**MANAGEMENT’S DISCUSSION AND ANALYSISOF**

**FINANCIAL CONDITION AND RESULTS OFOPERATIONS**

**For the Six Months Ended June 30,2004**

** **

*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 – Basis of Financial Statement   Preparation to theaccompanying financial statements for a list of these subsidiaries, including adescription of their respective principal business activities).*

* *

*Thefollowing discussion and analysis of our financial condition and results ofoperations should be read in conjunction with the accompanying financialstatements and the related notes.  Our financial statements, and the financialinformation discussed below, have been prepared in accordance with Philippinegenerally accepted accounting principles, or Philippine GAAP, which differs incertain significant respects from generally accepted accounting principles inthe United States.*

* *

*Thefinancial information appearing in this report and in the accompanyingfinancial statements is stated in Philippine pesos.  All references to “pesos,”“Philippine pesos” or “Php” are to the lawful currency of the Philippines; allreferences to “U.S. dollars,” “US$” or “dollars” are to the lawful currency ofthe United States; all references to “Japanese yen,” “JP¥” or “¥” are to thelawful currency of Japan**and allreferences to “Euro” or “€” are to the lawful currency of the European Union**.Translations of Philippine peso amounts into U.S. dollars in this report and inthe accompanying financial statements were made based on the exchange rate ofPhp56.176 to US$1.00, the volume weighted average exchange rate at**June 30, 2004**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 of 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-lookingstatement made in this report or elsewhere might not occur.*

**Financial Highlights**

| ** **                                | **June 30,**                  |       | **December 31,** | ** ** | **Increase (Decrease)** |
|-------------------------------------------|-------------------------------|------------|------------------|------------|-------------------------|
| **(in millions)**                         | **2004**                      |       | **2003**(1)      | ** ** | **Amount**              | ** ** | **%** |
| ** **                                | **(Unaudited)**               | ** ** | **(Audited)**    |       |                    |   |   |
| **Consolidated Balance Sheets**           |                          |       |             |       |                    |   |   |
| Total assets                              | Php300,899                    |       | Php297,626       |       | Php3,273                |   | 1 |
| Property, plant and equipment - net       | 243,444                       |       | 244,427          |       | (983)                   |   | – |
| Total debt                                | 146,263                       |       | 159,814          |       | (13,551)                |   | (8) |
| Total stockholders’ equity           | 104,830                       |       | 93,578           |       | 11,252                  |   | 12 |
| Debt to equity ratio                      | 1.40x                         |       | 1.71x            |       | –                  |   | – |
| ** **                                | ** **                    |
| ** **                                | **Six Months Ended June 30,** |
|                                      | ** **                    |       | ** **       | ** ** | **Increase**            |
|                                      | **2004**                      |       | **2003**(1)      | ** ** | **Amount**              | ** ** | **%** |
| ** **                                | **(Unaudited)**               |
| **Consolidated Statements of Income**     | ** **                    | ** ** | ** **       | ** ** | ** **              | ** ** | ** ** |
| Operating revenues                        | Php55,597                     |       | Php46,219        |       | Php9,378                |   | 20 |
| Operating expenses                        | 33,055                        |       | 31,919           |       | 1,136                   |   | 4 |
| Net operating income                      | 22,542                        |       | 14,300           |       | 8,242                   |   | 58 |
| EBIT(2)                                   | 21,449                        |       | 8,060            |       | 13,389                  |   | 166 |
| EBITDA(3)                                 | 34,694                        |       | 19,756           |       | 14,938                  |   | 76 |
| Net income                                | 12,008                        |       | 1,785            |       | 10,223                  |   | 573 |
| Operating margin                          | 41%                           |       | 31%              |       | –                  |   | – |
| EBITDA margin                             | 62%                           |       | 43%              |       | –                  |   | – |
| **Consolidated Statements of Cash Flows** |                          |       |             |       |                    |   |   |
| Net cash provided by operating activities | Php35,010                     |       | Php23,081        |       | Php11,929               |   | 52 |
| Net cash used in investing activities     | 11,496                        |       | 5,699            |       | 5,797                   |   | 102 |
| Capital expenditures                      | 11,576                        |       | 5,340            |       | 6,236                   |   | 117 |
| Net cash used in financing activities     | 20,352                        |       | 17,090           |       | 3,262                   |   | 19 |

_____________

* *

*(1) **As restated to reflect the change in accounting policyon leases, as described in Note 3 – Accounting Changes to the accompanyingfinancial statements.*

* *

*(2) EBIT is defined as earnings before minorityinterest in net income (losses) of consolidated subsidiaries, adding backinterest expense and related items, taxes and deducting interest income.  EBITshould not be considered in isolation or as a substitute for operating income,net income, cash flows from operating activities and other income or cash flowstatement data prepared in conformity with generally accepted accountingprinciples, or as a measure of profitability or liquidity.*

* *

*(3) EBITDA is defined as earnings before minorityinterest in net income (losses) of consolidated subsidiaries, adding backinterest expense and related items, taxes, depreciation and amortization,deducting interest income and is presented because it is generally accepted asproviding useful information regarding a company's ability to service and/orincur debt.  EBITDA should not be considered in isolation or as a substitutefor operating income, net income, cash flows from operating activities andother income or cash flow statement data prepared in conformity with generallyaccepted accounting principles, or as a measure of profitability or liquidity.*

* *

EBIT and EBITDA, on aconsolidated basis for the six months ended June 30, 2004 and 2003, are derivedas follows:

 

| ** **                                                                        | **Six Months Ended June 30,** |
|-----------------------------------------------------------------------------------|-------------------------------|
| ** **                                                                        | ** **                    | ** ** | ** ** | ** ** | **Increase** |
| ** **                                                                        | **2004**                      | ** ** | **2003**(b) | ** ** | **Amount** | ** ** | **%** |
| ** **                                                                        | **(Unaudited)**               |
| **(in millions)**                                                                 | ** **                    |
| Earnings before minority interest in net income 

of consolidated subsidiaries(a) | Php12,026                     |   | Php1,567 |   | Php10,459 |   | 667 |
| Add:  Interest expense and related items - net(a)                                 | 5,868                         |   | 5,592 |   | 276 |   | 5 |
| Provision for income tax(a)                                                       | 4,020                         |   | 1,146 |   | 2,874 |   | 251 |
| Less:  Interest income(a)                                                         | 465                           |   | 245 |   | 220 |   | 90 |
| EBIT                                                                              | 21,449                        |   | 8,060 |   | 13,389 |   | 166 |
| Add:  Depreciation and amortization(a)                                            | 13,245                        |   | 11,696 |   | 1,549 |   | 13 |
| EBITDA                                                                            | Php34,694                     |   | Php19,756 |   | Php14,938 |   | 76 |

________________

 

*(a)**See statementsof income in the accompanying financial statements.*

*(b) As restated to reflect the change in accountingpolicy on leases, as described in Note 3 – Accounting Changes to the accompanyingfinancial statements.*

 

Overview
 

We are the largest and most diversifiedtelecommunications company in the Philippines.  We have organized our businessinto three main segments:

 

•              *Wireless* — wireless telecommunicationsservices provided by PLDT’s subsidiaries, Smart Communications, Inc., ourcellular service provider, and Mabuhay Satellite Corporation, ACeS PhilippinesCellular Satellite Corporation, and Telesat, Inc., our satellite and very smallaperture terminal, or VSAT, operators; 

 

•              *Fixed Line* — fixed line telecommunicationsservices primarily provided through PLDT.  We also provide fixed line servicesthrough PLDT’s subsidiaries PLDT Clark Telecom, Inc., Subic TelecommunicationsCompany, Inc., Maratel, Inc. and Bonifacio Communications Corporation, whichtogether account for approximately 1% of our consolidated fixed lines inservice, and PLDT Global Corporation; and

 

•              *Information and CommunicationsTechnology* — information and communications infrastructure and services forinternet applications, internet protocol-based solutions and multimedia contentdelivery provided by PLDT’s subsidiary ePLDT, Inc.; internet access servicesprovided by ePLDT’s subsidiary Infocom Technologies, Inc.; and e-commerce, callcenters and IT-related services provided by other investees of ePLDT, asdescribed in *Note 9 – Investments* to the accompanying**financialstatements. 

** **

**Results of Operations**

** **

Thetable below shows the contribution by each of our business segments to ourconsolidated operating revenues, operating expenses and net operating income(losses) for the six months ended June 30, 2004and 2003.  Most of our revenues are derived from our operations within the Philippines.Our revenues derived from outside the Philippines consist primarily of revenues from incominginternational calls to the Philippines.

** **

 

**Six Months Ended June 30,**

 

** **

** **

** **

** **

** **

** **

** **

** **

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

 

**2004**

** **

**%**(1)

** **

**2003**(2)

** **

**%(**1)

** **

**Amount**

** **

**%**

** **

**(Unaudited)**

**(in millions)**

 

 

 

 

 

 

 

 

 

 

 

**Operating Revenues**

 

 

 

 

 

 

 

 

 

 

 

Wireless

Php31,231

 

56

 

Php22,493

 

49

 

Php8,738

 

39

Fixed line

23,384

 

42

 

22,862

 

49

 

522

 

2

Information and communications technology

982

 

2

 

864

 

2

 

118

 

14

 

55,597

 

100

 

46,219

 

100

 

9,378

 

20

**Operating Expenses**

 

 

 

 

 

 

 

 

 

 

 

Wireless

15,841

 

28

 

14,610

 

32

 

1,231

 

8

Fixed line

16,241

 

29

 

16,289

 

35

 

(48)

 

–

Information and communications technology

973

 

2

 

1,020

 

2

 

(47)

 

(5)

 

33,055

 

59

 

31,919

 

69

 

1,136

 

4

**Net Operating Income (Losses)******

 

 

 

 

 

 

 

 

 

 

 

Wireless

15,390

 

28

 

7,883

 

17

 

7,507

 

95

Fixed line

7,143

 

13

 

6,573

 

14

 

570

 

9

Information and communications technology

9

 

–

 

(156)

 

–

 

165

 

106

 

Php22,542

 

41

 

Php14,300

 

31

 

Php8,242

 

58

________________

* *

*(1) Operating expenses andnet operating income (losses) are computed as a percentage of operatingrevenues.*

*(2) As restated to reflect the change in accountingpolicy on leases, as described in Note 3 – Accounting Changes to theaccompanying financial statements.*

**Consolidated Operating Revenues**

 

Largely driven by the continued stronggrowth of our wireless business, particularly Smart’s cellular business, ourconsolidated operating revenues for the first half of 2004 increased by Php9,378 million, or 20%,to Php55,597 million from Php46,219 million in the same period in 2003.  The revenuecontribution of our wireless business accounted for 56% of our consolidatedoperating revenues for the first half of 2004, compared to 49% in the sameperiod in 2003.  Smart contributed Php30,903 millionin revenues for the first half of 2004, an increase of 40% over its revenuecontribution of Php22,117 million for the sameperiod in 2003.  

 

***Wireless***

 

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

 

The following table summarizes our consolidatedoperating revenues from our wireless business for the six months ended June 30, 2004 and2003 by service segment:

 

** **

**Six Months Ended June 30,**

** **

** **

** **

** **

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2004**

** **

**%**

** **

**2003**

** **

**%**

** **

**Amount**

** **

**%**

** **

**(Unaudited)**

**(in millions)**

 

Wireless services:

 

 

 

 

 

 

 

 

 

 

 

Cellular

Php30,903

 

99

 

Php22,117

 

98

 

Php8,786

 

40

Satellite, VSAT and others

328

 

1

 

376

 

2

 

(48)

 

(13)

Total

Php31,231

 

100

 

Php22,493

 

100

 

Php8,738

 

39

 

Our wireless servicerevenues increased by Php8,738 million, or 39%, to Php31,231 million in thefirst half of 2004 from Php22,493 million in the same period in 2003 mainly asa result of the continued strong growth in revenues generated from Smart’scellular service.  Accordingly, as a percentage of our consolidated operatingrevenues, wireless service revenues increased to 56% in the first half of 2004from 49% in the same period in 2003.

 

*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 GSM service customers in excess of allottedfree text messages, and (4) charges for value-added services, net of relatedcontent provider 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 GSM service;

 

•              service fees charged to PilipinoTelephone Corporation, or Piltel, for using Smart's GSM network for Piltel's *Talk'N Text* prepaid cellular service; and

 

•              other charges, including those forreconnection and migration. 

 

Proceedsfrom the sale of handsets and SIM packs are not recorded as part of cellularservice revenues.  Gains on the sale of handsets are offset against selling andpromotions expense, while losses on the sale of handsets and SIM packs areincluded as part of selling and promotions expense.

 

Our cellular servicerevenues in the first half of 2004 amounted to Php30,903 million, an increaseof Php8,786 million, or 40%, from Php22,117 million in the same period in2003.  Cellular service revenues accounted for 99% of our wireless revenues andcontributed 56% to our consolidated operating revenues in the first half of2004, compared to 48% in the same period in 2003.  This increase was primarilydue to the growth in Smart’s subscriber base, which increased by 4,331,123, or53%, from 8,143,389 as of June 30, 2003 to 12,474,512 as of June 30, 2004.  The strong subscriber growth offset the decline in blended monthly grossand net ARPU, which dropped by 13% and 10%, respectively.

 

Smartmarkets nationwide cellular communications services under the brand names *SmartBuddy, Smart Gold,**addict mobile,**Smart Infinity* and *SmartKid.  Smart Buddy* is a prepaid service while *Smart Gold, addict mobile*,*Smart Infinity* and *Smart Kid* are postpaid services, which are allprovided through Smart's digital GSM network.  Introduced in April 2003, *addictmobile*offers exclusive multimedia content to subscribers and featurespersonalized means for internet surfing, allowing subscribers to apply theirallocated free credits towards their choice of data and value-added services.  *SmartInfinity* is a premium postpaid plan, launched in January 2004 that caters toaffluent and highly mobile market, offering first class quality services,including a round-the-clock dedicated personal concierge service, internationalassistance services, premium handset packages and exclusive lifestyle content.*Smart Kid*, launched in May 2004, is especially designed for children,ages 5 to 12 years old, and is equipped with “Family Finder” whichautomatically forwards the child’s call to pre-assigned numbers on the phone, alocation-based finder service to enable them to keep in touch with their familymembers, as well as educational value-added services content.

 

The following table summarizes key measures of ourcellular business as of and for the six months ended June 30, 2004 and2003:

 

** **

**Six Months Ended June 30,**

** **

** **

** **

** **

** **

**Increase**

** **

**2004**

** **

**2003**

** **

**Amount**

** **

**%**

** **

**(Unaudited)**

**(in millions)**

 

 

 

 

 

 

 

Cellular revenues 

Php30,903

 

Php22,117

 

Php8,786

 

40

 

 

 

 

 

 

 

 

GSM**

30,643

 

21,937

 

8,706

 

40

* *

* *

* *

* *

* *

* *

* *

* *

*By component*

*27,193*

* *

*19,767*

* *

*7,426*

* *

*38*

Voice

14,508

 

11,525

 

2,983

 

26

Data

12,685

 

8,242

 

4,443

 

54

* *

* *

* *

* *

* *

* *

* *

* *

*By service type*

*27,193*

* *

*19,767*

* *

*7,426*

* *

*38*

Prepaid

25,165

 

18,178

 

6,987

 

38

Postpaid

2,028

 

1,589

 

439

 

28

* *

* *

* *

* *

* *

* *

* *

* *

*GSM-Others*(1)

*3,450*

* *

*2,170*

* *

*1,280*

* *

*59*

 

 

 

 

 

 

 

 

Others(2)

260

 

180

 

80

 

44

 

 

**As of June 30,**

** **

** **

** **

** **

** **

**Increase**

** **

**2004**

** **

**2003**

** **

**Amount**

** **

**%**

 

**(Unaudited)**

 

 

 

 

 

 

 

 

GSM Cellular subscriber base 

12,474,512

 

8,143,389

 

4,331,123

 

53

Prepaid 

12,200,978

 

7,920,447

 

4,280,531

 

54

Postpaid 

273,534

 

222,942

 

50,592

 

23

 

 

 

 

 

 

 

 

Systemwide subscriber base(3)

16,028,407

 

10,363,725

 

5,664,682

 

55

 

 

 

 

 

 

 

 

 

** **

 

**Six Months Ended June 30,**

 

** **

** **

** **

** **

**Increase**

 

**2004**

** **

**2003**

** **

**Amount**

** **

**%**

 

**(Unaudited)**

 

 

 

 

 

 

 

 

Traffic volumes (in millions)

 

 

 

 

 

 

 

Calls (in minutes)

2,041

 

1,709

 

332

 

19

Domestic

1,456

 

1,198

 

258

 

22

International

585

 

511

 

74

 

14

Inbound

511

 

442

 

69

 

16

Outbound

74

 

69

 

5

 

7

Text messages – outbound

16,774

 

10,744

 

6,006

 

56

________________

* *

*(1) **Refers to other non-subscriber-related revenues, suchas facility service fees from Smart’s revenue-sharing agreement with Piltel andinbound international roaming fees.*

* *

*(2) **Refers to all other services consisting primarily ofrevenues from Smart Money Holdings Corporation, public calling offices andSMARTalk payphones, and a small number of leased line contracts.*

* *

*(3) **Includes Piltel’s Talk’N Text subscribers of 3,553,895and 2,220,336 as of**June 30, 2004**and 2003, respectively.  Talk’N Text is a prepaid GSMservice provided by Piltel using Smart’s GSM network under a revenue-sharingagreement.*

 

*VoiceServices*

 

Smart’s revenues fromvoice services, which include all voice traffic and voice value-added servicessuch as voice mail and international roaming, increased by Php2,983 million, or26%, to Php14,508 million in the first half of 2004 from Php11,525 million inthe same period in 2003 mainly due to the increase in subscriber base.

 

Priorto January 2004, *Smart Buddy* subscribers were charged a rate of Php8.00per minute for calls made during peak hours and Php4.00 per minute for callsmade during off-peak hours regardless of whether the calls were made tosubscribers within the Smart network or to other mobile operators’ networks.Beginning January 2004, Smart**implemented all-day flat air time ratesfor calls made by its prepaid subscribers.  Calls terminating to other Smartand Piltel’s *Talk ‘N Text* subscribers are charged Php6.50 per minute,while an all-day flat rate of Php7.50 per minute is charged for callsterminating to other cellular network subscribers as well as local and NDDcalls.  

 

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

 

*DataServices*

 

Smart’s**revenuesfrom cellular data services, which include all text messaging-related servicesas well as value-added services, increased by Php4,443 million, or 54%, toPhp12,685 million in the first half of 2004 from Php8,242 million in the sameperiod in 2003.  Cellular data services accounted for 41% of Smart's GSMcellular revenues in the first half of 2004, compared to 38% in the same periodin 2003.  Text messaging-related services contributed revenues of Php11,675million in the first half of 2004, compared to Php7,720 million in the sameperiod in 2003, and accounted for 92% and 94% of the total cellular datarevenues for the first half of 2004 and 2003, respectively.  The increase inrevenues from text messaging-related services resulted mainly from a 56%increase in volume of text messages to 16,774 millionoutbound messages in the first half of 2004 from the 10,744 million outboundmessages handled in the same period in 2003.  Value-added services contributedrevenues of Php1,010 million in the first half of 2004, increasing by Php488million, or 93%, from Php522 million in the same period in 2003.

* *

The following table shows the breakdown of Smart’scellular data revenues for the six months ended June 30, 2004 and 2003:

* *

** **

**Six months ended June 30,**

** **

**Increase (Decrease)**

** **

**2004**

** **

**2003**

** **

**Amount**

** **

**%**

 

**(Unaudited)**

**(in millions)**

** **

** **

** **

** **

** **

** **

** **

Text messaging

** **

** **

** **

** **

** **

** **

** **

Domestic

Php10,859

 

Php6,865

 

Php3,994

 

58

International

816

 

855

 

(39)

 

(5)

 

11,675

 

7,720

 

3,955

 

51

Value-added services

 

 

 

 

 

 

 

Non-Zed(1)

Php559

 

Php233

 

Php326

 

140

*Smart Zed*TM

197

 

210

 

(13)

 

(6)

Mobile Banking, Roaming SMS, WAP*, Smart Money*

254

 

79

 

175

 

222

 

1,010

 

522

 

488

 

93

Total 

Php12,685

 

Php8,242

 

Php4,443

 

54

________________

* *

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

 

*FacilityServices*

 

Smart’s revenues from GSM service in the first half of 2004 and2003 included facility service fees totaling Php2,814 million and Php1,823 million, respectively, representingSmart’s 50% share from Piltel’s *Talk ‘N Text* revenues, net ofinterconnection fees.  As of June 30, 2004, Piltel had 3,553,895 *Talk ‘NText* subscribers compared to 2,220,336 subscribers as of June 30, 2003 usingSmart’s GSM network pursuant to a facilities service agreement between Smartand Piltel.  See *Note 15 – Related Party Transactions* to the accompanying**financial statements for a description of this agreement.

 

*SubscriberBase, ARPU and Churn Rates*

* *

Of Smart’s 12,474,512GSM subscribers as of June 30, 2004, prepaid subscribers accounted forapproximately 98% while postpaid subscribers accounted for the remaining 2%.Smart's prepaid GSM subscriber base grew by 54% to 12,200,978 as of June 30,2004 from 7,920,447 as of June 30, 2003, whereas Smart's postpaid GSMsubscriber base increased by 23% to 273,534 as of June 30, 2004 from 222,942 asof June 30, 2003.  Smart’s prepaid and postpaid net subscriber activationstotaled 2,369,843 and 24,557, respectively, in the first half of 2004, or amonthly average addition of 394,974 prepaid and 4,093 postpaid subscribers.Smart’s prepaid GSM gross activations in the first half of 2004 averaged616,395 subscribers per month compared to an average of 438,900 subscribers permonth in the same period in 2003.

 

Revenuesattributable to Smart’s prepaid service amounted to Php25,165 million in thefirst half of 2004, a 38% increase over the Php18,178 million earned in thesame period in 2003.  Net prepaid revenues in the first half of 2004 accountedfor 93% of GSM voice and data revenues, compared to 92% in the same period in2003.  Revenues attributable to Smart’s postpaid service amounted to Php2,028million in the first half of 2004, a 28% increase over the Php1,589 millionearned in the same period in 2003.  Net postpaid revenues in the first half of2004 accounted for 7% of GSM voice and data revenues, compared to 8% in thesame period in 2003.

 

The following table summarizes Smart's usage-basedmonthly ARPUs for the six months ended June 30, 2004and 2003:

 

 

**Six Months Ended June 30,**

 

**Gross**

** **

**(Decrease)**

** **

**Net**

 

**(Decrease)**

 

**2004**

** **

**2003**

** **

**Amount**

** **

**%**

** **

**2004**

** **

**2003**

 

**Amount**

 

**%**

 

 

 

**(Unaudited)**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Prepaid

Php459

Php530

 

Php(71)

 

(13)

 

Php381

 

Php421

 

Php(40)

 

(10)

Postpaid

1,709

1,734

 

(25)

 

(1)

 

1,282

 

1,302

 

(20)

 

(2)

Blended

489

563

 

(74)

 

(13)

 

402

 

445

 

(43)

 

(10)

 

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-providedcosts, 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-provided 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.

