 12 paging andtrunk radio operators.  These interconnection agreements include provisions forsettlement and payment of charges.  Settlements with interconnecting IGFoperators and CMTS operators for local calls are in the form of accesscharges.  Settlement with interconnecting IXCs and LECs for toll calls arebased on hauling and access charges, and to some extent, revenue sharing.Settlement also involves payment of access charges, but settlement for tollcalls is on a revenue-sharing basis.  LEC to LEC interconnection with haulingfrom one service area to another service area is settled based on trunkcharges, while overlay LEC to LEC interconnection in a given service area iswithout charges.  Paging and trunk radio interconnection settlements are basedon fixed charges.  

 

b.   U.S. Federal Communications Commission, or U.S. FCC,Ruling versus Philippine Telecommunications Companies

 

Effectiveas at February 1, 2003, PLDT stopped terminating traffic sent directly by eachof AT&T and MCI, because PLDT’s termination rate agreements with AT&Tand MCI lapsed in December 2002 without either agreeing with PLDT on anyprovisional arrangement or final agreement on new termination rates.  Inseparate orders dated February 7 and 26, 2003, the NTC confirmed that “absentany provisional or interim agreement” with U.S. carriers, there would be noprovision of termination services between the parties “who are therebyencouraged to seek other routes or options to terminate traffic to the Philippines.”Upon petitions of AT&T and MCI, on March 10, 2003, the International Bureauof the U.S. FCC issued an Order which directed all facilities-based carrierssubject to U.S. FCC jurisdiction to suspend payments for termination servicesto Philippine carriers, including PLDT, Smart and Subic Telecom, until suchtime as the U.S. FCC issued a Public Notice that AT&T’s and MCI’s circuitson the U.S.–Philippine route were fully restored.  The Order also removed the Philippinesfrom the list of U.S.–international routes approved for the provision ofInternational Simple Resale, or ISR.  In response to the International Bureau’sOrder, the NTC issued a Memorandum Order dated March 12, 2003, directing allaffected Philippine carriers “(1) not to accept terminating traffic via direct circuits from U.S.facilities-based carriers who do not pay Philippine carriers for servicesrendered; and (2) to take all measures necessary to collect payments forservices rendered in order to preserve the viability, efficiency, sustainedgrowth and development and continued competitiveness of the Philippinetelecommunications industry.”

 

On October17, 2003, based on negotiations between the NTC and the U.S. FCC to resolve theissue regarding termination rates, the NTC, in the expectation that the U.S.FCC would fully lift the March 10, 2003 Order, lifted its March 12, 2003 Orderand directed all Philippine carriers to immediately accept terminating trafficvia direct circuits from U.S. facilities-based carriers at mutually acceptablefinal or interim termination rates and other terms and conditions agreed uponby the parties.

 

On November17, 2003, after Smart reached interim agreements with each of AT&T and MCIon September 30 and November 12, 2003, respectively, the International Bureauof the U.S. FCC lifted its March 10, 2003 Order with respect to Smart andordered the U.S. carriers to resume making payments to Smart.

 

On January15, 2004, after PLDT reached interim agreements with each of MCI and AT&Tand reopened its circuits with these carriers on November 12, 2003 and January9, 2004, respectively, the International Bureau of the U.S. FCC lifted itsMarch 10, 2003 Order also with respect to PLDT and ordered the U.S. carriers toresume making payments to PLDT.

 

On May 13,2004, the U.S. FCC partially dismissed and partially denied applications byPhilippine carriers, including PLDT, and certain U.S. carriers for review ofthe March 10, 2003 Order of the International Bureau of the U.S. FCC.  Inparticular, the U.S. FCC affirmed the March 10, 2003 Order’s finding that“Philippine carriers engaged in collective action to “whipsaw” AT&T andMCI.” The U.S. FCC stated, however, that the findings of the March 10, 2003 Order were not findings under the U.S. anti-trust laws and that the U.S. Departmentof Justice is independently “investigating the possibility of anticompetitivepractices among Philippine carriers under its authority pursuant to U.S.anti-trust laws.”  The U.S. FCC also upheld the March 10, 2003 Order in respect of the suspension of payments for termination services to the Philippinecarriers pending restoration of the circuits.  In addition, the U.S. FCC denieda request to modify the March 10, 2003 Order of the International Bureau of theU.S. FCC to restore the Philippines to the list of U.S.-international routesapproved for the provision of ISR.  The U.S. FCC stated that it was dismissingthis request as moot because of the U.S. FCC’s recently adopted InternationalSettlements Policy Reform Order which eliminated ISR policies.

 

Althoughnot included in the initial list of countries exempted from the U.S. FCC’sInternational Settlements Policy, or ISP, the U.S. FCC identified theU.S.–Philippines route as eligible for being removed from the ISP in accordancewith its newly established procedures for doing so.  Under this procedure, theU.S. FCC asked for public comment on the removal of the Philippines from theISP.  In comments filed in June and July 2004, removal was reported by severalPhilippine and U.S. carriers, including AT&T and MCI, and was opposed byone U.S. carrier, International Access, Inc.  In November 2004, the U.S. FCCexempted a number of additional countries from the ISP, but not the Philippines.Instead, the U.S. FCC stated that it would rule separately regarding the Philippinesafter reviewing the issues raised by International Access, Inc.  These issuesare still pending before the U.S. FCC.

 

On July 6,2004, PLDT filed with the U.S. FCC a petition for reconsideration of the U.S.FCC’s May 13, 2004 Order on the grounds that the order should have vacated asmoot the International Bureau’s March 10, 2003 Order.

 

c.   Investigation by the U.S.Department of Justice

 

In January2004, PLDT received a grand jury subpoena seeking documents and a PLDT employeewas subpoenaed to testify before the grand jury in connection with a criminalinvestigation being conducted by the U.S. Department of Justice with respect toalleged anti-trust violations relating to the provision of internationaltermination services in the Philippines.  The U.S. Department of Justice has alsorequested testimony and documents from Smart in connection with thisinvestigation.  Further, in March 2004, PLDT (U.S.) Ltd., a subsidiary of PLDTGlobal, received a grand jury subpoena seeking documents, in response to whichPLDT (U.S.) Ltd. produced documents.  In February 2005, twoformer employees of PLDT U.S. Ltd. testified before the grand jury in the U.S.Department of Justice matter.  A PLDT employee was also scheduled to reappearfor testimony in February, but his appearance has been postponed.  On May 11, 2005, the U.S. Department of Justice informed our legal counsel in Washington, D.C.,Covington & Burling, that the U.S. Department of Justice has terminated itsantitrust investigation relating to termination rate increases implemented inearly 2003 by certain Philippine long distance carriers including PLDT and thatno enforcement action will be taken.