 

Smart’sprepaid service revenues consist mainly of charges for subscribers' actualusage of their prepaid cards.  Gross monthly ARPU for Smart’s prepaid GSMservice in the first half of 2004 was Php459, a decrease of 13%, compared toPhp530 in the same period in 2003.  The decline was attributable mainly to adecrease in the average outbound local voice revenue per subscriber in thefirst half of 2004.  On a net basis, ARPU in the first half of 2004 decreased by 10% to Php381 from Php421 in the same period in2003.  The lower rate of decrease in net ARPU compared to the decrease in grossARPU resulted mainly from a lower average interconnection expense persubscriber on the back of the increasing percentage of Smart-to-Smart trafficto local voice traffic, to 64% in the first half of 2004 from 58% in the sameperiod in 2003, as well as lower dealer discounts on *Smart Load.*  Smartcurrently expects its prepaid ARPUs to continue to decline now thatlower-denomination reloads are available and as it continues its expansion intothe lower end of the market.

 

Monthly ARPU forSmart’s postpaid GSM service is calculated in a manner similar to that ofprepaid service, except that the revenues consist mainly of monthly servicefees and charges on usage in excess of the monthly service fees.  Until April2003, pre-termination fees were reported as part of usage revenues and includedin the calculation of postpaid ARPUs; pre-termination fees of Php196 millionwere included in the ARPU computation during the first quarter of 2003, whichwere subsequently reversed in the second quarter of 2003.  ARPU is a measureassociated with a subscribers’ actual usage of the network on whichpre-termination fees would have had no effect.  Beginning the first half of2003, pre-termination fees were included, upon collection, under “Others” of“GSM Revenues” and are therefore no longer included for the purpose ofcalculating ARPUs.

 

Gross and net monthlyARPUs for postpaid GSM subscribers in the first half of 2004 slightly decreasedby 1% and 2%, respectively, compared to the ARPU levels in the same period in2003.  Smart's GSM monthly gross blended ARPU was Php489 in the first half of2004, a decrease of 13% compared to Php563 in the same period in 2003.  Blendednet monthly ARPU decreased by 10% to Php402 in the first half of 2004 fromPhp445 in the same period in 2003.

 

Smart's 50% share of Piltel's revenues from *Talk ‘N Text*under a revenue-sharing agreement between Smart andPiltel is not included in the computations of Smart's ARPUs.

 

Churn,or the rate at which existing subscribers have their service canceled in agiven period, is computed based on total disconnections in the period, net ofreconnections in the case of postpaid subscribers, divided by the average ofthe number of subscribers at the beginning and the end of a month, all dividedby the number of months in the same period.

 

Inthe past, a prepaid cellular subscriber was recognized as an active subscriberwhen that subscriber activated and used the SIM card in the handset, whichalready contains Php50 of pre-stored air time (reduced from Php100 in April2004).  Subscribers can reload their air time by purchasing prepaid “call andtext” cards that are sold in denominations of Php300, Php500 and Php1,000 or,by purchasing additional air time “over the air” via *Smart**Load*in smaller denominations of Php30, Php60, Php115 and Php200, by receiving loadsof Php2, Php5, Php10 and Php15 via *Pasa**Load*, or through theirhandsets using *Smart Money*.  Reloads have validity periods ranging fromone day to two months, depending on the amount reloaded.  A GSM prepaid accountis disconnected if the subscriber does not reload within four months after thefull usage or expiry of the last reload.  Our current policy is to recognize aprepaid subscriber as “active” only when the subscriber activates and uses theSIM card and reloads at least once during the month of initial activation or inthe immediate succeeding month.  For example, if a customer activated a SIMcard in April 2004 but had not reloaded by May 31, 2004,this customer would not be counted as a subscriber.  The rationale for thischange stems from our observance of the aggressive “SIM-swapping” activities inthe market beginning February 2004.  “SIM-swapping” refers to the promotionalactivity wherein subscribers can exchange their current prepaid SIM card foranother operator’s SIM card at no cost to the subscriber.  We believe thatthese activities have given rise to a situation where certain subscribers mayswap their SIM cards between mobile operators upon full usage of the pre-storedair time, which, without the adjustment to subscriber recognition, would haveled, based on the approach used in the past, to an overstatement of our prepaidsubscriber base.  Without this change in subscriber recognition, our prepaidsubscriber base would have been recorded at 12,703,101, a difference of 502,123subscribers, from our reported prepaid subscriber base of 12,200,978 as of June 30, 2004.

 

ForSmart's prepaid GSM subscribers, the average monthly churn rate for the firsthalf of 2004 was 2.0%, compared to 3.1% for the same period in 2003.  In linewith the various churn management initiatives implemented to address increasedchurn rates, in May 2003, Smart introduced *Smart Load*, an “over-the-air”electronic loading facility designed to make reloading of air time credits moreconvenient for, and accessible to consumers.  These “over-the-air” reloads,which have both voice and text functions, are packaged in smaller denominationsof Php30, Php60, Php115 and Php200, but have shorter validity periods of threedays, six days, 12 days and 30 days, respectively.  Starting with just 50,000outlets when it was launched, *Smart Load’s* distribution network nowencompasses over 500,000 retail agents, approximately 90% of which are microbusinesses.  As of June 30, 2004, approximately 91% of *Smart Buddy*subscriberswere using *Smart Load* as their reloading mechanism.  In the first halfof 2004, *Smart Load* has accounted for approximately 61% of sales derivedfrom reloads. 

 

On December 24, 2003, Smart introduced *Pasa Load*(literally means “transfer load”), aderivative service of *Smart Load* that allows for Php10 load transfers toother *Smart Buddy* and Piltel *Talk ‘N Text*subscribers.  On January 25, 2004, denominations of Php2, Php5 and Php15 were added to the *Pasa Load*menu.  All *Pasa Load* denominations have a one-day expiry period.  Webelieve that *Smart Load* and *Pasa Load* will encourage subscribersto stay within our cellular network instead of churning and re-subscribing at alater time.  

 

BeginningApril 18, 2004, *Pasa Load* was also made available to Smartpostpaid subscribers as well with identical denominations to those offered toprepaid subscribers.  The denominations have a similar one-day load expiry.The sender will be billed the amount of the load and a Php1.00 transaction feewhich will be added on top of the monthly service fee.

 

The average monthlychurn rate for Smart's postpaid GSM subscribers for the first half of 2004 was0.4%, compared to 3.9% in the same period in 2003.  Smart's policy is toredirect outgoing calls to an interactive voice response system if the postpaidsubscriber's account is either 45 days overdue or the subscriber has exceededthe prescribed credit limit.  If the subscriber does not make a payment within44 days of redirection, the account is disconnected.  Within this 44-dayperiod, a series of collection activities are implemented, involving thesending of a collection letter, call-out reminders and collection messages viatext messaging.

 

*Satellite,VSAT and Other Services*

 

Our revenues fromsatellite, VSAT and other services consist mainly of rentals received for thelease of Mabuhay Satellite's transponders and Telesat's VSAT facilities toother companies and charges for ACeS Philippines’ satellite phone service.Total revenues from these services for the first half of 2004 amounted toPhp328 million, a decrease of Php48 million, or 13%, from Php376 million in thesame period in 2003.

 

***Fixed Line***

 

Ourfixed line business provides local exchange service, international and nationallong distance services, data and other network services, and miscellaneousservices.  Revenues generated from this business for the first half of 2004totaled Php23,384 million, an increase of Php522 million, or 2%, from Php22,862million for the same period in 2003.  This increase was due to higher revenuesgenerated from our international and national long distance services and dataand other network services, partially offset by decreased revenues from localexchange service and miscellaneous services.  As a percentage of ourconsolidated operating revenues, however, fixed line revenues decreased for thefirst half of 2004 to 42% from 49% in the sameperiod in 2003 principally due to the continued strong growth of our wirelessbusiness.

 

The following table summarizes our consolidatedoperating revenues from our fixed line business for the six months ended June 30, 2004 and2003 by service segment:

 

 

**Six Months Ended June 30,**

 

** **

** **

** **

** **

** **

** **

** **

** **

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

 

**2004**

** **

**%**

** **

**2003**

** **

**%**

** **

**Amount**

** **

**%**

** **

**(Unaudited)**

**(in millions)**

 

 

 

 

 

 

 

 

 

 

 

Fixed line services:

 

 

 

 

 

 

 

 

 

 

 

Local exchange

Php10,379

 

44

 

Php10,465

 

46

 

Php(86)

 

(1)

International long distance

6,356

 

27

 

6,049

 

26

 

307

 

5

National long distance

3,487

 

15

 

3,292

 

14

 

195

 

6

Data and other network

3,019

 

13

 

2,876

 

13

 

143

 

5

Miscellaneous

143

 

1

 

180

 

1

 

(37)

 

(21)

Total

Php23,384

 

100

 

Php22,862

 

100

 

Php522

 

2

 

*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;

 

•              call revenues generated frompayphones and coin-operated phones; 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 of and for the six months ended June 30, 2004 and2003:

 

 

**Six Months Ended June 30,**

 

** **

** **

** **

** **

**Increase (Decrease)**

 

**2004**

** **

**2003**

** **

**Amount**

** **

**%**

 

**(Unaudited)**

 

 

 

 

 

 

 

 

Consolidated local exchange revenues (in millions)

Php10,379

 

Php10,465

 

Php(86)

 

(1)

Number of fixed lines in service:

 

 

 

 

 

 

 

PLDT Group

2,154,354

 

2,085,243

 

69,111

 

3

PLDT

2,132,404

 

2,060,437

 

71,967

 

3

Number of PLDT employees

9,992

 

11,237

 

(1,245)

 

(11)

Number of PLDT fixed lines in service per PLDT employee

213

 

183

 

30

 

16

 

Revenuesfrom our local exchange service for the first half of 2004 decreased by Php86million, or 1%, to Php10,379 million from Php10,465 million for the same periodin 2003.  The decrease was primarily due to the (1) shifting subscriberpreference from postpaid to prepaid services, which generate lower averagerevenue per subscriber, and (2) decline in installation revenues due to apromotion starting July 2003 which waived installation cost of subscribers inan effort to stimulate subscriber growth, partially offset by adjustments inour monthly local service rates.  The percentage contribution of local exchangerevenues to our total fixed line revenues also decreased for the first half of2004 to 44% from 46% in the same period in 2003.

 

Grossadditions to PLDT's fixed lines in service for the first half of 2004 totaled350,490, an increase of 159,059 from the gross additions of 191,431 for thesame period in 2003.  On a net basis, PLDT’s fixed line additions for the firsthalf of 2004 increased to 16,733 as against a decrease of 32,102 for the sameperiod in 2003.  While fixed line additions totaled 33,287 for PLDT’s prepaidfixed line services, PLDT’s postpaid fixed lines in service declined by 16,554for the first half of 2004.  As of June 30, 2004,PLDT’s postpaid and prepaid fixed line subscribers totaled 1,741,813 and390,591, respectively, which accounted for approximately 82% and 18%,respectively, of PLDT’s total fixed lines in service.

 

Initially intended as an affordable alternativetelephone service for consumers under difficult economic conditions, ourprepaid fixed line services**now form an important part of PLDT's overallchurn and credit risk exposure management and subscriber retention strategy.Prepaid phone kits, each containing Php500 worth of pre-stored call credits,are sold for Php1,900 per unit.  Prepaid**subscribers are charged basedon usage at a rate of Php1.00 per minute for local calls and the same rates areapplicable to postpaid fixed line subscribers for national and internationallong distance calls.  

 

A prepaid fixed linesubscriber is recognized as an active subscriber when that subscriber activatesand uses a prepaid call card.  Prepaid fixed line subscribers can reload their accountsby purchasing call cards that are sold in denominations of Php500, Php300 andPhp150.  Reloads are valid for two months for the Php500 and Php300 card.  Thelower denominated Php150 card, launched in September 2003, has an account lifeof 15 days.  A prepaid fixed line subscriber is disconnected if that subscriberdoes not reload within one month for the Php500 card, four months for thePhp300 card, and 15 days for the Php150 card after the expiry of the lastreload.  All sales of prepaid cards, whether through dealers or through PLDT'sbusiness 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 2004, we implemented four upward and one downward adjustments in ourmonthly local service rates compared to four upward and three downwardadjustments during the same period in 2003.  The average peso-to-dollar ratefor the first half of 2004 was Php55.952 to US$1.00, compared to the average ofPhp53.504 to US$1.00 for the same period in 2003.  This change in the averagepeso-to-dollar rate translated to a peso depreciation of 5%, which resulted inan average net increase of 4% in our monthly local service rates for the firsthalf of 2004. 

 

Theratio of PLDT fixed lines in service per PLDT employee improved from 183 as of June 30, 2003 to 213as of June 30, 2004.  This improvement resulted from the net decrease inPLDT’s employee headcount.  As of June 30, 2004,PLDT’s workforce was reduced by 11% to 9,992 employees from 11,237 employees asof June 30, 2003, mainly on account of PLDT’s manpower rightsizingprogram, or MRP. 

 

*International Long Distance Service*

 

Our international long distance revenues, which wegenerate 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, 2004 and 2003:

 

** **

**Six Months Ended June 30,**

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2004**

** **

**2003**

** **

**Amount**

** **

**%**

 

**(Unaudited)**

 

 

 

 

 

 

 

 

Consolidated international long distance revenues (in millions)

Php6,356
 

Php6,049

 

Php307

 

5

Inbound

5,218

 

5,052

 

166

 

3

Outbound

1,138

 

997

 

141

 

14

 

 

 

 

 

 

 

 

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

 

 

 

 

 

 

 

PLDT Group

1,159

 

1,196

 

(37)

 

(3)

Inbound

1,083

 

1,114

 

(31)

 

(3)

Outbound

76

 

82

 

(6)

 

(7)

Inbound-outbound call ratio

14.3:1

 

13.6:1

 

–

 

–

 

 

 

 

 

 

 

 

PLDT

1,146

 

1,117

 

29

 

3

Inbound

1,071

 

1,037

 

34

 

3

Outbound

75

 

80

 

(5)

 

(6)

Inbound-outbound call ratio

14.3:1

 

13.0:1

 

–

 

–

 

Our consolidatedinternational long distance revenues increased by Php307 million, or 5%, toPhp6,356 million in the first half of 2004 from Php6,049 million in the sameperiod in 2003, primarily as a result of an increase in our inboundinternational long distance revenues principally driven by an increase inaverage inbound termination rates.  Likewise, the percentage contribution ofinternational long distance revenues to our total fixed line revenues slightlyincreased to 27% in the first half of 2004 from 26% in the same period in 2003.

 

Ourrevenues from inbound international long distance calls in the first half of2004 increased by Php166 million, or 3%, to Php5,218 million from Php5,052million in the same period in 2003 primarily due to the positive impact of thedepreciation of the average value of the peso relative to the U.S. dollar andan increase in PLDT’s average inbound termination rates, partially offset bythe effect of lower inbound call volumes.

 

The depreciation ofthe peso contributed to the increase 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 pesos at the prevailingexchange rates at the time of billing.  The average conversion rate wasPhp56.09 for the first half of 2004 and Php53.49 for the first half of 2003.

 

After lengthy negotiations commencing in May 2002 withcarriers around the world, PLDT increased its average termination rates with carriersthat account for a substantial portion of its international inbound trafficterminating on its fixed line network to approximately US$0.12 per minuteeffective February 1, 2003.  Prior to the increase in termination rates, asubstantial portion of PLDT’s international inbound traffic terminating on itsfixed line network was charged an average termination rate of approximatelyUS$0.08 per minute.  For further discussion, please see *Note 25 – OtherMatters* – *U.S.**Federal Communications Commission, or U.S. FCC,Ruling versus Philippine Telecommunications Companies*to the accompanying financial statements.

 

Ourinbound international long distance call volumes in the first half of 2004decreased by 3% to 1,083 million minutes from 1,114 million minutes in the sameperiod in 2003, primarily due to increased competition from alternative meansof long distance communications, particularly e-mailing, international textmessaging and internet telephony and more inbound calls terminating directly tocellular subscribers.  

 

Our revenues fromoutbound international long distance calls in the first half of 2004 increasedby Php141 million, or 14%, to Php1,138 million from Php997 million in the sameperiod in 2003.  The depreciation of the peso contributed to the increase inoutbound international long distance revenues in peso terms because outboundcalls are charged at U.S. dollar rates and billed to our subscribers in pesosat the prevailing exchange rates at the time of billing.  Average billing rateswere Php55.85 and Php53.51 for the first half of 2004 and 2003, respectively.

 

Our outboundinternational long distance call volumes declined by 7% to 76 million minutesin the first half of 2004 from 82 million minutes in the same period in 2003,primarily due to cellular substitution (subscribers opting to use cellular forinternational outbound calls) and the popularity of alternative means ofcommunications such as e-mailing, international text messaging and internettelephony.

 

*NationalLong Distance Service*

 

Ournational long distance revenues consist of: 

 

•              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 distancerevenues and call volumes for the six months ended June 30, 2004 and 2003:

 

** **

**Six Months Ended June 30,**

** **

** **

** **

** **

** **

**Increase (Decrease)**

** **

**2004**

** **

**2003**

** **

**Amount**

** **

**%**

 

**(Unaudited)**

 

 

 

 

 

 

 

 

Consolidated national long distance revenues (in millions)

Php3,487

 

Php3,292

 

Php195

 

6

National long distance call volumes (in million minutes)

 

 

 

 

 

 

 

PLDT Group

969

 

1,035

 

(66)

 

(6)

PLDT

943

 

1,023

 

(80)

 

(8)

 

Our national longdistance revenues increased by Php195 million, or 6%, to Php3,487 million inthe first half of 2004 from Php3,292 million in the same period in 2003 as aresult of increased national direct dial, or NDD, rates and more beneficialinterconnection agreements with cellular operators.  Accordingly, thepercentage contribution of national long distance revenues to our total fixedline revenues increased to 15% in the first half of 2004 from 14% in the sameperiod in 2003.

 

Effective March 1, 2003, the rate for NDDcalls originating from PLDT subscribers and terminating to other local exchangecarriers increased to Php5.00 per minute from a flat rate of Php4.50 per minute.  Inaddition, NDD calls originating from and terminating to PLDT was also adjustedto Php5.00 per minute from a flat rate of Php4.50 per minute effective June 8, 2003.  

 

Further, we have entered into more beneficial interconnectionagreements with cellular operators.  Beginning January 2004, our settlementrate to cellular operators of Php4.50 per minute was reduced to Php4.00 perminute for calls terminating to cellular subscribers.  At the same time, thecellular operators’ settlement rate for calls terminating to PLDT subscribersincreased from Php2.50 per minute to Php3.00 per minute.  In 2003, certainlocal exchange carriers, previously under revenue sharing arrangements, enteredinto access charging agreements with PLDT.  Under the revenue sharingagreements, charges are generally apportioned 30% for the originating entity,40% for the backbone owner and another 30% for the terminating entity.  Underthese access charging agreements, the originating carrier generally pays accesscharges of (1) Php0.50 per minute for short haul traffic and Php1.25 per minutefor long haul traffic to the carrier owning the backbone network; and (2)Php1.00 per minute to the terminating carrier.  This change in interconnectioncharges resulted in a 7% decrease in average revenue per minute for callsoriginating from and terminating to other local exchange carriers.  

 

Ournational long distance call volumes, however, decreased by approximately 6% to969 million minutes in the first half of 2004 from 1,035 million minutes in thesame period in 2003.  Cellular substitution and the widespread availability andgrowing popularity of alternative non-voice means of communications, particularlycellular text messaging and e-mailing, have negatively affected call volumes.

 

Data and Other Network Services
 

Inthe first half of 2004, our data and other network services posted a revenue ofPhp3,019 million, an increase of Php143 million, or 5%, from Php2,876 millionin the same period in 2003.  The revenue contribution of this service segmentto our total fixed line revenues remained relatively flat at 13% in the firsthalf of 2004 and 2003.

 

Data and other network services we currently provideinclude traditional bandwidth services, broadband/packet-based/internet-basedservices and other packet-based switching services.

 

The foregoing services are used for domestic andinternational communications, broadband data transmission services, internetexchange services, private networking services, switch-based services andinternational packet-based services. 

 

Traditionalbandwidth services accounted for 39% of the total revenues from PLDT’s data andother network services in the first half of 2004, broadband/IP-based servicesaccounted for 55%, and other services accounted for the remaining 6%, comparedto 53%, 41% and 6%, respectively, in the same period in 2003.  These percentagechanges indicate a continuing shift in data and other network revenues fromtraditional bandwidth services to broadband/IP-based services.  We expect thistrend to continue given the growing demand for broadband transmission of voice,data and video due to the continued growth of the internet, e-commerce andother online services.

 

PLDToffers two residential internet service packages targeting separate markets:  *PLDTVibe*for light to medium internet users and *DSL*broadband for heavyinternet users.  As of June 30, 2004, the number of PLDT’s fixed linesubscribers for *PLDT Vibe*stood at 344,527, of which 181,168 werepostpaid and 163,359 were prepaid subscribers, compared to 117,110 as of June30, 2003, of which 84,566 were postpaid and 32,544 were prepaid subscribers,while the number of *DSL* subscribers reached 33,576 and 14,579 as of June30, 2004 and 2003, respectively.

 

InApril 2004, PLDT introduced additional enhanced IP-based solutions under anumbrella brand *IP-Plus*, namely, *Quality of Service*, or *QoS*,*IP Security*, or *IP Sec*, and *Voice**over Virtual PrivateNetwork*, or *VoVPN*.  With *QoS*, customers are given priorityservice for voice, premium and basic, with the highest priority given to voicesince it requires error-free transmission.  *IP Sec* optimizes the latestencryption technology to ensure utmost confidentiality of vital information.  *VoVPN*gives customers toll-grade quality sans the cost of toll.  All these *IP Plus*solutions translate to cost-efficiency, high reliability and increased securityand flexibility.

 

InJune 2004, PLDT established an Innovation Laboratory, or *Innolab*, in Cebu, a showand demo room where existing and potential clients as well as students can havea hands-on experience on various PLDT products and services designed for ourcorporate clientele.  It also serves as a venue for testing softwareapplications and computer programs and is expected to be the starting groundfor innovative ideas where new products and cost-effective solutions unfold.

* *

*Miscellaneous*

 

Miscellaneous revenuesare derived mostly from directory advertising and facilities rental.  In thefirst half of 2004, these revenues decreased by Php37 million, or 21%, toPhp143 million from Php180 million in the same period in 2003.  The decline wasmainly due to a decrease in royalty fee on account of a change in revenuesharing agreement from collection rate to a fixed/flat rate.  Miscellaneousrevenues accounted approximately 1% of our total fixed line revenues in thefirst half of 2004 and 2003, respectively.

 

Information and Communications Technology
 

Ourinformation and communications technology business is conducted by ePLDT, awholly-owned subsidiary of PLDT.  ePLDT's principal business is its operationof an internet data center under the brand name *Vitro*ä.  Granted pioneer status as an internet data center by the PhilippineBoard of Investments, or BOI, *Vitro*ä providesco-location services, server hosting, hardware and software maintenanceservices, website development and maintenance services, webcasting andwebhosting, shared applications, data disaster recovery and business continuityservices, intrusion detection, and security services such as firewall andmanaged firewall. 

 

ePLDTis focused on developing its call center business which capitalizes on theavailability of English-speaking labor in the Philippines.  The call centerservice business is being undertaken by the following wholly-ownedsubsidiaries:

 

•              Vocativ Systems, Inc., or Vocativ,which owns and operates a 722-seat call center facility with 677 customerservice representatives, or CSRs, exclusively for clients of a global providerof customer relationship management services.  Vocativ is currently expandingits capacity by 369 seats which will become operational by the fourth quarterof 2004; and

 

•              Parlance Systems, Inc., orParlance, which owns and operates a 767-seat call center facility with 862CSRs, exclusively for one of the largest direct-to-home satellite serviceproviders in the United States for customer support and billing requirements.Parlance is further expanding its capacity by 274 seats to accommodateanticipated increased call volumes from its existing client.  

 

ePLDThas also invested in a number of other e-commerce and internet-relatedbusinesses, which includes:

 

•        99.6% interest in Infocom, one ofthe 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 thru *DSL* or *NOW*cable internet; web consulting, development and hosting; and

 

•        52.09% interest in DigitalParadise, Inc., or DigiPar, an internet café business which assumed the assetsand brand of *Netopia.  Netopia* is now one of the largest and fastestgrowing internet café chains in the country with over 85 branches and over4,000 work stations.  DigiPar offers high-speed internet services, includinginternet advertising, gaming, printing and sale of retail items.

 

Pleaserefer to *Note 9 – Investments* to the accompanying notes to financialstatements for further discussion on ePLDT’s other information and communicationstechnology services.

 

Inthe first half of 2004, our information and communications technology businessgenerated total revenues of Php982 million, an increase of Php118 million, or14%, from the Php864 million in the same period in 2003.  These revenuesaccounted for 2% of our consolidated operating revenues for the first half of2004 and 2003.  ePLDT’s call center business contributed revenues of Php519million, internet service contributed revenues of Php256 million**and *Vitro*ä and others contributed revenues of Php207 million, representing 53%,26% and 21%, respectively, of the total revenues from our information andcommunications technology business in the first half of 2004, compared to 56%,21% and 23% in the same period in 2003.  Going forward, we expect revenues fromour call center business to continue to contribute significantly to ourinformation and communications technology revenues with the growing demand forcall center services. 

 

**Consolidated Operating Expenses**

 

Our consolidated operating expenses in the first halfof 2004 increased by Php1,136 million, or 4%, to Php33,055 million fromPhp31,919 million in the same period in 2003.  The increase was primarily dueto higher non-cash expenses, mainly depreciation and amortization.  As apercentage of our consolidated operating revenues, however, consolidatedoperating expenses decreased to 59% in the first half of 2004 from 69% in thesame period in 2003.

 

Wireless
 

Consolidated operatingexpenses associated with our wireless business in the first half of 2004amounted to Php15,841 million, an increase of Php1,231 million, or 8%, fromPhp14,610 million in the same period in 2003.  A significant portion of thisincrease was attributable to non-cash expenses mainly depreciation and amortizationcoupled with an increase in certain cash expenses particularly professional andother service fees and compensation and benefits.  As a percentage of ourwireless operating revenues, operating expenses associated with our wirelessbusiness decreased to 51% in the first half of 2004 from 65% in the same periodin 2003. 

 

The following table summarizes our consolidatedwireless-related operating expenses for the six months ended June 30, 2004 and 2003 and the percentage of each expense item to the total:

 

 

**Six Months Ended June 30,**

 

** **

 

** **

 

** **

 

** **

** **

**Increase (Decrease)**

 

**2004**

 

**%**

 

**2003**(1)

 

**%**

** **

**Amount**

** **

**%**

** **

**(Unaudited)**

**(in millions)**

 

 

 

 

 

 

 

 

 

 

 

Wireless services

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization(2)

Php6,117

 

39

 

Php4,944

 

34

 

Php1,173

 

24

Selling and promotions

3,366

 

21

 

4,161

 

29

 

(795)

 

(19)

Compensation and benefits

1,775

 

11

 

1,594

 

11

 

181

 

11

Maintenance

1,072

 

7

 

1,067

 

7

 

5

 

–

Rent

854

 

5

 

835

 

6

 

19

 

2

Provision for doubtful accounts

481

 

3

 

369

 

3

 

112

 

30

Professional and other service fees

466

 

3

 

271

 

2

 

195

 

72

Insurance and security services

439

 

3

 

349

 

2

 

90

 

26

Taxes and licenses

298

 

2

 

329

 

2

 

(31)

 

(9)

Provision for inventory obsolescence

128

 

1

 

46

 

–

 

82

 

178

Other operating expenses

845

 

5

 

645

 

4

 

200

 

31

Total

Php15,841

 

100

 

Php14,610

 

100

 

Php1,231

 

8

__________

* *

*(1)   As restated to reflect the change in accountingpolicy on leases, as described in Note 3 – Accounting Changes to theaccompanying financial statements.*

* *

*(2)   Includes depreciation of capitalized foreignexchange losses from the revaluation of net dollar liabilities of Php647million in the first half of 2004 and Php548 million in the same period in2003.*

 

Depreciationand amortization charges increased by Php1,173 million, or 24%, to Php6,117million substantially due to an increase in the depreciable asset base owing tocontinuing network expansion and upgrade and an increase in depreciationcharges of capitalized foreign exchange losses from revaluation of net dollarliabilities.  

 

Selling and promotionexpenses decreased by Php795 million, or 19%, to Php3,366 million due to lowerdealer discounts and advertising and promotions.  Smart’s average subscriberacquisition cost, or SAC, for prepaid subscribers in the first half of 2004 wasPhp463, a decrease of 35% from Php707 in the same period in 2003.  Dealerdiscounts and advertising and promotions per prepaid subscriber decreased by60% and 28%, respectively, partially offset by a 24% increase in handsetsubsidy for prepaid subscribers.  On the other hand, postpaid SAC in the firsthalf of 2004 was Php20,822, an increase of 91% from Php10,883 in the sameperiod in 2003.  Handset subsidies increased by 79% and accounted for 78% and83% of postpaid SAC in the first half of 2004 and 2003, respectively.  BlendedSAC declined by 39%, to Php659 in the first half of 2004 from Php1,075 in thesame period in 2003.  

 

Compensation andbenefits increased by Php181 million, or 11%, to Php1,775 million primarily dueto increased headcount and increased salaries, benefits and performance bonusesof Smart’s employees.  In addition, Smart accrued for an additional share underthe enhanced employee retirement fund approved by Smart’s Board of Directors inOctober 2003.  Smart's employee headcount increased by 4% to 5,537 as of June 30, 2004 from 5,335 as of June 30, 2003.  

 

Maintenance expensesincreased by Php5 million to Php1,072 million mainly on account of higherrepairs and maintenance costs, and higher site utility expenses due to thecontinued growth in the number of cell sites and other network facilities.

 

Rent expenses slightlyincreased by Php19 million, or 2%, to Php854 million on account of highertransmission links and higher office space rentals for the increased number ofwireless centers and space requirements for increased personnel.  As of June 30, 2004, Smart had 3,488 GSM cell sites and 4,565 base stations, compared with 2,389GSM cell sites and 3,285 base stations as of June 30, 2003. 

 

Provisionfor doubtful accounts increased by Php112 million, or 30%, to Php481 million tocover for possible uncollectible carrier accounts.  

 

Professionaland other service fees increased by Php195 million, or 72%, to Php466 millionmainly as a result of increased legal, consultancy and bill collection servicefees.

 

Insuranceand security services increased by Php90 million, or 26%, to Php439 million mainly due to the increase in the number of Smart’scell sites and in the amount of network equipment insured as a result of thecontinued growth and expansion of its GSM network.

 

Taxes and licenses decreased by Php31 million, or 9%, to Php298 million mainly due to a decrease in Smart’sbusiness-related taxes and NTC supervision and regulation fees, partly offsetby higher spectrum fees and disallowed input tax expense.  

 

Provision forinventory obsolescence increased by Php82 million, or 178%, to Php128 millionto cover for specifically identified slow moving handsets relating to ACeSPhilippines.

 

Otheroperating expenses increased by Php200 million, or 31%, to Php845 million mainly due to increases in Smart’s various businessand operational-related expenses such as facility usage fees, training, travel,supplies, printing, communication and delivery expenses.

 

Fixed Line
 

Consolidatedoperating expenses related to our fixed line business in the first half of 2004totaled Php16,241 million, a decrease of Php48 million, compared to Php16,289million in the same period in 2003.  The decrease was primarily due to PLDT’scost-containment initiatives, partially offset by higher non-cash expenses,mainly depreciation and amortization.  As a percentage of our total fixed lineoperating revenues, fixed line-related operating expenses decreased to 69% inthe first half of 2004, compared to 71% in the same period in 2003.

 

The following table shows the breakdown of our totalconsolidated fixed line-related operating expenses for the six months ended June 30, 2004 and 2003 and the percentage of each expense item to the total:

 

 

**Six Months Ended June 30,**

 

** **

 

** **

 

** **

 

** **

** **

**Increase (Decrease)**

 

**2004**

 

**%**

 

**2003**(1)

 

**%**

** **

**Amount**

** **

**%**

** **

**(Unaudited)**

**(in millions)**

 

 

 

 

 

 

 

 

 

 

 

Fixed line services:

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization(2)

Php6,980

 

43

 

Php6,571

 

40

 

Php409

 

6

Compensation and benefits

3,516

 

22

 

3,709

 

23

 

(193)

 

(5)

Maintenance

1,535

 

9

 

1,498

 

9

 

37

 

2

Provision for doubtful accounts

1,393

 

9

 

1,522

 

9

 

(129)

 

(8)

Selling and promotions

631

 

4

 

633

 

4

 

(2)

 

–

Professional and other service fees

496

 

3

 

511

 

3

 

(15)

 

(3)

Rent

492

 

3

 

492

 

3

 

–

 

–

Insurance and security services

360

 

2

 

381

 

2

 

(21)

 

(6)

Taxes and licenses

333

 

2

 

292

 

2

 

41

 

14

Provision for inventory obsolescence

–

 

–

 

86

 

1

 

(86)

 

(100)

Other operating expenses

505

 

3

 

594

 

4

 

(89)

 

(15)

Total

Php16,241

 

100

 

Php16,289

 

100

 

Php(48)

 

–

____________

*(1)   As restated to reflect the change in accountingpolicy on leases, as described in Note 3 – Accounting Changes to theaccompanying financial statements.*

* *

*(2)   Includes depreciation of capitalized foreignexchange losses from the revaluation of net dollar liabilities of Php2,319million in the first half of 2004 and Php2,120 million in the same period in2003.*

 

Depreciationand amortization charges increased by Php409 million, or 6%, to Php6,980million mainly due to higher depreciation of our regular asset base primarilyresulting from additional completed projects and an increase in depreciation ofcapitalized foreign exchange losses from the revaluation of our net dollarliabilities, which were incurred in acquiring various telecommunicationsequipment.

 

Compensationand benefits decreased by Php193 million, or 5%, to Php3,516 million mainly dueto a 11% reduction in headcount due to PLDT’s MRP, partially offset bycollective bargaining agreement-related increases in salaries and benefits ofPLDT employees.  See *Note 17 – Other Expenses – Net*to the accompanying financial statements for further discussion on PLDT’s MRP.

 

Maintenance expensesincreased by Php37 million, or 2%, to Php1,535 million primarily due to theexpiration of warranty for certain plant facilities and higher maintenancecosts of computer and peripherals in relation to charges for software supportagreements for certain systems in the first half of 2004 as compared to thesame period in 2003, partially offset by lower maintenance costs of the domesticfiber optic network primarily due to more remedial works done in 2003 than in2004.

 

Provisionfor doubtful accounts decreased by Php129 million, or 8%, to Php1,393 millionon account of lower provisions by PLDT for anticipated uncollectible accountsfrom various specifically identified domestic telecommunications carriers whichhave been provided for in 2003.  PLDT’s provision for doubtful accounts in thefirst half of 2004 and 2003 was equivalent to 6% and 6.2% of its operatingrevenues. 

 

Selling and promotion expenses decreased by Php2million to Php631 million mainly as a result of reduced corporate publicrelations expenses, partially offset by an increase in PLDT’s promotionalactivities in relation to various products and services.

 

Professional and otherservice fees decreased by Php15 million, or 3%, to Php496 million as a resultof lower advisory fees due to a decrease in number of consultants in line withPLDT’s cost management efforts, coupled with a decrease in collection agencyfees on account of lower final accounts subject for collection partially offsetby payment of higher legal fees in the first half of 2004 for various services.

 

Insuranceand security services decreased by Php21 million, or 6%, to Php360 millionprimarily due to a decrease in the number of contracted security guards.

 

Taxesand licenses increased by Php41 million, or 14%, to Php333 million mainly onaccount of higher business-related taxes paid in 2004 as compared to 2003.

 

Other operating costsdecreased by Php89 million, or 15%, to Php505 million mainly due to loweroffice supplies consumption and printing costs resulting from PLDT’s continuingcost-cutting activities, partially offset by higher contracted cost fortechnical and helpdesk resources and related computer and network maintenanceand in-house systems development.

 

***Information andCommunications Technology***

 

Consolidated operatingexpenses associated with our information and communications technology businesstotaled Php973 million in the first half of 2004, a decrease of Php47 million,or 5%, from Php1,020 million in the same period in 2003.  The decline was dueto the sale of our 51% interest in Contact World, a call center business, inJune 2003.  As a percentage of our information and communications technologyoperating revenues, operating expenses related to our information andcommunications technology business decreased to 99% in the first half of 2004from 118% in the same period in 2003.  The three largest expense items relatedto our information and communications technology business in the first half of2004 were compensation and benefits, depreciation and amortization, and rent,representing 38%, 15% and 13%, respectively, of our total operating expensesrelated to this business.  For the first half of 2003, compensation andbenefits, maintenance, and depreciation and amortization registered the largestexpenses representing 27%, 26% and 18%, respectively.

 

Net Operating Income
 

Ourconsolidated net operating income in the first half of 2004 was Php22,542million, an increase of Php8,242 million, or 58%, from Php14,300 million in thesame period in 2003.  Accordingly, our consolidated operating margin (netoperating income as a percentage of operating revenues) improved to 41% in thefirst half of 2004 from 31% in the same period in 2003.

*** ***

***Wireless***

 

Our wireless business segment recorded an operatingincome of Php15,390 million in the first half of 2004, an increase of Php7,507million, or 95%, over Php7,883 million registered in the same period in 2003.Smart's operating income contribution in the first half of 2004 increased byPhp7,282 million to Php15,274 million from Php7,992 million due primarily tothe growth in Smart’s subscriber base.

 

***Fixed Line***

 

In the first half of 2004, our fixed line businesssegment contributed a net operating income of Php7,143 million, higher byPhp570 million, or 9%, than Php6,573 million in the same period in 2003 mainlyas a result of higher fixed line operating revenues coupled with lower fixedline-related expenses.  PLDT’s net operating income contribution to thisbusiness segment in the first half of 2004 was Php6,921 million, an increase ofPhp545 million, or 9%, compared to Php6,376 million in the same period in 2003.

 

***Information andCommunications Technology***

 

Inthe first half of 2004, our information and communications technology businesssegment registered an operating income of Php9 million, an increase of Php165million, compared to an operating loss of Php156 million posted in the sameperiod in 2003.  This improvement reflects the contribution of ePLDT’s callcenter business which contributed 53% of information and communicationstechnology business’ operating income in the first half of 2004.

 

**Interest Expense andRelated Items - Net**

 

Interest expense and relateditems – net increased by Php276 million, or 5%, to Php5,868 million in thefirst half of 2004 from Php5,592 million in the same period in 2003 mainly dueto a net increase of Php462 million in PLDT’s interest expense resulting fromthe peso depreciation that increased interest expense on foreigncurrency-denominated loans in peso terms and a decrease in interest charged toconstruction as more projects were completed.  This increase was partiallyoffset by a decrease in Smart’s and Mabuhay Satellite’s interest expenses byPhp155 million and Php35 million, respectively, due to lower debt balances andlower interest rates mainly on foreign currency-denominated loans bearingfloating interest rates.

 

**Interest Income**

** **

Interest income increased by Php220 million, or 90%,to Php465 million in the first half of 2004 from Php245 million in the sameperiod in 2003 mainly attributable to higher average cash balances.

 
Other Expenses – Net
 

In the first half of2004, consolidated other expenses – net were Php1,050 million, a decrease ofPhp3,574 million, or 77%, compared to Php4,624 million in the same period in2003 principally due to: (1) a decrease in asset impairment charge of Php1,144million, or 93%, to Php85 million in the first half of 2004 from Php1,229 millionin the same period in 2003; (2) recognition of provision for unrealizable assets of Php1,408 million in2003; and (3) a decrease in manpower rightsizing cost by Php1,224 million, or87%, to Php187 million in the first half of 2004 from Php1,411 million in thesame period in 2003.  The manpower rightsizing costcorresponded to 258 and 1,681 employees affected by PLDT’s MRP in the firsthalf of 2004 and 2003, respectively.  See *Note 17 – Other Expenses – Net*tothe accompanying financial statements for further discussion.

 

**Income Before Income Taxand Minority Interest**

 

Our income beforeincome tax and minority interest in net income (losses) of consolidatedsubsidiaries in the first half of 2004 was Php16,046 million, representing anincrease of Php13,333 million, or 491%, from Php2,713 million in the sameperiod in 2003, mainly attributable to a higher operating revenues generated inthe first half of 2004 coupled with a substantial decline in other expenses -net during the same period.  However, on a non-consolidated basis, incomebefore income tax and equity share in net income of our subsidiaries improvedby Php2,429 million, or 134%, to Php612 million in the first half of 2004 asagainst a net loss of Php1,817 million in the same period in 2003.  

 

Ourconsolidated provision for income tax increased by Php2,874 million, or 251%,to Php4,020 million in the first half of 2004 from Php1,146 million in the sameperiod in 2003.  On a non-consolidated basis, our provision for income tax wasPhp215 million in the first half of 2004, from an income tax benefit of Php401million in the same period in 2003.  

 

In the first half of2004, our effective corporate tax rates were lower than the 32% statutorycorporate tax rate due to differences between our consolidated andnon-consolidated income as shown in our financial statements and our taxableincome.  These differences arose from the following:

 

•              the effect of a three-year incometax holiday granted to Smart by the BOI in connection with the pioneer statusit awarded to Smart's 

GSMnetwork expansion project;

 

•              income already subjected to finaltax or lower tax rate; and

 

•              equity in net income of ourassociates, which has already been subjected to tax and therefore, as income toPLDT, is no longer subject to income tax. 

 

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 tax dueon GSM operations.  The exemption rate was computed by dividing the incrementalGSM revenues by eligible GSM revenues (both gross of interconnection revenues)where the incremental GSM revenues were derived by deducting the BOI-prescribedbase figure (Smart’s gross GSM revenue in 2000) from the total GSM revenues.After adjusting for non-deductible items and unrealized and realized foreignexchange losses, Smart’s net taxable income was multiplied by the statutorycorporate income tax rate of 32% and the exemption rate.  The resulting figurewas the income tax holiday that will be deducted from the income tax due on GSMrevenues with the difference being the income tax due for the period.  

 

**Net Income**

 

As aresult of the factors discussed above, our consolidated net income for thefirst half of 2004 was Php12,008 million, representing an increase of Php10,223million, or 573%, over our restated consolidated net income of Php1,785 millionin the same period in 2003.  This increase was principally due to Smart’s net incomecontribution of Php11,635 million for the first half of 2004, a significantimprovement of Php5,511 million, or 90%, over its net income contribution ofPhp6,124 million in the same period in 2003 and a substantial decline in otherexpenses – net of Php3,574 million due to the decrease in asset impairmentcharges and manpower rightsizing cost by Php1,144 million and Php1,224 million,respectively, and the recognition of provision for unrealizable assets ofPhp1,408 million in 2003.  On a non-consolidated basis, PLDT's net income inthe first half of 2004, before taking into account its equity share in netincome of investees, was Php397 million, as against a net loss of Php1,416million in the same period in 2003.  The increase in net income was mainlyattributable to lower manpower rightsizing cost by Php1,224 million.

 

Basicand diluted earnings per common share, or EPS, increased to Php65.62 andPhp61.81, respectively, in the first half of 2004 from basic and diluted EPS ofPhp5.54 in the same period in 2003, after giving retroactive effect to commonshare equivalents.  See *Note 19 – Earnings Per Common Share* to theaccompanying financial statements for further discussion.

 

**Liquidity and Capital Resources**

 

Thefollowing table shows our consolidated and non-consolidated cash flows for thesix months ended June 30, 2004 and 2003 as well as consolidated and non-consolidatedcapitalization and other selected financial data as of June 30, 2004 and2003:

 

 

**Consolidated**

 

**Non-Consolidated**

 

**Six Months Ended June 30,**

 

**Six Months Ended June 30,**

 

**2004**

 

**2003**(1)

 

**2004**

 

**2003**(1)

** **

**(Unaudited)**

**(in millions)**

 

 

 

 

 

 

 

**Cash Flows**

 

 

 

 

 

 

 

Net cash provided by operating activities

Php35,010

 

Php23,081

 

Php14,721

 

Php10,262

Net cash (used in) provided by investing activities

(11,496)

 

(5,699)

 

8,655

 

2,671

Capital expenditures

11,576

 

5,340

 

2,667

 

1,496

Net cash used in financing activities

20,352

 

17,090

 

16,687

 

13,112

Net increase (decrease) in cash and cash equivalents

3,110

 

240

 

6,735

 

(199)

 

** **

 

** **

 

** **

 

** **

 

**Consolidated**

 

**Non-Consolidated**

 

**June 30,**

** **

**December 31,**

 

**June 30,**

 

**December 31,**

 

**2004**

 

**2003**(1)

 

**2004**

 

**2003**(1)

** **

**(Unaudited)**

** **

**(Audited)**

** **

**(Unaudited)**

 

**(Audited)**

**(in millions)**

 

 

 

 

 

 

 

**Capitalization**

 

 

 

 

 

 

 

Notes payable

Php150

 

Php2,133

 

Php–

 

Php1,933

Current portion of long-term debt

22,273

 

23,742

 

13,918

 

15,850

Long-term debt - net of current portion

123,840

 

133,939

 

108,799

 

116,392

Total debt

146,263

 

159,814

 

122,717

 

134,175

Stockholders’ equity

104,830

 

93,578

 

104,830

 

93,578

 

Php251,093

 

Php253,392

 

Php227,547

 

Php227,753

** **

 

 

 

 

 

 

 

**Other Financial Data**

 

 

 

 

 

 

 

Cash and cash equivalents

Php22,373

 

Php19,263

 

Php12,013

 

Php5,278

Property, plant and equipment - net

243,444

 

244,427

 

184,571

 

188,152

Total assets

300,899

 

297,626

 

263,047

 

261,184

Net debt(2)

123,890

 

140,551

 

110,704

 

128,897

_______________

* *

*(1)**Asrestated to reflect the change in accounting policy on leases, as described inNote 3 – Accounting Changes to the accompanying financial statements.*

* *

*(2) Total debt less cash and cash equivalents.*

 

As of June 30, 2004, our consolidated cash and cash equivalents totaled Php22,373 million.Principal sources of consolidated cash and cash equivalents in the first halfof 2004 were cash flows from operations amounting to Php35,010 million anddrawings from long-term credit facilities aggregating Php4,824 million.  Thesefunds were used principally for capital outlays of Php11,576 million, includingcapitalized interest of Php302 million; total debt principal payments ofPhp19,413 million; and interest payments of Php5,908 million.

 

***Operating Activities***

 

On a consolidated basis, net cash flows fromoperating activities in the first half of 2004 increased by Php11,929 million,or 52%, to Php35,010 million from Php23,081 million in the same period in 2003.

 

A growing portion ofour consolidated cash flow is generated by our wireless business, whichaccounted for 56% of our consolidated operating revenues in the first half of2004, compared to 49% in the same period in 2003.  Revenues from our fixed lineand information and communications technology services accounted for 42 and 2%,respectively, of our consolidated operating revenues in the first half of 2004and 49% and 2%, respectively, for the first half of 2003.  

 

PLDT'scontribution to our consolidated cash flows from operations in the first halfof 2004 was Php14,721 million, representing an increase of Php4,459 million, or43%, from Php10,262 million in the same period in 2003.  The increase wasprimarily due to higher level of settlements of current liabilities in thefirst half of 2003. 

 

Our subsidiaries, particularly Smart, made significantcontributions to our cash from operations.  In the first half of 2004, Smartgenerated cash from operations of Php19,701 million, or 56% of our consolidatedcash flows from operations, representing an increase of Php7,797 million, or65%, compared to Php11,904 million, or 52%, of our consolidated operating cashflows in the same period in 2003.  Smart’s strong cash flows reflect thecontinuing strong performance of its cellular business.  However, Smart issubject to loan covenants that restrict its ability to pay dividends, redeempreferred shares, make distributions to PLDT or otherwise provide funds to PLDTor any associate without the consent of its lenders.  On May 26, 2004, afterobtaining the relevant waivers from Finnvera and certain of its lendersprior to actual payment, Smart paid a dividend of Php11,280 million to PLDT,equivalent to 70% of Smart’s 2003 net income.  InJune 2003, after receiving similar approvals from Finnvera and certain lenders, Smart paiddividends in the amount of Php4,300 million to PLDT, representing 70% ofSmart’s 2002 net income and in the amount of Php1,866 million to PLDT inNovember 2003, equivalent to the remaining 30% of its 2002 net income.  Smartmade its first dividend payment of Php1,540million to PLDT in December 2002, representing 40% ofSmart’s net income in 2001.  We cannot assure you that Smart will be able toobtain such waivers or any other waivers in the future, or what amount, if any,Smart would be permitted or financially able to distribute.  We expect that wewill have difficulty meeting our debt payment obligations if we do not continueto receive cash dividends from Smart. 

 

Asof June 30, 2004, related party liabilities included (1) PLDT’s payables toSmart amounting to Php4,186 million, representing interconnection fees; (2)Smart’s liabilities to Piltel totaling Php1,907 million, relating mostly toprepaid air time reloads for *Talk ‘N Text* subscribers through *SmartLoad*, and (3) Piltel’s liabilities to PLDT amounting to Php1,050 million,representing interconnection charges.  See “Related Party Transactions” in thisreport and *Note 15 – Related Party Transactions* to the accompanyingfinancial statements for further discussion.

 

Investing Activities
 

On a consolidated basis, net cash used in investingactivities in the first half of 2004 of Php11,496 million increased by Php5,797million, or 102%, compared to Php5,699 million in the same period in 2003.This increase was primarily the result of higher aggregate capital spending.  

 

Our consolidatedcapital expenditures in the first half of 2004 totaled Php11,576 million, anincrease of Php6,236 million, or 117%, from Php5,340 million in the same periodof 2003 primarily due to PLDT’s and Smart’s increased capital spending.Smart's capital spending of Php8,813 million in the first half of 2004 was usedto further expand and upgrade its GSM and transmission network facilities toincrease capacity and coverage in respect of basic and advanced cellularservices.  PLDT's capital spending of Php2,667 million was principally used tofinance the expansion of its fixed line data and network services.  ePLDT andits subsidiaries’ capital spending of Php75 million was used to primarily fundits *Vitro*TM, Infocom andcall center business operations.  Consolidated capital expenditures in thefirst half of 2003 amounted to Php5,340 million, of which Php1,496 million,Php3,740 million, Php51 million and Php38 million were attributable to PLDT,Smart, ePLDT and PLDT Global, respectively.  The balance represented othersubsidiaries’ capital spending.  

 

Underthe terms of Piltel’s debt restructuring plan, PLDT issued a Letter of Supportfor 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$150million.  Under the Letter of Support, PLDT provided to Piltel Php2,317 million(US$48 million) in 2000, Php2,039 million (US$41 million) in 2001, and Php571million (US$11 million) in 2002.  There was no drawdown under the Letter ofSupport in 2003 nor in the first half of 2004.  Drawings under the PLDT Letterof Support are converted into U.S. dollars at the prevailing exchange rates atthe time of drawdown.  As of June 30, 2004, the remaining undrawn balanceunder the Letter of Support was US$50 million (approximately Php2,823million).  If, among other things, Piltel's financial and operating performancewere to deteriorate or any amounts were required to be paid to Piltel'sunrestructured creditors in cash to settle their claims (aggregate principal ofUS$1 million as of December 31, 2003), additional drawings under the Letter ofSupport would likely be required to provide all or a portion of the fundsneeded by Piltel.  We cannot assure that additional amounts will not have to bedrawn under the Letter of Support nor can we predict when the remaining undrawnbalance under the Letter of Support will be exhausted.  See *Note 9 –Investments* to the accompanying financial statements for furtherdiscussion.

 

***Financing Activities***

 

On a consolidated basis, we used net cash ofPhp20,352 million for financing activities in the first half of 2004, comparedto Php17,090 million in the same period in 2003.  On a non-consolidated basis,net cash used in financing activities in the first half of 2004 was Php16,687million, compared to Php13,112 million in the same period in 2003.  The netcash used in financing activities in the first half of 2004 was mainlyattributable to debt repayments by PLDT in line with its ongoing debt reductionprogram.  

 

*Debt Financing*

 

Additions to ourconsolidated long-term debt in the first half of 2004 totaled Php4,824 million,of which Php2,522 million came from PLDT's drawings, primarily from long-termloan facilities used to finance capital expenditures and refinancing facilitiesused to repay maturing debts.  Payments in respect of principal and interestamounted to Php19,413 million and Php5,908 million, respectively, in the firsthalf of 2004, of which Php14,760 million and Php5,320 million were attributableto PLDT, respectively.

 

Our consolidatedindebtedness as of June 30, 2004 was Php146,263 million, representing adecrease of Php13,551 million, or 8%, compared to Php159,814 million as of December 31, 2003.  This decrease was mainly due to the reductions of Php11,458 millionand Php1,796 million in PLDT’s and Smart’s indebtedness, respectively.  PLDT’sindebtedness decreased by 9% to Php122,717 million as of June 30, 2004 from Php134,175 million as of December 31, 2003, due to PLDT’s debt repayments in linewith PLDT’s efforts to reduce overall indebtedness.  Smart's indebtedness as of June 30, 2004 was Php18,790 million, a decrease of 9% from Php20,586 millionas of December 31, 2003.

 

Asof June 30, 2004, PLDT had undrawn committed dollar-denominated long-termcredit facilities in the aggregate amount of US$68 million, inclusive of theremaining US$25 million undrawn portion of the US$149 million Kreditanstalt für Wiederaufbau refinancing facility, US$4 millionundrawn portion of the US$12 million term loan facility extended byDEG-Deutsche Investitions-und Entwicklungsgesellschaft mbH under an agreementdated May 29, 2003 and the JP¥4,055 million undrawn portion of the JP¥5,615million syndicated term loan facility supported by Nippon Export and InvestmentInsurance of Japan under an agreement dated June 11, 2003.  As of June 30, 2004, Smartstill had available facilities under its €50million Framework Agreement with HypoVereinsbank up to a maximum aggregateamount of €44 million.  Smart availed ofthe US$40 million remaining balance of its US$100 million NEXI-supported loanfacility in April 2004.  

 

After giving effect tothe anticipated application of existing refinancing facilities, the scheduledmaturities of our outstanding long-term debt as of June 30, 2004 are as follows:

 

**Year**

** **

**US$ Loans(2)**

** **

**JP¥ Loans(3)**

** **

**Peso Loans**

** **

**Total**

 
**Consolidated**

 

**(in millions)**

 
** **

 

 

 

 

 

 

 

 

 

 

 

 

2004(1)

 

US$150

 

Php8,407

 

JP¥2,014

 

Php1,040

 

Php839

 

Php10,286

 
2005

 

469

 

26,349

 

6,818

 

3,522

 

880

 

30,751

 
2006

 

441

 

24,766

 

6,816

 

3,521

 

826

 

29,113

 
2007

 

476

 

26,740

 

3,178

 

1,642

 

–

 

28,382

 
2008

 

69

 

3,898

 

1,589

 

821

 

–

 

4,719

 
2009 and onwards

 

813

 

42,052

 

–

 

–

 

810

 

42,862

 
 

**Non-Consolidated**

 

 

 

 

 

 

 

 

 

 

 

 

** **

 

 

 

 

 

 

 

 

 

 

 

 

2004(1)

 

US$76

 

Php4,297

 

JP¥2,014

 

Php1,040

 

Php802

 

Php6,139

2005

 

322

 

18,068

 

6,818

 

3,522

 

780

 

22,370

2006

 

305

 

17,159

 

6,816

 

3,521

 

770

 

21,450

2007

 

419

 

23,540

 

3,178

 

1,642

 

–

 

25,182

2008

 

69

 

3,893

 

1,589

 

821

 

–

 

4,714

2009 and onwards

 

813

 

42,052

 

–

 

–

 

810

 

42,862

________________

*(1)**July 1, 2004**through**December 31, 2004**.*

*(2) The exchange rate usedwas Php56.176 to US$1.00.*

*(3) The exchange rate usedwas Php0.5166 to JP**¥1.00.*

 

Approximately Php103,251million principal amount of our consolidated outstanding long-term debt as of June 30, 2004 is scheduled to mature over the period from 2004 to 2008.  Of this amount,approximately Php79,855 million is attributable to PLDT, Php18,790 million toSmart, and the remainder to Mabuhay Satellite, Maratel and ePLDT.

 

*Covenants*

 

Ourdebt instruments contain restrictive covenants, including covenants thatprohibit us from paying common dividends, and require us to comply withspecified financial ratios and other financial tests, calculated in conformitywith accounting principles generally accepted in the Philippines,at relevant measurement dates, principally at the end of each quarterly period.

 

The financial tests under our debt instruments, asamended, include maintaining a positive tangible net worth and compliance withthe following ratios:

 

•        interest coverage ratio,calculated on a non-consolidated basis and excluding PLDT’s equity share in netearnings or losses of investees, of not less than 180% or 200%;

 

•        total debt to EBITDA on anon-consolidated basis of not more than 5.0:1 from March 31, 2004 to June 30,2004, not more than 4.5:1 from September 30, 2004 to December 31, 2004 and notmore than 4.0:1 from March 31, 2005 and thereafter;

 

•        long-term indebtedness toappraised value of equity/tangible net worth on a non-consolidated basisranging from not more than 1.1:1 to not more than 3.0:1; 

 

•        current ratio on anon-consolidated basis, ranging from not less than 0.9:1 to not less than1.2:1;

 

•        debt service coverage ratio on anon-consolidated basis of at least 1.1:1; and

 

•        debt to free cash flow ratio on anon-consolidated basis of not more than 5.5:1 from March 31, 2004 to June 30,2004, not more than 5.0:1 from September 30, 2004 to June 30, 2005, not morethan 4.5:1 from September 30, 2005 to June 30, 2006, and not more than 4.0:1from September 30, 2006 onwards.

 

In addition, some ofPLDT’s debt instruments contain covenants requiring PLDT to comply withspecified financial tests on a consolidated basis calculated in conformity withaccounting principles generally accepted in the Philippines.  These include:

 

•        long-term debt to appraised valueof equity/tangible net worth of not more than 2.33:1;

 

•        total debt to EBITDA of not morethan 4.5:1 in 2004 and not more than 4.0:1 in 2005 and thereafter; 

 

•        current ratio ranging from notless than 0.75:1 to 0.9:1; and

 

•        interest coverage ratio of notless than 200%.

 

Theprincipal factors that can negatively affect our ability to comply with thesefinancial ratios and other financial tests are depreciation of the pesorelative 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.  Sinceapproximately 97% of PLDT’s total debt is denominated in foreign currencies,principally in U.S. dollars, many of these financial ratios and other tests arenegatively affected by any weakening of the peso.  As of June 30, 2004, the peso depreciated by 1% to Php56.176to US$1.00, from Php55.586 to US$1.00 as of December 31, 2003.  The peso hasbeen subjected to significant fluctuations.  In 2003, the peso depreciated toPhp55.075 to US$1.00 on March 12, 2003 then recovered to a high of Php52.021 to US$1.00 on May 8, 2003 only todepreciate again to a low of Php55.767 to US$1.00 on November 27, 2003.During the first half of 2004, the peso appreciated to a high of Php55.142 on January 6, 2004 butdepreciated to a low of Php56.429 on March 22, 2004. 

 

PLDT'sability to maintain compliance with financial covenant requirements measured ona non-consolidated basis is principally affected by the performance of itsfixed line business.  PLDT cannot be assured of the benefit of net revenues andcash flows generated by Smart and PLDT’s other investees in assisting incomplying with non-consolidated covenants.

 

Wehave maintained compliance with all of our financial ratios and covenants asmeasured under our loan agreements and other debt instruments.  However, ifnegative factors adversely affect our financial ratios, we may be unable tomaintain compliance with these ratios and covenants or be unable to incur newdebt.  Under some of our loan agreements, certain of our financial ratios willcontinue to become more restrictive as the loans near maturity.  Inability tocomply with our financial ratios and covenants could result in a declaration ofdefault and acceleration of some or all of our indebtedness.  The terms of someof our debt instruments have no minimum amount for cross-default.

 

Pleasesee *Note 12 – Long-term Debt* for a detailed discussion of our covenants.

 

Financing Requirements
 

We believe that our available cash, including cashflow from operations and drawings from existing and anticipated creditfacilities, will provide sufficient liquidity to fund our projected operating,investment, capital expenditures and debt service requirements for the next 12months.  

 

We continue to pursuevarious initiatives and financing transactions with the objective of furtherimproving the balance between our cash flows and debt service requirements andreducing our overall indebtedness.  In addition, PLDT has managed its capitalexpenditures, reduced its investments, suspended dividend payments to commonshareholders and increased its application of available cash to reduce itsindebtedness.  Further, we are benefiting from increasing revenue and cash flowcontributions from our subsidiaries, particularly Smart.  Smart, however, willbe required to obtain further waivers from Finnvera and certain lenders to payadditional dividends in future periods.  See “–– Operating Activities” forfurther details.

 

*Credit Ratings*

 

Our credit ratings may significantly affect the termsof our prospective financings, particularly financing costs.  None of ourexisting indebtedness contains provisions under which credit rating downgradeswould trigger a default, changes in applicable interest rates or other similarterms and conditions.  

 

On June 24, 2004 and March 23, 2004,Standard and Poor's Ratings Group affirmed its "BB" rating and stableoutlook on PLDT.  

 

OnApril 8, 2004, Fitch Ratings upgraded PLDT's long-term foreign currency andlocal currency ratings to "BB" from "BB-" (BB minus) whilethe rating of PLDT's convertible preferred stock was similarly upgraded to"B+" (B plus) from "B".  The rating action follows asustained period of improvement in PLDT's operating and financial profilemainly due to the growth of Smart.  The stable outlook also reflects Fitch'sview that neither the existing competitive landscape nor the planned resumptionof common share dividends by PLDT would materially disrupt our deleveragingefforts.

 

On March 23, 2004, Moody’s affirmed PLDT’s “Ba2” senior unsecured debt rating with a negativeoutlook and its “B1” preferred rating with a stable outlook.  On January 27,2004, PLDT’s foreign currency senior unsecured debt rating was upgraded byMoody’s Investors Service to “Ba2” from a recent “Ba3” as of July 29, 2003 andpreferred stock rating moved up to “B1” from “B2.”  The rating reflectscontinued improvements in the operating performance of Smart and theexpectation of on-going free cash flow to help repay debt maturities in thecoming years.  The negative outlook on PLDT's rating is constrained, reflectingMoody's decision to downgrade the Philippine Government's long-term foreigncurrency bond rating to “Ba2” with a negative outlook also on January 27, 2004.  

 

*Off-BalanceSheet Arrangement*

 

On October 10, 2002,PLDT entered into a Receivables Purchase Deed, or RPD, with a foreign financialinstitution, or the Purchaser, under which PLDT agreed (1) to sell itsreceivables from certain eligible foreign carriers for an advance payment ofUS$50 million, with a balance of US$33 million as of June 30, 2004, and (2) toservice, administer and collect the receivables on behalf of the Purchaser.Under the RPD, the Purchaser has no recourse to PLDT should an eligible carrierfail or refuse to settle the assigned/purchased receivables, except if PLDTcommits a breach on its representations and warranties.  For the six monthsended June 30, 2004 and 2003, receivables sold under the RPD amounted to US$5million (Php297 million) and US$5 million (Php272 million), respectively.  Losson sale of receivables under the RPD amounted to US$0.65 million (Php37million) and US$0.84 million (Php45 million) for the six months ended June 30, 2004 and 2003, respectively.

 

*Equity Financing*

 

Through our subscriberinvestment plan, or SIP, which provides postpaid fixed line subscribers theopportunity to buy shares of our 10% cumulative convertible preferred shares aspart of the upfront payments collected from subscribers, PLDT was able to raisePhp68 million in the first half of 2004 and Php43 million in the same period in2003.  As approved by the NTC, the SIP was made optional in 2003 from beingcompulsory in earlier years.

 

Cash dividend paymentsin the first half of 2004 amounted to Php718 million, compared to Php694million in the same period in 2003, all of which were paid solely to preferredshareholders of PLDT.  The most recent cash dividend paid by PLDT to its commonshareholders was in April 2001 (dividends declared in March 2001); since then,no dividends have been paid to common shareholders.

 

***Contractual Obligations and Commercial Commitments***

 

*Contractual Obligations*

 

The following table discloses our contractualobligations outstanding as of June 30, 2004: 

 

 

**Payments Due by Period**

 

**Total**

** **

**Within 1 year**

** **

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

** **

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

** **

**After 5 years**

 

 

 

**(Unaudited)**

 

 

**(in millions)**

 

 

 

 

 

 

 

 

 

Long-term debt obligations

Php146,113

 

Php22,236

 

Php70,734

 

Php20,885

 

Php32,258

Long-term lease obligations:

 

 

 

 

 

 

 

 

 

Operating Lease

5,433

 

1,304

 

2,362

 

924

 

843

Capital Lease

1,354

 

532

 

657

 

165

 

–

Unconditional purchase obligations(1)

12,587

 

3,615

 

2,256

 

2,784

 

3,932

Other long-term obligations

22,131

 

–

 

–

 

14,049

 

8,082

Total contractual cash obligations

Php187,618

 

Php27,687

 

Php76,009

 

Php38,807

 

Php45,115

_____________

* *

*(1) **The amoun**ts disclosed in the table above are based on theoriginal Air Time Purchase Agreement with ACeS International Limited, or AIL.In 2003, a Standstill Agreement was executed to cover, among other matters, theamended minimum and supplemental air time payment provisions for the year2003.*

 

*Long-term Debt Obligations*

* *

For a discussion of our long-term debt obligations,see *Note 12 – Long-term Debt* to the accompanying financial statements.

* *

*Long-term Operating Lease Obligations*

* *

***Transponder Lease Agreement***.   On December 28, 1995, PLDT and Mabuhay Satelliteentered into a Transponder Lease Agreement, which was amended on May 10, 2000.  Thisagreement has a term of ten years commencing on December 18, 1997, unless earlierterminated in accordance with the terms thereof.  The annual basic rent for thetransponders was US$13 million as of June 30, 2004,and PLDT’s aggregate remaining obligation under this agreement wasapproximately Php2,477 million as of that date.

 

***Domestic Fiber Optic Network Submerged Plant Agreement***.   On July 4, 2000, PLDT entered into an agreementwith NTT World Engineering Marine Corporation for submarine cable repair andrelated services for the maintenance of PLDT's domestic fiber optic networksubmerged plant for a period of five years up to July 4, 2005.  Under thisagreement, PLDT is required to pay NTT World Engineering Marine Corporation afixed annual standing 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 of June 30, 2004, PLDT’saggregate remaining obligation under this agreement was approximately Php128million. 

 

***Digital Passage 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 of June 30, 2004, PLDT’s aggregateremaining obligation under these contracts amounted to approximately Php36million.

 

***LicenseAgreement 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 of June 30, 2004, PLDT’s aggregate remaining obligation under thisagreement was approximately Php55 million.

 

***OtherLong-term Operating Lease Obligations***.  We have various long-term lease contracts for periods ranging fromtwo to ten years covering certain offices, warehouses, cell sites,telecommunication equipment locations and various office equipment.  Inparticular, Smart has lease obligations aggregating Php2,666 million as of June 30, 2004 inrespect of office and cell site rentals with over 2,000 lessors nationwide.

 

*Long-term Capital Lease Obligations*

 

***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 MunicipalTelephone Act.  Under these agreements, PLDT was granted the exclusive right toperform telecommunications management services, to expand services, and topromote the use of the DOTC-contracted facilities in certain covered areas fora period of 15 years.  Title to the properties shall be transferred to PLDTupon expiration of the lease term.  As of June 30, 2004,the aggregate remaining obligation under this agreement was approximately Php914 million.  In case of cancellation, PLDT isliable to pay Php100 million under each of thetwo contracts as liquidated damages.  

 

On June 1, 2004,PLDT served the DOTC a notice of termination of the lease agreement in respectof 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 hasinfused more than Php200 million for upgrades and maintenance to keep thesystem operable.  Further, the enactment of R.A. 7925, which negated the DOTC'swarranty to grant PLDT the exclusive right to provide telecommunicationservices in the areas stipulated, prevented PLDT from achieving the originallyprojected profitability thereby rendering it impossible for PLDT to continuefulfilling its obligation under the lease agreement.Although several discussions have been held since then to seek a mutuallyacceptable 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.  As of the date of this report, the DOJ has not yet responded tothe DOTC's referral.  As of June 30, 2004, 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 Php144 million and Php508 million,respectively.

 

***Other Long-termCapital Lease Obligations.***  The PLDT Group has various long-term leasecontracts for a period of three years covering various office equipment.  Inparticular, Smart has capital lease obligations aggregating Php436 million inrespect of office equipment.

 

*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 ACeS services in thePhilippines.  In exchange, the Air Time Purchase Agreement states that PLDT hasto purchase from AIL a minimum of US$5 million worth of air time annually overten years commencing on the date of commercial operations of the Garuda Isatellite.  In the event AIL’s aggregate billing revenue is less than US$45million in any given year, the Air Time Purchase Agreement also states thatPLDT has to make supplemental air time purchase payments not to exceed US$15million per year during the ten-year term. 

 

As of June 30, 2004, PLDT’s aggregate remainingminimum obligation under the original Air Time Purchase Agreement wasapproximately Php12,030 million.  See *Note 15 – Related Party Transactions*and *Note 21 – Provisions and Contingencies* to the accompanying financialstatements for further details relating to the Air Time Purchase Agreement withAIL.  

 

***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$0.5million during the first year and US$0.3 million in each year thereafter.

 

Effective July 1, 2003, VeriSign has agreed to amend the agreementand issued Addendum 6 to write-off all past due invoices and payments owed to VeriSign,which were invoiced or scheduled to be invoiced under the agreement prior tothis Addendum 6.  All royalty payments and annual support fees due through June2003 will be part of the write-off in the amount of US$0.8 million.  Forcontract year 4 (September 2003-August 2004), the annual support fee will bereduced from US$0.3 million to US$ 40,000 and for contract years 5-7 (September2004-August 2007) from US$0.3 million to US$0.16 million.  In addition,VeriSign agreed to reduce the affiliate revenue sharing rates from 50% ofsuggested retail price to 25% of suggested retail price for both enterprise andinternet products for 12 months starting July 2003 and negotiable thereafter.As of June 30, 2004, ePLDT’s aggregate remaining minimumobligation under this agreement was approximately Php18 million pertaining toannual support fee.

 

Effective July 1, 2004, VeriSign has agreedto amend the Agreement and issued Addendum 8 as extension of Addendum 6.Annual support fee for year 5 (September 2004 to August 2005) will remain atUS$40,000 and affiliate revenue sharing rates will remain at 25%.

 

***License Purchase Agreement with I-Contact Solutions Pte. Ltd.***  On April 2, 2003, iPlus Intelligent Network Inc., oriPlus, a wholly-owned subsidiary of ePLDT and the Philippines’ pioneer inIP-based IT response center, entered into an Application Services Provider, orASP, and Reseller Contract with I-Contact Solutions Pte. Ltd., or I-Contact, ofSingapore.  Under the agreement, iPlus will purchase licenses of the CosmoCallUniverseTM IP-based contact center solution.  CosmoCall Universesupports multi-channel customer interactions including telephone, web chat, webvoice, web video, web collaboration, e-mail and voicemail in one high capacity,high availability, multi-tenant platform.  CosmoCall Universe is a complete,unified contact center suite that includes ACD, IVR, CTI, predictive dialing,multimedia recording and a complement of other powerful managementapplications.  The aggregate valueof these licenses is US$2.1 million and these licenses will be deliveredquarterly over a two-year period.  Further to the agreement, I-Contact will appoint iPlus as theexclusive reseller and ASP for the Philippine market and will provide iPluswith all the necessary support in terms of sales, marketing, and technicalservices.  Effective March 30, 2004, I-Contact has agreed to amend the Contract 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.  As of June 30, 2004, iPlus’ aggregateremaining obligation under this agreement was US$0.45 million (approximatelyPhp25 million). 

 

***Other Unconditional Purchase Obligations.***The******PLDT group has various purchasecontracts for periods ranging from two to three years covering the use of fraudmanagement system and satellite hub and remote VSAT network systems.

 

*Other Long-term Obligations*

 

***Mandatory Conversion and Purchase of Shares***.   As of June 30, 2004, PLDT had issued a total of 3million shares of Series V Convertible Preferred Stock, 5 million shares ofSeries VI Convertible Preferred Stock and 4 million shares of Series VIIConvertible Preferred Stock in exchange for a total of 59 million shares ofSeries K, Class I Convertible Preferred Stock of Piltel pursuant to the debtrestructuring of Piltel.  

 

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 remaining outstandingshares under these series will be mandatorily converted to shares of PLDT’scommon stock.  Under a put option exercisable for 30 days, holders of commonshares received on mandatory conversion will be able to require PLDT topurchase such PLDT common shares for Php1,700 per share, US$36.132 per share,and JP¥4,071.89 per share for Series V, VI and VII, respectively.

 

Asof June 30, 2004, 145,320 shares of Series V Convertible PreferredStock and 531,251 shares of Series VI Convertible Preferred Stock had beenconverted to PLDT’s common shares.  The aggregate value of the put option basedon outstanding shares as of June 30, 2004 was Php22,131million, of which Php14,049 million is payableon June 4, 2008 and Php8,082 million on June4, 2009, if all of the outstanding shares of Series V, VI and VII ConvertiblePreferred Stocks were mandatorily converted and all the underlying shares ofcommon stock were put to PLDT.  The market value of the underlying shares ofcommon stock was Php12,859 million, based onthe market price of PLDT’s common stock of Php1,150per share as of June 30, 2004.

 

*CommercialCommitments*

 

As of June 30, 2004, our outstanding commercial commitments, in the form of letters of credit,amounted to Php5,099 million.  These commitments will expire within one year.

 

InOctober 1998, Smart entered into a Frame Supply Contract with NokiaTelecommunications OY for the supply of hardware, software and documentationfor its GSM cellular network.  In the same month, Smart and Nokia (Philippines),Inc., or Nokia, signed a Frame Services Contract that covers the design,planning, installation, commissioning, integration, acceptance testing,training and handling of the network.  In August 2001, Smart issued MasterPurchase Orders, or MPOs, in the amount of US$200 million in favor of Nokia forthe purchase of additional equipment to expand Smart’s GSM network.  The US$200million MPO was completed in November 2003.  On May 30, 2003, Smart entered intoa Technical Support Services Agreement, or TSSA, with Nokia in the amount ofUS$8 million.  This TSSA has been fully served as of December 31, 2003.  

 

In January 2004, Smart signed a new MPO in favor ofNokia amounting to US$117 million (Phase 7 under the Frame Supply Contractbetween Smart and Nokia).  Smart is, however, under no legal obligation toincur these expenditures.

 

On June 23, 2004, Smart signed a TSSA with Nokia in the amount ofUS$10 million which is valid until December 31, 2004.

 

As of June 30, 2004, Smart had no guaranteeobligations, standby repurchase obligations or other commercial commitments.

 

**Quantitative and Qualitative Disclosures about Market Risks**

 

Our operations are exposed to various risks, includingliquidity risk, foreign exchange risk and interest rate risk.  The importanceof managing these risks has significantly increased in light of considerablechange and continuing volatility in the Philippine and international financialmarkets.  With a view to managing these risks, we have incorporated financialrisk management functions in our organization, particularly in our treasuryoperations.

 

Liquidity Risk Management
 

We seek to manage ourliquidity profile to be able to finance our capital expenditures and serviceour maturing debts.  To cover our financing requirements, we intend to useinternally generated funds and proceeds from debt and equity issues and salesof certain assets. 

 

Aspart of our liquidity risk management program, we regularly evaluate ourprojected and actual cash flow information and continuously assess conditionsin the financial markets for opportunities to pursue fund-raising initiatives.These initiatives may include bank loans, export credit agency-guaranteedfacilities, and debt capital and equity market issues.

 

***Foreign Exchange Risk Management***

 

Asof June 30, 2004, the Philippine peso had depreciated against the U.S.dollar to Php56.176 to US$1.00 from Php53.522 to US$1.00 as of June 30, 2003, whichin turn represented a depreciation against the U.S. dollar from Php50.541 to US$1.00 at June 30, 2002.  In the first halfof 2004, PLDT capitalized net foreign exchange losses of Php772 million, as compared to Php356 million in the same period in 2003.  Of thesecapitalized net foreign exchange losses, Php709million in the first half of 2004 and Php103million in the same period in 2003, were attributable to foreigncurrency-denominated liabilities used to finance our capital investments andwere therefore recorded as additions to the carrying value of the relatedproperty accounts. 

 

The following table shows our consolidated andnon-consolidated foreign currency-denominated monetary assets and liabilitiesand their peso equivalents as of June 30, 2004 and as of December 31, 2003:

 

** **

**June 30, 2004****(1)**

** **

**December 31, 2003****(2)**

 
** **

**U.S. dollars**

** **

**Pesos**

** **

**U.S. dollars**

** **

**Pesos**

 
** **

 

**(Unaudited)**

 

 

**(in millions)**

 

**(Audited)**

 

 

 
**Consolidated**

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

Cash and cash equivalents

US$294

 

Php16,503

 

US$146

 

Php8,098

Receivables-net

176

 

9,871

 

195

 

10,855

Other current assets

–

 

9

 

–

 

–

 

470

 

26,383

 

341

 

18,953

Liabilities

 

 

 

 

 

 

 

Notes payable

–

 

–

 

3

 

150

Accounts payable

87

 

4,863

 

60

 

3,322

Accrued expenses and other current liabilities

74

 

4,086

 

25

 

1,342

Long-term debt

2,606

 

142,758

 

2,819

 

153,542

Deferred credits and other noncurrent liabilities

217

 

12,228

 

209

 

11,613

 

2,984

 

163,935

 

3,116

 

169,969

Net foreign currency-denominated liabilities

US$2,514

 

Php137,552

 

US$2,775

 

Php151,016

**Non-Consolidated**

 

 

 

 

 

 

 

Assets

 

 

 

 

 

 

 

Cash and cash equivalents

US$199

 

Php11,198

 

US$54

 

Php3,014

Receivables-net

123

 

6,892

 

134

 

7,463

Other current assets

–

 

9

 

–

 

–

 

322

 

18,099

 

188

 

10,477

Liabilities

 

 

 

 

 

 

 

Accounts payable

10

 

572

 

16

 

874

Accrued expenses and other current liabilities

59

 

3,346

 

7

 

386

Long-term debt

2,193

 

119,555

 

2,373

 

128,757

Deferred credits and other noncurrent liabilities

218

 

12,228

 

209

 

11,613

 

2,480

 

135,701

 

2,605

 

141,630

Net foreign currency-denominated liabilities

US$2,158

 

Php117,602

 

US$2,417

 

Php131,153

________________

* *

*(1) **The exchange rate used was Php56.176 to US$1.00.*

*(2) **The exchange rate used was Php55.586 to US$1.00.*

 

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.

* *

Asof June 30, 2004, approximately 98% and 97% of our total consolidatedand non-consolidated debts, respectively, were denominated in foreigncurrencies.  Of our foreign currency-denominated debts, 7% and 8% are inJapanese yen, on a consolidated and non-consolidated basis, respectively, andthe balance in U.S. dollars.  Thus, a weakening of the peso against the U.S.dollar or Japanese yen will increase both the principal amount of our unhedgedforeign currency-denominated debts (representing 62% and 59% of ourconsolidated and non-consolidated debts, respectively), and interest expense onour debt in peso terms.  In addition, many of our financial ratios and otherfinancial tests will be negatively affected.  If, among other things, the valueof the peso against the U.S. dollar drops from its current level, we may beunable 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 12 – Long-term Debt* to theaccompanying financial statements.

 

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, and hedges to cover all of our exposureare not currently or readily available.

 

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.  As of June 30, 2004, PLDT’s outstandingforward foreign exchange contracts, principal-only long-term cross-currencyswap contracts and currency option contracts amounted to US$76 million, US$725million, and US$73 million and JP¥863 million, respectively. 

 

Smart’s outstandingforward foreign exchange contracts amounted to US$121 million as of June 30, 2004.  Also, Smart had a long-term cross-currency swap contract which matured on April 30, 2003.  The final exchange has been made and the contract has been terminated.

 

Forfurther discussions of these contracts, see *Note 12 – Long-term Debt*tothe accompanying financial statements.

 

***Interest Rate Risk Management***

 

From time to time and on a limited basis, we enterinto interest rate swap agreements in order to manage our exposure to interestrate fluctuations.

 

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

 

**Effect of PesoDepreciation**

 

Inthe first half of 2004 and 2003, our operating revenues, which have beenreceived in U.S. dollars or in respect of which we have been able to adjust ourservice fees to reflect changes in the peso-to-dollar exchange rate exceededour U.S. dollar-linked operating expenses.  As a result, the depreciation ofthe peso against the dollar over this period had a positive net impact on ouroperating profit.  However, since substantially all of our indebtedness isdenominated in U.S. dollars, such depreciation has also increased our interestexpense in peso terms and increased the peso amounts of our U.S.dollar-denominated indebtedness.  We have capitalized foreign exchange lossesin respect of U.S. dollar-denominated indebtedness, and net income in futureperiods is expected to be negatively affected as a result of higherdepreciation expense resulting from such capitalization.  Our cash flows arenegatively affected by the higher peso cost of repaying U.S. dollar-denominateddebts, and our ability to comply with financial covenants and ratios isnegatively affected by the increase in the amount of our debts and our interestexpenses in peso terms.

** **

**Impact of Inflation and Changing Prices**

** **

Inflationcan be a significant factor in the Philippine economy, and we are continuallyseeking ways 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 2004 was 5.1%, compared to 2.9%in the same period in 2003.

** **

**OTHER INFORMATION**

** **

Piltel Debt Exchange Transaction

** **

On July 2, 2004,Smart announced that it had successfully closed the Piltel debt exchangetransaction.  This concluded the process begun in March this year when Smartinvited various creditors of Piltel to exchange their indebtedness for varioustypes of Smart debt and/or cash, as follows:

 

•        Cash settlement, at a maximumexchange price of US$0.40 for each US$1.00 equivalent of Piltel debt exchanged;

•        US$ Smart debt maturing inDecember 2007 at the rate of US$0.525 for each US$1.00 equivalent of Pilteldebt exchanged, with interest at US$ LIBOR plus 1% per annum, payablequarterly;

•        US$ Smart debt maturing inDecember 2008 at the rate of US$0.575 for each US$1.00 equivalent of Pilteldebt exchanged, with interest at US$ LIBOR plus 1% per annum, payablequarterly;

•        US$ Smart 10-year debt maturing inJune 2014, at par by reference to the US$1.00 equivalent of Piltel debtexchanged, with fixed interest at 2.25% per annum, payable quarterly; and 

•        For Yen Trade creditor, US$ Smart10-year debt maturing in June 2014, at par by reference to the US$1.00equivalent of Piltel debt exchanged, with fixed interest at 2.25% per annum,payable quarterly and with an option to elect, by not less than 15 months’prior notice, for an early repayment at a discount either on December 2007 at52.5% of the relevant debt amount or on December 2008 at 57.5% of the relevantdebt amount.

 

By the end of theoffer period on May 31, 2004, Smart had received offers from Piltel’s creditorsrepresenting approximately 69.4% in aggregate of the outstanding restructuredPiltel debt.  In addition, it had received, from a significant portion of thePiltel creditors who did not participate in the transaction, waivers to certainprovisions of the agreements governing Piltel’s restructured indebtedness,allowing Smart to close the transaction.  Given the high level of acceptancefrom the Piltel creditors, the Board of Directors of PLDT and Smart endorsed Smart’sdecision to proceed with the Piltel debt exchange transaction.

 

As a result, Smart became Piltel’s largest creditor,holding US$289 million of Piltel’s US$417 million restructured debt.  Based onthe options chosen by the participating creditors, Smart has issued to themUS$283.2 million in new debt and paid US$1.5 million in cash.

 

Option
 
**Allocation**

** **

**Exchange**

** **

**New Debt/Cash**

** **

**Amount**

** **

**%**

** **

**Ratio (%)**

** **

**Outlay of Smart**

** **

** **

(in millions, except percentage)

 

 

 

 

 

 

 

 

 

2014 Smart Debt

 

US$280.1

 

67.2

 

100.0

 

US$280.1

2008 Smart Debt

 

5.0

 

1.2

 

57.5

 

2.9

2007 Smart Debt

 

0.4

 

0.1

 

52.5

 

0.2

Subtotal

 

285.5

 

68.5

 

210.0

 

283.2

Cash

 

3.8

 

0.9

 

40.0

 

1.5

**Total**

** **

**US$289.3**

** **

**69.4**

** **

**250.0**

** **

**US$284.7**

 

Further, inline with the previously announced intention of Smart to acquire PLDT’s equityholdings in Piltel, also on July 2, 2004, Smart entered into a Sale and Purchase Agreementwith PLDT to acquire the latter’s 59.3 million shares of Piltel Series K, ClassI Convertible Preferred Stock for Php2,066 million.  The payment was settledthrough an offset of amounts owed to Smart by PLDT arising primarily frominterconnection charges.  At a later stage, Smart intends to acquire the commonshares held by PLDT in Piltel, thereby consolidating PLDT’s wireless holdings.

 

On July 9, 2004, Smartconverted a total of 4.8 million shares of Piltel Series K, Class I ConvertiblePreferred Stock into 820.3 million shares of Piltel common stock, equivalent to32.7% of the total outstanding shares of common stock of Piltel after such conversion.Such initial conversion resulted in diluting PLDT’s ownership in Piltel to30.5%.  Smart intends to convert its remaining 54.5 million shares of PiltelSeries K, Class I Convertible Preferred Stock into 9,260 million shares ofcommon stock from the increase in authorized capital stock of Piltel.  Piltelhas scheduled a special stockholders’ meeting on September 3, 2004 to approve thisincrease.  Once all the outstanding shares of Piltel Series K, Class IConvertible Preferred Stock are fully converted, Smart will hold a total of10,080 million shares of common stock of Piltel, equivalent to 85.6% of theresulting total outstanding shares of common stock after such conversion.  Inaggregate therefore, ownership of Piltel by PLDT and Smart will be 92.1%.

 

On July 19, 2004, Smartreceived confirmation from the Philippines’ Securities and Exchange Commission, or SEC, that theissuance of 820.3 million shares of common stock of Piltel, equivalent to 32.7%of total outstanding shares of common stock of Piltel after the initialconversion will not trigger a mandatory tender offer requirement under Section19 of the Securities Regulation Code.  The SEC also confirmed that theconversion of the remaining preferred stocks made through an increase in Piltel’scapital stock is also exempt from mandatory tender offer requirement.

 

U.S. FederalCommunications Commission, or U.S. FCC, Ruling versus Philippine TelecommunicationsCompanies 

 

Effectiveas of February 1, 2003, PLDT stopped terminating traffic sent directly byeach of AT&T and MCI, because PLDT’s termination rate agreements withAT&T and MCI lapsed in December 2002 without either agreeing with PLDT onany provisional arrangement or final agreement on new termination rates.  Inseparate orders dated February 7 and 26, 2003, the National TelecommunicationsCommission, or NTC, confirmed that “absent any provisional or interimagreement” with U.S. carriers, there would be no provision of terminationservices between the parties “who are thereby encouraged to seek other routesor options to terminate traffic to the Philippines.”  Upon petitions ofAT&T and MCI, on March 10, 2003, the International Bureau of the U.S. FCCissued an Order which directed all facilities-based carriers subject to U.S.FCC jurisdiction to suspend payments for termination services to Philippinecarriers, including PLDT, Smart and Subic Telecom, until such time as the U.S.FCC issues a Public Notice that AT&T’s and MCI’s circuits on theU.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 directcircuits from U.S. facilities-based carriers who do not pay Philippine carriersfor services rendered; and (2) to take all measures necessary to collectpayments for services rendered in order to preserve the viability, efficiency,sustained growth and development and continued competitiveness of thePhilippine telecommunications industry.”

 

On October 17, 2003,based on negotiations between the NTC and the U.S. FCC to resolve the issueregarding termination rates, the NTC, in the expectation that the U.S. FCCwould fully lift the March 10, 2003 Order, lifted its March 12, 2003 Order anddirected all Philippine carriers to immediately accept terminating traffic viadirect circuits from U.S. facilities-based carriers at mutually acceptablefinal or interim termination rates and other terms and conditions agreed uponby the parties.

 

On November 17, 2003,after Smart reached interim agreements with each of AT&T and MCI on September30 and November 12, 2003, respectively, the International Bureau of the U.S.FCC lifted its March 10, 2003 Order with respect to Smart and ordered the U.S.carriers to resume making payments to Smart.

 

OnJanuary 15, 2004, after PLDT reached interim agreements with each of MCI andAT&T and reopened its circuits with these carriers on November 12, 2003 andJanuary 9, 2004, respectively, the International Bureau of the U.S. FCC liftedits March 10, 2003 Order also with respect to PLDT and ordered the U.S.carriers to resume making payments to PLDT.

 

On May 13, 2004, the U.S. FCC partially dismissed andpartially denied applications by Philippine carriers, including PLDT, andcertain U.S. carriers for review of the March 10, 2003 Order of theInternational Bureau of the U.S. FCC.  In particular, the U.S. FCC affirmed theMarch 10, 2003 Order’s finding that “Philippine carriers engaged incollective action to “whipsaw” AT&T and MCI.” 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. Department of Justice is independently“investigating the possibility of anticompetitive practices among Philippinecarriers under its authority pursuant to U.S. anti-trust laws.”  The U.S. FCC also upheld the March 10, 2003 Orderin respect of the suspension of payments for termination services to thePhilippine carriers pending restoration of the circuits.  In addition, the U.S.FCC denied a request to modify the March 10, 2003 Order of the InternationalBureau of the U.S. FCC to restore the Philippines to the list ofU.S.-international routes approved for the provision of ISR.  The U.S. FCCstated that it was dismissing this request as moot because of the U.S. FCC'srecently adopted International Settlements Policy Reform which eliminatedInternational Settlements Policy, or ISP.  

 

Although not included in the initial list of countriesexempted from the U.S. FCC’s ISP, the U.S. FCC identified the U.S.-Philippinesroute as eligible for being removed from the ISP in accordance with its newlyestablished procedures for doing so.  Under this procedure, the U.S. FCC askedfor public comment on the removal of the Philippines from the ISP.  In comments filed in June and July,2004, removal was supported by several Philippine and U.S. carriers,including AT&T and MCI, and was opposed by one U.S. carrier,International Access, Inc.  

 

OnJuly 6, 2004, PLDT filed with the U.S. FCC a Petition for Reconsideration ofthe Commission’s May 13, 2004 Order on the grounds that the Order should havevacated as moot the International Bureau’s March 10, 2003 Order.

 

Investigation by U.S. Department of Justice 

 

InJanuary 2004, PLDT received grand jury subpoena seeking documents and a PLDTemployee was subpoenaed to testify before the grand jury in connection with acriminal investigation being conducted by the U.S. Department of Justice withrespect to alleged antitrust violations relating to the provision ofinternational termination services in the Philippines.  The U.S. Department ofJustice has also requested testimony and documents from Smart in connectionwith this investigation.  Further, in March 2004, PLDT (U.S.) Ltd., asubsidiary of PLDT Global, received a grand jury subpoena seeking documents, inresponse to which PLDT (U.S.) Ltd. is currently producing documents.  Inaddition, in March 2004, a PLDT (U.S.) Ltd. employee received a subpoena totestify before the grand jury in connection with this investigation.  Thisemployee has not yet been asked to appear before the grand jury.  At this time,the PLDT Group cannot predict the outcome of this investigation.

 

Adoption of International Accounting Standards, or IAS
 

In recent years, the Philippine AccountingStandards Council, or ASC, has been adopting the International AccountingStandards, or IAS, issued by the International Accounting Standards Council, orIASC with no local equivalent standards and has been replacing existing localstandards.  

 

The International Accounting Standards Board, orIASB, assumed from the IASC the responsibility for setting the internationalaccounting standards.  The standards issued by the IASB are designated asInternational Financial Reporting Standards, or IFRS.  Upon its inception, theIASB also adopted the IAS issued by the IASC.  The IASB carried on improvementson certain IAS in preparation for the full adoption of IFRS in 2005.  In linewith this initiative, the IASB has recently issued revised IAS, IFRS andexposure drafts, or EDs, most of which are to be effective in 2005.

 

We are currently in the process of evaluating theimpact of the new and revised standards on our financial statements.  See *Note3 – Accounting Changes* to the accompanying financial statements for furtherdiscussion.

 

Related Party Transactions
 

In the ordinary course of business, companiesbelonging to the PLDT Group are engaged in arm’s-length intercompanytransactions.  We believe that the terms of these transactions are comparablewith those available from unrelated parties. 

 

•              *Telecommunications servicesprovided within the PLDT Group* —interconnection agreements and connectivity service agreements for leasedlines, under terms similar with those agreed with other telecommunicationsproviders outside the PLDT Group.

 

•              *Transponder Lease Agreementbetween PLDT and Mabuhay Satellite*—an agreement pursuant to which Mabuhay Satellite leases to PLDT C-bandtransponders on board the Agila II satellite.  Total fees under this agreementtotaled Php341 million and Php385 million for the six months ended June 30, 2004 and2003, respectively.  PLDT’s outstanding obligations under this agreementamounted to Php26 million as of June 30, 2004 and December 31, 2003. 

 

•              *Facilities Management Agreementbetween PLDT and Piltel*— anagreement under which PLDT undertakes the management, operation and maintenanceof Piltel’s regional telecommunications facilities as well as Executive OrderNo. 109, network operations and services, including E.O. 109 fixed linebuild-out installations, public calling offices, payphone facilities, and thesystems required to support these services.  Total management fees under thisagreement totaled Php35 million and Php41 million for the six months ended June 30, 2004 and2003, respectively.  PLDT’s outstanding receivables under this agreementamounted to Php367 million and Php329 million as of June 30, 2004 and December 31, 2003,respectively.

 

•              *Facilities Management Agreementbetween Piltel and Subic Telecom*— anagreement under which Subic Telecom manages the regional telephone network,customer operations, network operations and payphones of Piltel in Subic and Olongapo City.  Totalmanagement fees under this agreement totaled Php11 million for the six monthsended June 30, 2004 and 2003.  This new agreement is effective for threeyears until September 2004.  Subic Telecom’s outstanding receivables under thisagreement amounted to Php51 million and Php11 million as of June 30, 2004 and December 31, 2003,respectively. 

 

•              *Agreements between Smart andPiltel*— agreements relating to theintegration of Smart’s and Piltel’s operations under which Smart undertakes tomanage Piltel’s facilities, customer services, administrative support andmanagement services and billing services.  Total fees under these serviceagreements totaled Php463 million and Php348 million for the six months ended June 30, 2004 and2003, respectively.  Smart’s outstanding receivables under these agreements amounted to Php221million and Php906 million as of June 30, 2004 and December 31, 2003, respectively.  In addition, Smart also entered into a facilitiesservice agreement with Piltel under which Piltel accesses Smart's existing GSMnetwork and facilities to enable Piltel to offer prepaid cellular service usingGSM technology in exchange for approximately 50% of Piltel's revenues, net ofinterconnection expenses.  Total facilityfees under this agreement amounted to Php2,814 million and Php1,823 million for the six months endedJune 30, 2004 and 2003,respectively.  Under this agreement,outstanding receivables of Smart amounted to Php1,219 million and Php633million as of June 30, 2004 and December 31, 2003, respectively.  

 

•              *Air Time Purchase Agreementbetween PLDT and AIL and Related Agreements*— an agreement under which PLDT has been granted the exclusive right tosell ACeS services in the Philippines.  In March 2003, PLDT, together with the otherfounder shareholders, entered into a Standstill Agreement in respect of the AirTime Purchase Agreement.  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 following the lapse of the November 15, 2003 deadline set for thenegotiation of a revised Air Time Purchase Agreement.  On June 21, 2004, AILalso sent PLDT a letter citing PLDT in default under the Air Time PurchaseAgreement for non-payment of outstanding amounts and for repudiation of itsobligations thereunder.  See *Note 21 – Provisions and Contingencies*tothe accompanying financial statements for further discussion.  

 

•              *Agreements between Smart andMabuhay Satellite ––*Smart enteredinto transponder lease agreement with Mabuhay Satellite for the use of thetransponders aboard its satellite, Agila II.  The monthly rent for thetransponders is on a tiered-pricing scheme per megahertz based on the actualusage of Smart.  Total fees under this agreement amounted to Php49 million andPhp24 million for the six months ended June 30, 2004and 2003, respectively.  Outstanding obligations of Smart under this agreementamounted to Php10 million and Php13 million as of June 30, 2004 and December 31, 2003,respectively.

 

•              *Agreements between Smart andACeS Philippines*— agreements underwhich Smart (1) provides ACeS Global Mobile Personal Communications bySatellite, or GMPCS, services, in the Philippines under a revenue-sharingagreement, 

(2) undertakes the management, maintenance andoperations of GMPCS, and 

(3) provides certain administrative support andservices in certain aspects of ACeS Philippines’ business operations.  Totalfees under these agreements, net of ACeS’ share, totaled Php41 million andPhp36 million for the six months ended June 30, 2004 and 2003, respectively.Under these agreements, Smart’s outstanding obligation to ACeS amounted toPhp36 million as of June 30, 2004 while Smart had no outstanding obligation asof December 31, 2003.

 

In addition, transactions to which PLDT or itssubsidiary is a party, in which a director or key officer or owner of more than10% of the common shares of PLDT, or any member of the immediate family of adirector or key officer or owner of more than 10% of the common shares of PLDThad a direct or indirect material interest as of June 30, 2004 and December 31,2003 and for the six months ended June 30, 2004 and 2003 are as 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 domestic fiber optic network; (3) PLDTis licensed to market managed data and other services using NTT Communications’Arcstar brand; and (4) PLDT and NTT Communications agreed to cooperativearrangements for international telecommunication services.  Total fees underthese agreements totaled Php146 million and Php147 million for the six monthsended June 30, 2004 and 2003, respectively.  PLDT’s outstandingobligations under these agreements amounted to Php31 million and Php40 millionas of June 30, 2004 and December 31, 2003, respectively.

 

•              *Agreements between Smart and**Asia**Link B.V*. — agreements under whichAsia Link undertakes to provide technical support services for the operationsand maintenance of Smart’s CMTS.  Total fees under these agreements totaledPhp214 million and Php147 million for the six months ended June 30, 2004 and2003, respectively.  Under these agreements, Smart had outstanding payables ofPhp119 million and Php228 million as of June 30, 2004and December 31, 2003, respectively.  Asia Link is a subsidiary of theFirstPacific 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 signed an insurancepolicy with Malayan Insurance Co. Inc., or Malayan, wherein premiums are paiddirectly to Malayan.  Premium payments to Gotuaco and Malayan covering the12-month period ending July 31, 2004 totaled Php324 million.  Two directors of PLDT have adirect/indirect interest in or serve as director/officer of Gotuaco andMalayan.

 

For a more detailed discussion of the related party transactionsenumerated above, see *Note 15 –Related Party Transactions* to theaccompanying**financial statements.****

 

 

**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY**

** **

**FINANCIAL STATEMENTS**

** **

AS OF JUNE 30, 2004 AND DECEMBER 31, 2003

AND FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND2003

 

** **

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

** **

**BALANCE SHEETS**

**(in million pesos)**

 

** **

**Consolidated**

 

**Non-Consolidated**

** **

**June 30, 2004**

December 31, 2003

 

**June 30, 2004**

December 31, 2003 

** **

**(Unaudited)**

(As restated –  Note 3)

 

**(Unaudited)**

 

(As restated –  Note 3)

**ASSETS**

**Current Assets**

** **

** **

 

 

 

Cash and cash equivalents (Notes 5 and 22)

**22,373**

19,263

 

**12,013**

5,278

Receivables – net (Notes 6, 15, 22 and 25)

**19,541**

19,516

 

**14,507**

15,740

Inventories and supplies – net (Note 7)

**2,768**

2,421

 

**1,159**

1,513

Prepayments and other current assets (Notes 16 and 18)

**4,506**

3,961

 

**2,936**

2,957

Total Current Assets

**49,188**

45,161

 

**30,615**

25,488

**Noncurrent Assets**

** **

 

 

** **

 

Property, plant and equipment –****net (Notes 3, 7, 8, 12 and 20)

**243,444**

244,427

 

**184,571**

188,152

Investments****– net (Notes 2, 3, 9, 12, 14, 15 and 20)

**1,572**

1,610

 

**45,213**

44,831

Deferred income tax – net (Notes 3 and 18)

**663**

244

 

–

–

Other noncurrent assets – net (Notes 15 and 16)

**6,032**

6,184

 

**2,648**

2,713

Total Noncurrent Assets

**251,711**

252,465

 

**232,432**

235,696

 

**300,899**

297,626

 

**263,047**

261,184

 

** **

** **

 

** **

 

**LIABILITIES AND STOCKHOLDERS’ EQUITY**

**Current Liabilities**

** **

** **

 

** **

 

Notes payable (Notes 10 and 22)

**150**

2,133

 

–

1,933

Accounts payable (Notes 15 and 22)

**10,466**

7,664

 

**3,409**

6,126

Accrued expenses and other current liabilities  (Notes 3, 11, 15 and 22)

**13,182**

13,454

 

**5,984**

5,835

Current portion of long-term debt (Notes 8, 12, 22 and 23)

**22,273**

23,742

 

**13,918**

15,850

Dividends payable (Note 14)

**677**

572

 

**677**

572

Income tax payable (Note 18)

**2,852**

761

 

–

466

Total Current Liabilities

**49,600**

48,326

 

**23,988**

30,782

**Noncurrent Liabilities**

** **

 

 

** **

 

Long-term debt – net of current portion (Notes 8, 12, 22 and 23)

**123,840**

133,939

 

**108,799**

116,392

Deferred income tax – net (Note 18)

**6,246**

5,988

 

**6,246**

5,988

Deferred credits and other noncurrent liabilities (Notes 3, 13, 15, 16, 21 and 22)

**15,530**

15,011

 

**19,184**

14,444

Total Noncurrent Liabilities

**145,616**

154,938

 

**134,229**

136,824

**Minority Interest in Consolidated Subsidiaries**

**853**

784

 

–

–

**Stockholders’****Equity**(Notes 3 and 14)

** **

 

 

** **

 

Preferred stock, Php10 par value, authorized 822,500,000 shares;  issued and outstanding 461,146,615 shares as of June 30, 2004  and 461,588,319 shares as of December 31, 2003

**4,611**

4,616

 

**4,611**

4,616

Common stock, Php5 par value, authorized 234,000,000 shares;  issued and outstanding 169,566,523 shares as of June 30, 2004  and 169,476,120 shares as of December 31, 2003

**848**

847

 

**848**

847

Capital in excess of par value

**49,090**

49,017

 

**49,090**

49,017

Retained earnings

**50,281**

39,098

 

**50,281**

39,098

Total Stockholders’ Equity

**104,830**

93,578

 

**104,830**

93,578

 

**300,899**

297,626

 

**263,047**

261,184

* *

*See accompanying Notes toFinancial Statements.*
****
**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY**

** **

**STATEMENTS OF INCOME**

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

** **

** **

**Consolidated**

** **

**Non-Consolidated**

** **

**Consolidated**

** **

**Non-Consolidated**

** **

**Six Months Ended June 30,**

** **

**Three Months Ended June 30,**

** **

**2004**

2003

** **

**2004**

2003

** **

**2004**

2003

 

**2004**

2003

 

(Unaudited) 

**OPERATING REVENUES** (Note 15)

** **

 

 

 

 

 

 

 

 

 

 

Wireless services

**31,231**

22,493

 

**–**

–

 

**16,275**

11,553

 

**–**

–

Fixed line services

**23,384**

22,862

 

**23,206**

22,520

 

**11,690**

11,422

 

**11,566**

11,239

Information and communications technology services

**982**

864

 

**–**

–

 

**540**

507

 

**–**

–

 

**55,597**

46,219

 

**23,206**

22,520

 

**28,505**

23,482

 

**11,566**

11,239

**OPERATING****EXPENSES**

** **

 

 

** **

 

 

** **

 

 

** **

 

Depreciation and amortization (Note 8)

**13,245**

11,696

 

**6,851**

6,441

 

**6,725**

5,893

 

**3,447**

3,215

Compensation and benefits (Note 16)

**5,660**

5,582

 

**3,445**

3,637

 

**2,860**

2,841

 

**1,722**

1,770

Selling and promotions 

**4,015**

4,808

 

**622**

630

 

**1,857**

2,562

 

**272**

337

Maintenance (Note 15)

**2,716**

2,832

 

**1,611**

1,472

 

**1,431**

1,559

 

**824**

775

Provision for doubtful accounts (Note 6)

**1,865**

1,902

 

**1,387**

1,404

 

**767**

772

 

**693**

702

Rent (Notes 3 and 15)

**1,469**

1,488

 

**737**

779

 

**755**

745

 

**396**

382

Professional and other service fees (Note 15)

**996**

826

 

**471**

483

 

**559**

405

 

**247**

242

Insurance and security services

**802**

733

 

**355**

377

 

**407**

368

 

**178**

190

Taxes and licenses (Note 21)

**641**

635

 

**328**

287

 

**314**

357

 

**174**

165

Provision for inventory obsolescence

**128**

143

 

**–**

86

 

**–**

127

 

**–**

86

Other operating expenses (Note 15) 

**1,518**

1,274

 

**478**

548

 

**761**

645

 

**252**

288

 

**33,055**

31,919

 

**16,285**

16,144

 

**16,436**

16,274

 

**8,205**

8,152

**NET OPERATING INCOME**

**22,542**

14,300

 

**6,921**

6,376

 

**12,069**

7,208

 

**3,361**

3,087

**INTEREST EXPENSE AND RELATED ITEMS – NET** (Notes 3, 8, 10 and 12)

**(5,868)**

(5,592)

 

**(5,342)**

(4,880)

 

**(2,920)**

(2,636)

 

**(2,660)**

(2,302)

**EQUITY SHARE IN NET (LOSSES) INCOME  OF INVESTEES, INCLUDING GOODWILL AMORTIZATION AND PROVISION FOR IMPAIRMENT IN VALUE OF INVESTMENTS**(Notes 3 and 9)

**(43)**

(1,616)

 

**11,611**

3,201

 

**(21)**

(1,612)

 

**6,588**

908

**INTEREST INCOME**

**465**

245

 

**96**

51

 

**253**

142

 

**62**

37

**OTHER EXPENSES – NET**     (Notes 6, 15, 17 and 22)

**(1,050)**

(4,624)

 

**(1,063)**

(3,364)

 

**(425)**

(3,880)

 

**(495)**

(2,895)

**INCOME (LOSS) BEFORE INCOME TAX AND MINORITY INTEREST IN NET LOSSES (INCOME) OF CONSOLIDATED SUBSIDIARIES**

**16,046**

2,713

 

**12,223**

1,384

 

**8,956**

(778)

 

**6,856**

(1,165)

**PROVISION FOR (BENEFIT FROM) INCOME TAX** (Note 18)

**4,020**

1,146

 

**215**

(401)

 

**2,166**

142

 

**88**

(467)

**INCOME (LOSS) BEFORE MINORITY INTEREST IN NET LOSSES (INCOME) OF CONSOLIDATED SUBSIDIARIES**

**12,026**

 

 

1,567

 

** **

** **

**12,008**

 

 

1,785

 

** **

** **

**6,790**

 

 

(920)

 

** **

** **

**6,768**

 

 

(698)

**MINORITY INTEREST IN NET LOSSES (INCOME) OF CONSOLIDATED SUBSIDIARIES**

**(****18****)**

218

 

**–**

**–**

 

**(22)**

222

 

**–**

–

**NET INCOME (LOSS)**

**12,008**

1,785

 

**12,008**

1,785

 

**6,768**

(698)

 

**6,768**

(698)

**Earnings Per Common Share** (Note 19)

** **

 

 

** **

 

 

** **

 

 

** **

 

Basic

**65.62**

5.54

 

**65.62**

5.54

 

**37.30**

(6.61)

 

**37.30**

(6.61)

Diluted

**61.81**

5.54

 

**61.81**

5.54

 

**35.07**

(5.77)

 

**35.07**

(5.77)

* *

*See accompanying Notes to**Financial Statements.*

* *

**PHILIPPINE LONGDISTANCE TELEPHONE COMPANY**

** **

**STATEMENTS OF CHANGESIN STOCKHOLDERS’ EQUITY**

**(in million pesos)**

** **

 

**Preferred Stock**

** **

**Common Stock**

** **

**Capital in Excess of  Par Value**

** **

**Retained Earnings**

** **

**Total**

 

(Unaudited)

Balances at January 1, 2003

 

 

 

 

 

 

 

 

 

As previously reported

4,584

 

847

 

48,953

 

30,234

 

84,618

Effect of change in accounting for leases (Note 3) 

–

 

–

 

–

 

(551)

 

(551)

As restated

4,584

 

847

 

48,953

 

29,683

 

84,067

Net income for the period

 

 

 

 

 

 

 

 

 

As previously reported

–

 

–

 

–

 

1,780

 

1,780

Effect of change in accounting for leases (Note 3)

–

 

–

 

–

 

5

 

   5

As restated

–   

 

–

 

–

 

1,785

 

1,785

Cash dividends

–

 

–

 

–

 

(785)

 

(785)

Issuance of capital stock – net (Note 14)

33

 

–

 

11

 

–

 

  44

Balances at June 30, 2003 

4,617

 

 847

 

48,964

 

30,683

 

85,111

Balances at January 1, 2004

 

 

 

 

 

 

 

 

 

As previously reported

4,616

 

 847

 

49,017

 

39,665

 

94,145

Effect of change in accounting for leases (Note 3)

**–**

 

–

 

–

 

(567) 

 

(567)

As restated

4,616

 

847

 

49,017

 

39,098

 

93,578

Net income for the period

**–**

 

–

 

–

 

12,008

 

12,008

Cash dividends

**–**

 

–

 

–

 

(825)

 

(825)

Issuance of capital stock – net (Note 14)

(5)

 

1

 

73

 

–

 

  69

**Balances at****June 30, 2004******

**4,611**

** **

**848**

** **

**49,090**

** **

**50,281**

** **

**104,830**

* *

*See accompanying Notes to Financial Statements.*

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

** **

**STATEMENTS OF CASH FLOWS**

**(in million pesos)**

** **

** **

**Consolidated**

** **

**Non-Consolidated**

** **

**Six Months Ended June 30,**

** **

**2004**

2003

** **

**2004**

2003

** **

(Unaudited)

**CASH FLOWS FROM OPERATING ACTIVITIES**

** **

 

 

 

** **

Income before income tax and minority interest in net losses of consolidated subsidiaries

**16,046**

2,713

 

**12,223**

1,384

Adjustments for:

** **

 

 

 

 

Depreciation and amortization

**13,245**

11,696

 

**6,851**

6,441

Provision for doubtful accounts

**1,865**

1,902

 

**1,387**

1,404

Provision for inventory obsolescence

**128**

143

 

–

86

Equity share in net losses (income) of investees, including goodwill amortization and provision for impairment in value of investments

**43**

1,616

 

**(11,611)**

(3,201)

Others

**1,018**

3,243

 

**503**

1,478

Interest expense

**5,868**

5,592

 

**5,342**

4,880

Interest income

**(465)**

(245)

 

**(96)**

(51)

Operating income before working capital changes

**37,748**

26,660

 

**14,599**

12,421

Decrease (increase) in:

** **

 

 

 

 

Receivables

**(1,942)**

(3,228)

 

**(481)**

(881)

Inventories and supplies

**(451)**

(66)

 

**353**

113

Prepayments and other current assets

**(652)**

210

 

**63**

331

Increase (decrease) in:

** **

 

 

 

 

Accounts payable

**2,822**

(2,393)

 

**726**

(1,249)

Accrued expenses and other current liabilities

**(383)**

3,312

 

**(73)**

65

Cash generated from operations

**37,142**

24,495

 

**15,187**

10,800

Income taxes paid

**(2,****132)**

(1,414)

 

**(****466)**

(538)

Net cash provided by operating activities

**35,010**

23,081

 

**14,721**

10,262

**CASH FLOWS FROM INVESTING ACTIVITIES**

** **

 

 

 

 

Additions to property, plant and equipment

**(11,274)**

(4,799)

 

**(2,417)**

(965)

Proceeds from disposal of property, plant and equipment

**17**

25

 

**12**

4

Interest paid – capitalized to property, plant and equipment

**(302)**

(541)

 

**(250)**

(531)

Proceeds from disposal of investments in shares of stocks

**–**

99

 

**–**

**–**

Additions to investments

**(61)**

(252)

 

**–**

**–**

Dividends received

**–**

**–**

 

**11,280**

4,300

Interest received

**465**

245

 

**94**

51

Increase in other noncurrent assets

**(341)**

(476)

 

**(64)**

(188)

Net cash (used in) provided by investing activities

**(11,496)**

(5,699)

 

**8,655**

2,671

**CASH FLOWS FROM FINANCING ACTIVITIES**

** **

** **

** **

** **

 

Proceeds from long-term debt

**4,824**

7,562

 

**2,****522**

7,475

Payments of long-term debt

**(17,413)**

(18,770)

 

**(12,760)**

(14,998)

Proceeds from notes payable

**–**

2,916

 

**–**

2,170

Payments of notes payable

**(2,000)**

(724)

 

**(2,000)**

(100)

Interest paid – net of capitalized portion

**(5,908)**

(5,933)

 

**(5,320)**

(5,119)

Cash dividends paid

**(718)**

(694)

 

**(718)**

(694)

Increase (decrease) in deferred credits and other noncurrent liabilities

**795**

(1,490)

 

**1,521**

(1,889)

Proceeds from issuance of capital stock

**68**

43

 

**68**

43

Net cash used in financing activities

**(20,352)**

(17,090)

 

**(16,687)**

(13,112)

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

**(52)**

(52)

 

**46**

(20)

**NET INCREASE (DECREASE) IN CASH AND  CASH EQUIVALENTS**

**3,110**

 240

 

**6,735**

(199)

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

**19,263**

10,876

 

**5,278**

4,165

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

**22,373**

11,116

 

**12,013**

3,966

* *

*Seeaccompanying Notes to Financial Statements.*

 

**PHILIPPINE LONG DISTANCE TELEPHONE COMPANY**

** **

**NOTES TO FINANCIAL STATEMENTS**

 

 

**1.     Corporate Information**

** **

ThePhilippine Long Distance Telephone Company, or PLDT, was incorporated under theold Corporation Law of the Philippines (Act 1459, as amended) on November 28, 1928, following themerger of four telephone companies under common U.S. ownership.  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. 

 

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 Pacific Exchange in the United States.  On October 19, 1994, an AmericanDepositary Receipts, or ADRs, facility was established pursuant to which CitibankN.A., as depositary, issued ADRs evidencing American Depositary Shares, orADSs, with each ADS representing one PLDT common share.  JP Morgan Chase Bankhas been appointed as successor depositary for PLDT’s ADRs effective February 10, 2003.The ADSs are listed and traded on the New York Stock Exchange and the PacificExchange 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. 

 

Asof June 30, 2004, we had 18,483 employees on a consolidated basis and9,992 on a non-consolidated basis.  As of December 31, 2003,we had 18,191 and 10,230 employees on a consolidated and non-consolidatedbasis, respectively.  

 

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

 

 

 

**2.     Basis of FinancialStatement Preparation**

** **

Ourfinancial statements have been prepared in conformity with generally acceptedaccounting principles in the Philippines, or Philippine GAAP, based on the historical costconvention.

 

Ourunaudited financial statements include, in our opinion, all adjustmentsconsisting only of normal recurring adjustments, necessary to present fairlythe results of operations for the interim periods.  The results of operationsfor the six months ended June 30, 2004 are not necessarily indicative of the results ofoperations that may be expected for the full year.

 

Inpreparing the unaudited June 30, 2004 financial statements, we followed thesame accounting policies, except as discussed in *Note 3 – AccountingChanges, Adoption of Statement of Financial Accounting Standards, or SFAS12/International Accounting Standards, or IAS 12 “Income Taxes”*and*Adoption of SFAS 17/IAS 17 “Leases”,*and methods of computation that we hadapplied in the preparation of the audited December 31, 2003 financialstatements.

 

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

 

**Name of Subsidiary/Investee**

**Principal Activity**

**Percentage of Ownership**

** **

 

** **

**Wireless**

 

** **

Smart Communications, Inc., or Smart, and subsidiaries

Cellular mobile services

**100.0**

Telesat, Inc., or Telesat

Satellite communications services

**94.4**

ACeS Philippines Cellular Satellite Corporation, or  ACeS Philippines

Satellite phone services

**88.5**

Mabuhay Satellite Corporation  (formerly Mabuhay Philippines 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**

Smart-NTT Multimedia, Inc., or SNMI

Data and network services

**100.0**

PLDT Global Corporation, or PLDT Global, and subsidiaries

Telecommunications services

**100.0**

PLDT-Maratel, Inc. (formerly Maranao Telephone Company, 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.

 

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

 

Minorityinterests represent the equity interests in Maratel, BCC, Telesat and MabuhaySatellite not held by the PLDT Group.

 
******
***Investmentsin Shares of Stock***

 

Investmentsin shares of stock of companies where our ownership interest ranges from 20% to50% (collectibly referred to as associates) on the consolidated financial statementsand of associates and subsidiaries on the non-consolidated financialstatements, except for the investments in Pilipino Telephone Corporation, orPiltel, (see *Note 9 – Investments*), are accounted for under the equitymethod of accounting.  Associates are entities in which we have a significantinfluence and which are neither a subsidiary nor a joint venture of the PLDTGroup.  Under the equity method, our investments in associates are carried inthe balance sheets at cost plus post-acquisition changes in our share in netassets of the investees, less impairment in value, if any.  The statements ofincome reflect our share in the results of operations of associates(consolidated) and of associates and subsidiaries (non-consolidated).Unrealized gains arising from transactions with our associates are eliminatedto the extent of our interests in associates, against our investments inassociates.  Our investments in associates include goodwill (net of accumulatedamortization) on acquisition, which are treated in accordance with theaccounting policy for goodwill, see *Note 4 – Summary of SignificantAccounting Policies*.

 

Otherinvestments in companies over which we exercise no significant influence andfor which control is temporary are stated at cost, less allowance for anysignificant and permanent decline in market value.

 

 

 

**3.   Accounting Changes**

 

ThePhilippine Accounting Standards Council, or ASC, approved the adoption of SFAS17/IAS 17 “Leases” and SFAS 12/IAS 12 “Income Taxes”, which became effective inthe Philippines for financial statements covering periods beginningon or after January 1, 2004.

 

***Adoptionof SFAS 12/IAS 12 “Income Taxes”***

 

SFAS12/IAS 12 prescribes the accounting treatment for current and noncurrentdeferred income taxes.  The standard requires the use of a balance sheetliability method in accounting for deferred income taxes.  It requires therecognition of a deferred tax liability and, subject to certain conditions, adeferred tax asset, for all temporary differences with certain exceptions.  Thestandard provides for the recognition of a deferred tax asset when it isprobable that taxable income will be available against which the deferred taxasset can be used.  It also provides for the recognition of a deferred taxliability with respect to asset revaluations.  Our adoption of this standardonly affected certain classifications in our balance sheets and did not haveany effect in our statements of income.

 

***Adoption of SFAS 17/IAS 17 “Leases”***

 

SFAS17/IAS 17 requires the capitalization of finance leases, which transfersubstantially all the risks and benefits incidental to ownership of leaseditem, at the inception of the lease at the fair value of leased property or, iflower, at the present value of the minimum lease payments.  SFAS 17/IAS 17 alsorequires that a lease where the lessor retains substantially all the risks andbenefits of ownership of the asset be classified as operating leases, whichshould be recognized as an expense in the income statement on a straight-linebasis over the lease term.

 

Asallowed under the transitory provisions of SFAS 17/IAS 17, we adopted thestandard and have accordingly restated our comparative financial statementsretroactively.  The after tax effect of the change was an increase of Php5 millionin consolidated net income for the six months ended June 30, 2003 and a reduction ofPhp567 million and Php551 million in the beginning retained earnings in 2004and 2003, respectively.  Basic and diluted earnings per common share increasedby Php0.02 for the six months ended June 30, 2003.See *Note 8 – Property, Plant and Equipment* for the related disclosure oncapital lease.

 

 

 

**4.   Summary of Significant Accounting Policies**

 

Oursignificant accounting policies and practices are discussed below to facilitatethe understanding of our financial statements:

 

***RevenueRecognition***

 

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 technologyservices.  We provide such services to mobile, business, residential andpayphone customers.  Revenues, which exclude value-added tax, represent thevalue of fixed consideration that have been received or are receivable.Revenues are recognized when there is evidence of an arrangement,collectibility is reasonably assured, and the delivery of the product orservice has occurred. 

 

*Subscriptions*

 

Weprovide telephone and data communication services under prepaid andpostpaid payment arrangements.  Revenues include fees for installation andactivation.   

 

*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.  Payphone service revenue is recognizedupon provision of service.  Revenues related to products and value-addedservices are recognized upon delivery of the product or service.

 

*Equipmentsales*

 

Salesof communication equipment are recognized upon delivery to the customer.

 

***Cashand Cash Equivalents***

 

Cash includes cash on hand and in banks.  Cash equivalents areshort-term, highly liquid investments that are readily convertible to knownamounts of cash with original maturities of three months or less from the dateof acquisition and that are subject to an insignificant risk of change invalue.

 

***Receivables***

 

Receivables are stated atface value, net of allowance for doubtful accounts.

 

***Allowance for Doubtful Accounts***

 

Allowance for doubtful accounts is maintained at alevel considered adequate to provide for potentially uncollectiblereceivables.  The level of allowance is based on historical collection,write-off experience, current economic trends, changes in our customer paymentterms, age status of receivables and other factors that may affectcollectibility.  An evaluation of the receivables, designed to identifypotential charges to the allowance, is performed on a continuous basis duringthe period.  The allowance is established by charges to income in the form ofprovision for doubtful accounts which is computed as a certain percentage ofoperating revenues adequate to cover potentially uncollectible accounts.  

 

***Inventories and Supplies***

 

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

 

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

 

***Property,Plant and Equipment***

 

Property,plant and equipment are stated at cost less accumulated depreciation andamortization and 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 interest on borrowed funds used during theconstruction period and capitalized foreign exchange losses related to foreigncurrency-denominated liabilities used to acquire such assets, net of foreignexchange gains on restatement of monetary assets.  When assets are sold orretired, their costs and accumulated depreciation, amortization and impairmentlosses, if any, are eliminated from the accounts and any gain or loss resultingfrom their disposal is included in the statements of income of such period.

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

 

**Property, Plant and Equipment**

**Estimated Useful Lives**

 

 

Buildings

25 – 40 years

Cable and wire facilities 

20 – 25 years

Central office equipment

15 – 20 years

Information origination/termination equipment

5 – 15 years

Communications satellite

15 years

Vehicles and other work equipment

5 – 10 years

Furniture

3 – 10 years

Cellular facilities

10 years

Land improvements

10 years

 

Theuseful lives and depreciation and amortization method are reviewed periodicallyto ensure 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 that are directly attributable to the construction of plant and equipmentare capitalized during the construction period, see*Note 8 – Property, Plantand Equipment.*

 

***Impairmentof Assets***

 

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 statements ofincome.  The recoverable amount is the higher of an asset’s net selling priceor value in use.  The net selling price is the amount obtainable from the saleof an asset in an arm’s–length transaction while value in use is the presentvalue of estimated future cash flows expected to arise from the continuing useof an asset or from its disposal at the end of its useful life.  Recoverableamounts are estimated for individual assets or, if it is not possible, for thecash-generating unit to which the asset belongs.  Reversal of impairment lossesrecognized in prior years is recorded when there is an indication that theimpairment losses recognized for the asset no longer exist or have decreased.The reversal is recorded as income.  However, the increased carrying amount ofan asset due to a reversal of an impairment loss is recognized to the extent itdoes not exceed the carrying amount that would have been determined had theimpairment loss not been recognized for that asset in prior periods.

 

***Goodwill***

 

Goodwill,included under “Other noncurrent assets” in the consolidated balance sheets,represents the excess of acquisition cost over the fair value of identifiablenet assets of a subsidiary at the date of acquisition.  With respect to aninvestment in a subsidiary, goodwill is included in the carrying amount of theinvestment.  Goodwill is amortized on a straight-line basis over the estimateduseful economic life up to a maximum of five years.  It is stated at cost lessaccumulated amortization and any impairment in value.

*** ***

***Deferred Charges***

 

Issuance costs, underwriting fees and related expensesincurred in connection with the issuance of debt instruments are deferred andamortized using the effective interest rate method.  Deferred charges areincluded under “Other noncurrent assets” in the balance sheets.

 

***NotesPayable***

*** ***

Notespayable are presented net of related discounts.  Discounts are amortized overthe life of the notes using the effective interest rate method.

*** ***

***Provisions***

*** ***

We recognize provisions when we have obligations,legal or constructive, as a result of past events, if it is probable that anoutflow of resources embodying economic benefits will be required to settle theobligation and a reliable estimate can be made of the amount of theobligation.  If the effect of the time value of money is material, provisionsare determined by discounting the expected future cash flows at a pre-tax ratethat reflects current market assessments of the time value of money and, whereappropriate, the risks specific to the liability. Where discounting is used,the increase in the provision due to the passage of time is recognized as anadditional provision.

 

***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.

 

Afinance lease gives rise to depreciation expense for the asset as well asborrowing cost for each period.  Finance charges are charged directly againstincome.  The depreciation policy for leased assets is consistent with that fordepreciable assets that are owned.  

 

Leaseswhere the lessor retains substantially all the risks and benefits of ownershipof the asset are classified as operating leases.  Operating lease payments arerecognized as an expense in the income statement on a straight-line basis overthe lease term.  For income tax reporting purposes, expenses that should havebeen incurred under lease agreement are considered as deductible expenses.

 

***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 to prepare the asset are in progress and expenditures and borrowingcosts are being incurred.  Borrowing costs are capitalized until the assets areready for their intended use.  If the resulting carrying amount of the asset exceedsits recoverable amount, an 

impairmentloss is recorded.  Borrowing costs include interest charges and other costsincurred in connection with the borrowing of funds, as well as differencesarising from foreign currency borrowings used to finance these projects to theextent that they are regarded as an adjustment to interest cost.

*** ***

***Retirement Costs***

 

PLDT and Smart have funded, noncontributory retirementplans, administered by the respective Fund’s Trustees, covering permanentemployees.  Retirement costs are actuarially determined using the projectedunit credit of accrued benefit valuation method.  This method reflects servicesrendered by employees to the date of valuation and incorporates assumptionsconcerning employees’ projected salaries.  Retirement costs include currentservice cost plus amortization of past service cost, experience adjustments andchanges in actuarial assumptions over the expected average remaining workinglives of the covered employees.

 

PLDT’sother subsidiaries provide for estimated retirement benefits required to bepaid under Republic Act, or R.A. No. 7641 to qualified employees.  The benefitis computed as a certain percentage of basic monthly salary for every year ofservice.

 

***Foreign Currency Transactions and Translations***

 

Transactions in foreign currencies are recorded inPhilippine pesos by applying to the foreign currency amount the spot exchange rateprevailing at the transaction date.  Foreign exchange gains or losses arisingon the spot settlements or restatement of monetary items at rates differentfrom those at which they were initially recorded during the period or presentedin the previous financial statements are recorded in the statements of incomein the period in which they arise, except for exchange losses arising fromborrowed funds used and liabilities incurred to finance the acquisition ofproperty, plant and equipment, net of foreign exchange gains from all otherforeign currency monetary items, if any, which are capitalized to theappropriate property, plant and equipment accounts, see *New AccountingStandards Effective Subsequent to June 30, 2004, SFAS 21/IAS 21,*“*TheEffects of Changes in Foreign Exchange Rates*”. 

 

Financialstatements of consolidated foreign subsidiaries that are integral to ouroperations are translated as if the transactions of the foreign operation hadbeen those of the PLDT Group.  At each balance sheet date, foreign currencymonetary items are translated using the closing rate, nonmonetary items whichare carried at historical cost are translated using the historical rate as ofthe date of acquisition and nonmonetary items which are carried at fair valueare translated using the exchange rate that existed when the values weredetermined.  Income and expense items are translated at the exchange rates onthe dates of the transactions.  Resulting exchange differences are recognizedin the statements of income.

 

***FinancialInstruments***

 

PLDT andSmart use forward exchange contracts (including prepaid forwards) to hedgeforeign currency assets, liabilities and firm commitments.  Translation gainsor losses on these forward exchange contracts are computed by multiplying theforward notional amounts by the difference between the spot exchange ratesprevailing on balance sheet dates and the spot exchange rates on the contractinception dates (or the last reporting dates).  The resulting gains or lossesare offset against the translation losses or gains on the underlying hedgedtransactions.  Any premium or discount is amortized over the period of thecontract and charged or credited to current operations.  For short-term forwardtransactions, the contracted forward rates are used to record the underlyinghedged transactions.

 

For the prepaid forward contracts, such prepaidforward is recorded as receivable from the counterparty bank and presented aspart of “Receivables” account in the consolidated balance sheets.  Payment ofprepaid forward entitle Smart to a discount on the contracted forward rate.The discount is recognized as income over the term of the related forwardexchange contract.

 

PLDTalso enters into currency swap contracts to hedge the currency risk on its fixedrate notes.  With these swaps, PLDT effectively converts its U.S. dollar notesto peso notes.  Thus, the underlying notes are no longer revalued to spotexchange rates on balance sheet date but are recorded at the hedged exchangerates.  Swap costs due on the contracts are accrued as of balance sheet date.

 

PLDTalso utilizes various structures incorporating currency option (both buy andsell) contracts to hedge the currency risk on its fixed rate notes and othershort-term obligations.  These contracts provide PLDT the right to purchase orthe obligation to sell foreign currency at pre-determined prices.  Premiumpayments due on the contracts are amortized over the contract term and chargedto current operations.  Changes in the options’ intrinsic values are alsocharged or credited to current operations.

 

Interestrate swap agreements are entered into to manage exposure to interest ratefluctuations.  Net income/expense on the swaps is accrued as of balance sheetdate.

 

Unrealizedmark-to-market gains and losses on outstanding derivatives entered into ashedges are not included in the determination of net income but are disclosed inthe related notes to financial statements.

 

Otherderivative financial instruments entered into that are not designated as hedgesare marked to market, with the revaluation gains and losses credited or chargedto current operations, see *NewAccounting Standards Effective Subsequent to June 30, 2004, SFAS 21/IAS 21,*“*TheEffects of Changes in Foreign Exchange Rates*”.

*** ***

***Income Taxes***

 

Deferredincome tax is provided using the balance sheet liability method, on alltemporary differences at the balance sheet date between the tax bases of assetsand liabilities and their carrying amounts for financial reporting purposes.

 

Deferredincome tax liabilities are recognized for all taxable temporary differences:(i)  except where the deferred income tax liability arises from goodwillamortization or the initial recognition of an asset or liability in atransaction that is not a business combination and, at the time of thetransaction, affects neither the accounting income nor taxable income or loss;and (ii) in respect of taxable temporary differences associated withinvestments in subsidiaries and associates, except where the timing of the reversalof the temporary difference can be controlled and it is probably that thetemporary difference will not reverse in the foreseeable future.

 

Deferredincome tax assets are recognized for all deductible temporary differences overthe regular corporate income tax to the extent that it is probable that taxableincome will be available against which the deductible temporary differences canbe utilized:  (i) except where the deferred income tax asset relating to thedeductible temporary difference arises from the initial recognition of an assetor liability in a transaction that is not a business combination and, at thetime of the transaction, affects neither the accounting income nor taxableincome or loss; and (ii) in respect of deductible temporary differencesassociated with investments in subsidiaries and associates, deferred tax assetsare only recognized to the extent that it is probable that the temporarydifferences will reverse in the foreseeable future and taxable income will beavailable against which the temporary difference can be utilized.

 

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

 

Deferredincome tax assets and liabilities are measured at the tax rate that is expectedto apply to the period when the asset is realized or the liability is settled,based on the applicable tax rate at the balance sheet date.

 

***EarningsPer Common Share***

 

Basicearnings per common share, or EPS, is calculated by dividing the net income orloss for the period attributable tocommon shareholders (net income or loss adjusted for dividends on all series ofpreferred shares) by the weighted average number of common shares outstandingduring the period, after giving retroactive effect to any stock dividenddeclarations.

 

DilutedEPS is calculated in the same manner assuming that, at the beginning of the periodor at the time of issuance during the period, all outstanding options areexercised and convertible preferred shares are converted to common shares.Outstanding stock options will have a dilutive effect under the treasury stockmethod only when the average market price of the underlying common share duringthe period exceeds the exercise price of the option.  

 

Where the effect of the assumed conversion of thepreferred shares and the exercise of all outstanding options have anti-dilutiveeffect, basic and diluted EPS are stated at the same amount.

 

If the required dividends to be declared on eachseries of convertible preferred shares divided by the number of equivalentcommon shares, assuming such convertible preferred shares are converted tocommon shares, would decrease the basic EPS, then such convertible preferredshares would be deemed 

dilutive.  As such, the diluted EPS will be calculatedby dividing net income attributable to common shareholders (net income lessdividends on the non-dilutive preferred shares) by the weighted average commonshares including the common share equivalent arising from dilutive convertiblepreferred shares.

 

***Segment Reporting***

 

Segment assets include operating assets used by asegment and consist principally of operating cash, receivables, inventories andproperty, plant and equipment, net of allowances and provisions.  Segmentliabilities include all operating liabilities and consist principally ofaccounts payable, accrued expenses and long-term debt.  Segment assets andliabilities do not include deferred income taxes.

 

Segmentrevenues, segment expenses and segment performance include transfers betweenbusiness segments.  The transfers are accounted for at competitive marketprices charged to unaffiliated customers for similar products.  Such transfersare eliminated in our consolidation.

 

***Useof Estimates***

 

The preparation of financial statements in conformitywith generally accepted accounting principles in the Philippinesrequires us to make estimates and assumptions that affect the reported amountsof our assets and liabilities and disclosure of contingent assets and liabilitiesat the date of financial statements, and the reported amounts of revenues andexpenses during the period reported.  Actual results could differ from ourestimates.

 

***Adoption of International Accounting Standards, or IAS***

 

In recent years, the PhilippineAccounting Standards Council, or ASC, has been adopting the InternationalAccounting Standards, or IAS, issued by the International Accounting StandardsCouncil, or IASC.

 

Weare expected to adopt the following new IAS which will be effective in thePhilippines beginning January 1, 2005 which could have a significant impact onour financial statements in the year of adoption as well as in future years.

 

•           IAS19, “Employee Benefits”,requires 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.  A specific portion of the netactuarial gains and losses (comprising experience adjustments and the effectsof changes in actuarial assumptions) that exceeds the greater of (i) 10% of thepresent value of the defined benefit obligation (before deducting plan assets);and (ii) 10% of the fair value of any planned assets is recognized immediatelyas income or expense;

 

•           IAS 21, “The Effects of Changes inForeign Exchange Rates”, requires the recognition of foreign exchange losses inthe period such are incurred.  As of June 30, 2004,undepreciated capitalized foreign exchange losses on a consolidated andnon-consolidated basis included in property, plant and equipment amounted to Php58,930million and Php53,111 million, respectively.  Upon adoption in 2005 of SFAS21/IAS 21, the proposed treatment is to adjust any undepreciated capitalizedforeign exchange losses, net of exchange losses that qualify as borrowing costand income tax effect, against beginning retained earnings, to the extent thatamounts capitalized do not meet the conditions under the new standard, and torestate prior periods’ financial statements.  Further, IAS 21 requires thedetermination of the functional currency of an entity;

 

•           IAS 27 “Consolidated and SeparateFinancial Statements”, supersedes IAS 27 “Consolidated Financial Statements andAccounting for Investments in Subsidiaries”.  Under the revised IAS 27, theexclusion of a subsidiary from consolidation when there are severe long-termrestrictions that significantly impair a subsidiary’s ability to transfer fundsto the parent under the superseded standard will be removed. Upon the adoptionof this new standard, Piltel will be required to be included in ourconsolidated financial statements retrospectively.  See *Note 2 – Basis ofFinancial Statement Preparation, Note 4 – Summary of Significant AccountingPolicies*and *Note 9 – Investments*.  Piltel’s net liability and netincome as of and for the six months ended June 30, 2004 amounted to Php21,430million and Php810 million respectively.  See *Note 25 – Other Matters*for Piltel debt exchange transaction.  In addition, investments in subsidiariesand associates are to be accounted for either at cost or in accordance with IAS39 “Financial Instruments: Recognition and Measurement” in the separate(non-consolidated) financial statements of the parent company.  Accumulatedequity in net earnings of subsidiaries and associates in PLDT’snon-consolidated financial statements amounted to Php965 millionand Php584 million as of June 30, 2004 and December 31, 2003, respectively; 

 

•           IAS 32, “Financial Instruments:Disclosure and Presentation”, covers the disclosure and presentation of allfinancial instruments.  The 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 by the company, types of risksassociated with both recognized and unrecognized financial instruments (pricerisk, credit risk, liquidity risk, and cash flow risk), fair value informationof both recognized and unrecognized financial assets and financial liabilities,and the PLDT Group’s financial risk management policies and objectives.  TheStandard also requires financial instruments to be classified as liabilities orequity in accordance with their substance and not their legal form.

 

•           IAS 39, “Financial Instruments:Recognition and Measurement”, establishes the accounting and reportingstandards for recognizing, measuring, and disclosing information about PLDTGroup’s financial assets and financial liabilities.  The Standard requires afinancial asset or financial liability to be recognized initially at fairvalue.  Subsequent to initial recognition, the PLDT Group should continue tomeasure financial assets at their fair values, except for loans and receivablesheld-to-maturity investments, which are measured at cost or amortized costusing the effective interest rate method.  Financial liabilities aresubsequently measured at cost or amortized cost, except for liabilitiesclassified as “at fair value through profit and loss” and derivatives, whichare measured at fair value;  

 

•           IAS 39 also covers the accountingfor derivative instruments.  The Standard has expanded the definition of aderivative instrument to include derivatives (derivative-like provisions)embedded in non-derivative contracts.  Under the Standard, every derivativeinstrument is recorded in the balance sheet as either an asset or liabilitymeasured at its fair value.  Derivatives that are not hedges are adjusted tofair value through income.  If the derivative is a hedge, depending on thenature of the hedge, changes in the fair value of derivatives are either offsetagainst the change in fair value of the hedged assets, liabilities, or firmcommitments through earnings, or recognized in stockholders’ equity until the hedgeditem is recognized in earnings.  We must formally document, designate, andassess the effectiveness of derivative transactions that receive hedgeaccounting treatment; and

 

•           SFAS 40/IAS 40, “InvestmentProperty”, prescribes the accounting treatment for investment property which isdefined as land and/or building held to earn rentals or for capitalappreciation or both.  Investment property is initially recognized at cost.Subsequent to initial recognition, 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.  

 

The International Accounting Standards Board, or IASB, assumed from theIASC the responsibility for setting the international accounting standards.The standards issued by the IASB are designated as International FinancialReporting Standards, or IFRS.  Upon its inception, the IASB also adopted theIAS issued by the IASC.  The IASB carried on improvements on certain IAS inpreparation for the full adoption of IFRS in 2005.  In line with thisinitiative, the IASB has recently issued revised IAS and IFRS, most of whichare to be effective in 2005, as follows:

 

•           IAS 1 – “Presentation of FinancialStatements”;

•           IAS 2 – “Inventories”;

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

•           IAS 10 – “Events After Balance SheetDate”;

•           IAS 16 – “Property, Plant andEquipment”;

•           IAS 17 – “Leases”;

•           IAS 24 – “Related PartyDisclosures”;

•           IAS 28 – “Investments inAssociates”;

•           IAS 31 – “Investments in JointVentures”;

•           IAS 33 – “Earnings Per Share”;

•           IFRS 1 – “First Time Adoption ofInternational Financial Reporting Standards”;

•           IFRS 2 – “Share Based Payment”; 

•           IFRS 3 – “Business Combinations”;and

•           IFRS 4 – “Disposal of Non-CurrentAssets and Presentation of Discontinued Operations”.

 

We are currently in the process ofevaluating the impact of the new and revised standards in our financialstatements.

 

 

 

**5.   Cash and Cash Equivalents**

** **

This account consists of:

** **

 

**Consolidated**

 

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

(in million pesos)

Cash on hand and in banks

**2,151**

2,627

 

**911**

512

Temporary investments

**20,222**

16,636

 

**11,102**

4,766

 

**22,373**

19,263

** **
**12,013**

5,278

 

Cash in banks earns interest at prevailing bank deposit rates.  Temporaryinvestments are made for varying periods of up to one month depending on ourimmediate cash requirements, and earn interest at the prevailing short-termdeposit rates.

 

 

**6.   Receivables – Net**

** **

This account consists of receivables from:

 

 

**Consolidated**

 

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

(in million pesos)

Customers and carriers

**29,656**

28,662

 

**22,768**

22,603

Others

**3,765**

2,777

 

**2,157**

2,168

 

**33,421**

31,439

 

**24,925**

24,771

Less allowance for doubtful accounts

**13,880**

11,923

 

**10,418**

9,031

 

**19,541**

19,516

** **
**14,507**

15,740

 

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, with a balance of US$33 million as of June 30, 2004, and (2)to service, administer and collect the receivables on behalf of the Purchaser.Under the RPD, the Purchaser has no recourse to PLDT should an eligible carrierfail or refuse to settle the assigned/purchased receivables, except when PLDTcommits a breach on its representations and warranties under the RPD.

 

Sale ofreceivables under the RPD amounted to US$5million (Php297 million) and US$5 million (Php272million) for the six months ended June 30, 2004 and 2003, respectively.  Loss on sale of receivables underthe RPD amounted to US$0.65 million (Php37 million)and US$0.84 million (Php45 million) for the six months ended June 30, 2004 and 2003, respectively.  

 

 

 

**7.   Inventories and Supplies – Net**

 

This account consists of:

 

 

**Consolidated**

** **

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

(in million pesos)

Terminal and cellular phone units

**1,855**

1,265

** **

**188**

362

Spare parts and supplies

**1,205**

1,318

** **

**1,201**

1,308

Others

**435**

486

** **

**7**

80

 

**3,495**

3,069

** **

**1,396**

1,750

Less allowance for inventory obsolescence

**727**

648

** **

**237**

237

 

**2,768**

2,421

** **

**1,159**

1,513

 

Spare parts and supplies issued to various projectsare included as part of property under construction shown under *Note 8 –Property, Plant and Equipment – Net*.  
****
** **

 

**8.   Property, Plant and Equipment – Net**

 

Thisaccount 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)

***Consolidated***

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

** **

**At****December 31, 2003****(As restated – Note 3)**

Cost

117,992

104,391

63,488

25,522

23,545

10,392

5,733

2,619

14,379

368,061

Accumulated depreciation and amortization 

(29,410)

(38,561)

(29,081)

(5,072)

(14,217)

(4,479)

(2,507)

(307)

–

(123,634)

Net book value

88,582

65,830

34,407

20,450

9,328

5,913

3,226

2,312

14,379

244,427

** **

**Six Months Ended**

******June 30, 2004****(Unaudited)**

Opening net book value

88,582

65,830

34,407

20,450

9,328

5,913

3,226

2,312

14,379

244,427

Additions/Transfers – net

3,441

1,620

5,350

171

1,909

47

197

–

(284)

12,451

Disposals/Retirement

(99)                                                                              

(11)

(4)

(5)

(15)

–

(42)

–

–

(176)

Accumulated depreciation and amortization 

(2,707)

(3,504)

(4,467)

(441)

(1,513)

(348)

(258)

(20)

–

 

(13,258)

Closing net book value

89,217

63,935

35,286

20,175

9,709

5,612

3,123

2,292

14,095

243,444

** **

**At****June 30, 2004****(Unaudited)**

 

 

 

 

 

 

 

 

 

 

Cost

121,163

105,977

68,904

25,682

25,239

9,473

5,510

2,619

14,095

378,662

Accumulated depreciation and amortization 

(31,946)   

(42,042)

(33,618)

(5,507)

(15,530)

(3,861)

(2,387)

(327)

–

 

(135,218)

Net book value

89,217

63,935

35,286

20,175

9,709

5,612

3,123

2,292

14,095

243,444

 

 

 

 

 

 

 

 

 

 

 

***Non-Consolidated***

 

 

 

 

 

 

 

 

 

 

** **

**At****December 31, 2003******

**(As restated – Note 3)**

Cost

107,046

103,076

–

23,656

14,606

–

5,410

2,104

12,872

268,770

Accumulated depreciation and amortization 

(26,805)

(38,049)

–

(4,183)

(9,089)

–

(2,234)

(258)

–

(80,618)

Net book value

80,241

65,027

–

19,473

5,517

–

3,176

1,846

12,872

188,152

** **

**Six Months Ended****June 30, 2004****(Unaudited)**

Opening net book value

80,241

65,027

–

19,473

5,517

–

3,176

1,846

12,872

188,152

Additions/Transfers – net

2,222

1,548

–

102

976

–

195

1

(1,593)

3,451

Disposals/Retirement 

(98)

(11)

–

(5)

(12)

–

(42)

(1)

–

(169)

Accumulated depreciation and amortization 

(2,214)

(3,407)

–

(327)

(653)

–

(253)

(9)

–

(6,863)

Closing net book value

80,151

63,157

–

19,243

5,828

–

3,076

1,837

11,279

184,571

**At****June 30, 2004****(Unaudited)**

Cost

109,133

104,601

–

23,748

15,436

–

5,418

2,105

11,279

271,720

Accumulated depreciation and amortization 

(28,982)

(41,444)

–

(4,505)

(9,608)

–

(2,342)

(268)

–

(87,149)

Net book value

80,151

63,157

–

19,243

5,828

–

3,076

1,837

11,279

184,571

 

Substantially all our telecommunications equipment ispurchased outside the Philippines.  A significant source of financing for suchpurchases are foreign loans requiring repayment in currencies other thanPhilippine pesos, principally in U.S. dollars (see *Note 12 – Long-term Debt*).Interest, using an average capitalization rate of 7%, and net foreign exchangelosses capitalized to property, plant and equipment for the six months ended June 30, 2004 and2003 were as follows:

 

****

**Consolidated**

** **

**Non-Consolidated**

 

**Six Months Ended June 30,**

 

**2004**

2003

 

**2004**

2003

 

(Unaudited)

 

(in million pesos)

Interest

**302**

541

 

**250**

531

Foreign exchange losses - net

**898**

635

 

**772**

356

 

Asof June 30, 2004 and December 31, 2003, the undepreciated capitalizednet foreign exchange losses amounted to Php58,930 million and Php61,028 million,respectively, on a consolidated basis and amounted to Php53,111 million andPhp54,661 million, respectively, on a non-consolidated basis.  

 

InJune 2003, ACeS Philippines recognized animpairment provision of Php974 million in respect of certain equipment inrelation to the business of ACeS International Limited, or AIL, after havingdetermined certain factors which raised substantial doubt about AIL’s abilityto continue as a going concern.  See *Note 9 – Investments* for furtherdiscussion.

 

Certainproperty, plant and equipment have been restated to include the followingamounts for capitalized leases as of June 30, 2004and December 31, 2003:

 

** **

**June 30, 2004****(Unaudited)**

 

December 31, 2003  (As restated – Note 3)

 

**Central office equipment**

**Vehicles, furniture and other network equipment**

** **

** **

** **

**Total**

 

Central office equipment

Vehicles, furniture and other network equipment

 

 

 

Total

*** ***

(in million pesos)

***Consolidated***

** **

** **

** **

 

 

 

 

Cost

**315**

**704**

**1,019**

 

315

574

889

Less accumulated depreciation

**239**

**256**

**495**

 

227

153

380

 

**76**

**448**

**524**

 

88

421

509

 

** **

** **

** **

 

 

 

 

***Non-Consolidated***

** **

** **

** **

 

 

 

 

Cost

**308**

**–**

**308**

 

308

–

308

Less accumulated depreciation

**236**

**–**

**236**

 

226

–

226

 

**72**

**–**

**72**

 

82

–

82

 

The future minimum payments for capitalized leases areas follows as of June 30, 2004:

 

** **

**Consolidated**

**Non-Consolidated**

**Year**

(Unaudited)

** **

(in million pesos)

2004(1)

373

257

2005

403

217

2006

334

217

2007

244

223

Total minimum lease payments

1,354

 914

Less amount representing interest

311

285

Present value of net minimum lease payments

1,043

 629

Less current portion

373

172

Long-term obligations (Note 13)

 670

 457

 

(1)   July 1, 2004 through December 31, 2004

 

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 leaseback transaction.

 

 

 

**9.   Investments**

 

This account consists of:

 

 

**Consolidated**

 

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

** **

**June 30, 2004****(Unaudited)**

December 31, 2003

(As restated – Note 3)

 

(in million pesos)

Investments in shares of stock:

 

** **

 

** **

 

Cost:

** **

** **

 

** **

 

Common

**6,668**

6,702

 

**25,955**

25,955

Preferred

**8,344**

8,353

 

**18,293**

18,292

 

**15,012**

15,055

 

**44,248**

44,247

Less cost of investment in Piltel

**11,691**

11,691

** **

**11,691**

11,691

 

**3,321**

3,364

 

**32,557**

32,556

Accumulated equity in net (losses) income of investees and provision for impairment in value  of investment at end of the period

**(****13,496****)**

(13,445)

 

**965**

 584

Less accumulated equity in net losses and provision  for impairment in value of investment in Piltel

**11,691**

 11,691

 

**11,691**

11,691

Net accumulated equity in net (losses) income 

** **

 

 

** **

 

    of investees and provision for impairment  in value of investment at end of the period 

    (Note 14)

**(1,805)**

 (1,754) 

 

**12,656**

12,275

Total cost and accumulated equity in net income of investees

**1,516**

1,610

 

**45,213**

44,831

Investment in debt securities – net

**56**

–

 

**–**

–

Total

**1,572**

1,610

 

**45,213**

44,831

 

 

 

**Consolidated**

** **

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

**June 30, 2004****(Unaudited)**

December 31, 2003

(As restated – Note 3)

 

(in million pesos)

 

** **

 

 

** **

 

Investments in shares of stock:

** **

 

 

** **

 

 

** **

 

 

** **

 

At equity:

** **

 

 

** **

 

Smart 

**–**

–

 

**42,344**

42,018

Mabuhay Satellite 

**–**

–

 

**1,564**

1,508

Subic Telecom 

**–**

–

 

**301**

348

ePLDT 

**–**

–

 

**327**

257

Clark Telecom 

**–**

–

 

**205**

177

Telesat 

**–**

–

 

**183**

190

SNMI

**–**

–

 

**111**

111

Maratel

**–**

–

 

**120**

96

BCC 

**–**

–

 

**6**

74

PLDT Global

**–**

–

 

**3**

3

ACeS Philippines

**–**

–

 

**–**

–

Others

**15**

53

 

–

–

 

**15**

  53

 

**45,164**

44,782

At cost:

** **

 

 

** **

 

Mabuhay Space Holdings Limited, or MSHL,  net of permanent decline in value of investment 

**792**

839

 

**–**

–

Stradcom International Holdings, Inc.

**616**

629

 

**–**

–

Piltel

**–**

–

 

**–**

–

Others

**93**

89

 

**49**

49

 

**1,501**

1,557

 

**49**

  49

Total

**1,516**

1,610

 

**45,213**

44,831

 

The movements in our accumulated equity in net(losses) income of investees can be accounted for as follows:

 

 

**Consolidated**

 

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

** **

**June 30, 2004****(Unaudited)**

December 31, 2003

(As restated – Note 3)

 

 

(in million pesos)

 

Beginning balance

**(1,754)**

(109)

 

**12,275**

4,707

Equity in net (losses) income of investees, including goodwill amortization and provision for impairment in value of investment for the period

**(43)**

(1,618)

 

**11,615**

13,008

Dividends received and others

**(8)**

(27)

 

**(11,234)**

(5,440)

Net accumulated equity in net (losses) income of investees and impairment in value of investment

**(1,805)**

(1,754) 

 

**12,656**

12,275

*** ***
******
***Investmentin ePLDT***

 

ePLDTwas incorporated to serve as the principal corporate vehicle for PLDT’sinformation and communications technology initiatives and ventures.  As of June 30, 2004, ePLDTheld interests in a number of businesses, which include: 

 
- Internet Data Center under the brand name VitroÔ; 
- 100% investment in Vocativ Systems Inc., or Vocativ, a 722-seat call center facility with 677 customer service representatives, or CSRs, that commenced full commercial operations in April 2002 exclusively for clients of a global provider of customer relationship management services. Vocativ is currently expanding its capacity by 369 seat which will become operational by the fourth quarter of 2004; 

 
- 100% investment in Parlance Systems, Inc., or Parlance, a 767-seat call center facility with 862 CSRs, that commenced full commercial operations in June 2002 exclusively for one of the largest direct-to-home satellite service providers in the United States for customer support and billing requirements.  Parlance is further expanding its capacity by 274 seats to accommodate anticipated increased call volumes from its existing client;

 
- 100% owned subsidiary, mySecureSign, Inc., a principal affiliate of VeriSign, Inc., which is the largest certification authority and issuer of digital certificates worldwide; 

 
- 100% owned subsidiary, iPlus Intelligent Network, Inc., which provides IT helpdesk/contact center solutions and terminals for credit, debit and cash card transaction;

 
- 100% owned subsidiary, Sidera Technologies, Inc., which engages in the business of designing and managing reloadable chip-based cards.  In March 2003, ePLDT had written off its investment, advances and related assets in Sidera Technologies, Inc. totaling Php213 million;

 
- 99.6% investment in Infocom Technologies Inc., or Infocom, an internet service provider;

 
- 50% investment in ePDS, Inc., a bills printing company, which provides laser printing and enveloping services for statements, bills and invoices, and other value-added services to companies in the Philippines.  ePDS, Inc. has an initial paid-up capital of Php11 million.  ePDS was incorporated on July 22, 2003, through a joint venture agreement among ePLDT, DataPost Pte Ltd., or DataPost, a subsidiary of Singapore Post and G3 Worldwide ASPAC, or Spring, the largest international mail services provider.  Datapost and Spring own 30% and 20%, respectively, of the remaining equity interest in ePDS;

 
- 52.09% investment in Digital Paradise, Inc., or DigiPar, an internet café business which assumed the assets and brand of  Netopia .   Netopia  is now one of the largest and fastest growing internet café chain in the country with over 85 branches over 4,000 work stations.  ePLDT’s 40% convertible debt in Netopia Computer Technologies, Inc. in 2002 was assigned to DigiPar in exchange for a 41% equity interest in DigiPar in 2003;

 
- 22.5% interest in convertible securities of Stradcom International Holdings, Inc., the parent company of Stradcom Corporation which has an existing concession agreement with the Philippine government for the modernization of the Philippine Land Transportation Office, including the computerization of driver’s license issuance, vehicle registration and traffic adjudication systems; 

 
- 20.5% equity interest in the Philippine e-procurement joint venture, BayanTrade Dotcom, Inc.; and

 
- 20% equity interest in Airborne Access Corporation, a pioneering wireless internet service provider, catering primarily to mobile professionals by delivering wireless internet access to its subscribers through more than 44 wireless access points throughout Metro Manila.  Airborne Access Corporation has an initial paid-up capital of Php3 million.

 

On June 30, 2003, ePLDTsold its 51% interest in Contact World, Inc., a call center facilityaccommodating 200 seats and assigned its receivables from the same to ServiceZone, Inc., a U.S. based call center operator, for a total considerationof US$700,000.  Salmat Pty Limited of Australia wasour previous joint venture partner in Contact World, a company engaged in the callcenter business.

 

On September 10, 2003, ePLDT sold its 45% equity interest in Mind Stream, Inc. to Exceed LearningInstitute, Inc. for a total consideration of Php11 million worth of trainingcredits.  Mind Stream, Inc. is an information technology or IT learning centerunder license with the National Institute of Information Technology of Indiafor IT courseware.

 

***Investmentin BCC***

 

In 2002 and 2003, PLDTentered into a separate Deed of Assignment of Subscription with Smart and FortBonifacio Development Corporation, or FBDC, where Smart and FBDC assigned,transferred and conveyed in favor of PLDT their total subscription of 750,000common shares and 750,000 preferred shares of BCC and all their interest andrights therein for a total consideration of Php93 million.  The assignmentsinclude subscription payable aggregating Php68 million. The shares represent75% of the subscribed capital stock of BCC.

 

BCCwas incorporated primarily to own, construct, establish, maintain, lease andotherwise operate, to the extent allowed by law, communication infrastructureand to provide related services, including but not limited to, value-addedservices, within the Fort Bonifacio Global City and Villamor Air Base.

 

***Investmentin Piltel***

 

Piltelexperienced significant operational and financial difficulties arising fromseveral factors affecting its business.  In 1999, it imposed a moratorium onpayment of its outstanding indebtedness and began negotiations for therestructuring of its indebtedness to financial creditors.  On June 4, 2001, Piltelcompleted the restructuring of approximately Php41billion of indebtedness and other claims, representing approximately 98% of itstotal liabilities as of that date, including its contingent liability toMarubeni Corporation, or Marubeni, arising out of a Build-Transfer Agreementbetween Piltel and Marubeni.

 

Underthe terms of the debt restructuring, 50% of Piltel’s debt was cancelled inexchange for Piltel convertible preferred shares, which were mandatorilyexchanged for PLDT convertible preferred shares, and the balance wasrestructured into 10-year and 15-year loans secured by substantially all of thepresent and future assets of Piltel.  See *Note 14 – Stockholders’ Equity*for the terms of the PLDT convertible preferred shares.

 

In 2003,holders of Piltel’s convertible bonds and bank debt with aggregate amounts ofUS$1 million (including accretion costs up to June 4, 2001) and US$6 million, respectively, agreed to participate in the debt restructuring plan.Consequently, 50% of the redemption amounts were released in exchange for: (1)92,475 Piltel’s Series K, Class I Convertible Preferred Stocks which were thenexchanged for 18,495 PLDT’s Series VI Convertible Preferred Stocks, in respectof the convertible bonds; and (2) 430,400 Piltel’s Series K, Class IConvertible Preferred Stocks which were then exchanged for 86,080 PLDT’s SeriesVI Convertible Preferred Stocks, in respect of the bank debt.  The remaining50% of the redemption amounts were exchanged for a participation in the“Convertible Notes Facility” and “U.S. Dollar Facility” for the holders ofPiltel’s convertible bonds and bank debt, respectively.

 

Piltelis not in compliance with the terms of convertible bonds with principal amountof US$0.7 million (approximately US$0.9 million redemption price at the optionof holders).  Summarized below are the principal terms of the restructured debtof Piltel: 

 

 

**10-Year Loans**

**15-Year Loans**

**Term Notes Facility**

**Convertible Notes**

Final maturity

10 years from Effective Date

15 years from Effective Date

15 years plus 10 days from Effective Date

15 years from Effective Date

Amortization

per annum

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 offered rate, or LIBOR, for three-month U.S. dollar deposits plus 1.00% p.a.

 

**Yen facility** – LIBOR for three-month Yen 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 six-month U.S. dollar deposits plus 1.00% p.a.

 

Interest payment dates

Quarterly in arrears

Semi-annually

 

Total long-term debt of Piltel amounted toPhp23,523 million and Php23,475 million as of June 30, 2004 and December 31, 2003, respectively, withmaturities of up to June 14, 2016, which consist of thefollowing: 

 

** **

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

** **

** **

(in millions)

** **

**Restructured debt**

** **

** **

** **

** **

Philippine Pesos

** **

** **

** **

 

10 year Tranche B

** **

**Php2,164**

 

Php2,166

15 year Tranche C

** **

**2,164**

 

2,166

15 year Term Notes Facility

** **

**292**

 

293

 

** **

**4,620**

 

4,625

U.S. Dollars

** **

** **

 

 

10 year Tranche B

**US$35**

**1,951**

US$35

1,932

15 year Tranche C

**35**

**1,951**

35

1,932

15 year Conversion Notes Facility

**122**

**6,832**

122

6,768

 

**US$****192**

**10,734**

US$192

10,632

Japanese Yen

** **

** **

 

 

10 year Tranche B

**JPY7,814**

**4,037**

 JPY7,822

4,062

15 year Tranche C

**7,814**

**4,037**

7,822

4,062

 

**JPY****15,628**

**8,074**

JPY15,644

8,124

Total

** **

**23,428**

 

23,381

**Unrestructured debt**

** **

** **

 

 

U.S. Dollars

** **

** **

 

 

Convertible bonds

**US$1**

**52**

US$1

51

**Liabilities under capital lease**

** **

**43**

 

43

 

** **

**Php23,523**

 

Php23,475

 

As of June 30, 2004, approximately 99.6% of Piltel’s debtshave been restructured except for convertible bonds with a principal amount ofUS$1 million.

 

Piltel may not be able to restructure or otherwise pay the claimsrelating to its unrestructured debt.  However, default on and acceleration ofPiltel’s unrestructured indebtedness do not create a cross-default underPiltel’s restructured indebtedness or any indebtedness of PLDT.

 

If Piltel’s non-participating creditors take forceful measures toenforce their claims, it is possible that Piltel would be required to submititself to a court-supervised rehabilitation proceeding or an involuntaryinsolvency proceeding seeking liquidation.  All of Piltel’s creditors thatparticipated in the debt restructuring agreed in connection with the debtrestructuring that they would submit Piltel to a rehabilitation proceeding inthose circumstances and petition for the adoption of a plan of rehabilitationthat includes the financial terms of the debt restructuring plan.  However, thelaws and procedures governing a rehabilitation proceeding in the Philippinecourts remain untested in significant respects.  It cannot be assured that arehabilitation plan which incorporates the financial terms of the debtrestructuring would be adopted promptly or at all.  Even if such arehabilitation plan were adopted, it cannot be assured that Piltel would proveto be viable thereafter and that it will be able to meet obligations, includingits obligations owed to PLDT or its affiliates. 

 

As part of the settlement of fees inconnection with the debt restructuring, 208 million common shares of Piltelheld by PLDT were transferred to Piltel’s financial advisors in 2001 reducingPLDT’s ownership in Piltel’s outstanding common shares to less than 51%.Effective June 27, 2001, Piltel ceased to be treated as aconsolidated subsidiary as a result of the reduction of PLDT’s equity interestin Piltel’s common shares from 57.6% to 45.3%.  PLDT accounted for itsinvestment in Piltel using the equity method from June 27, 2001 to December 31, 2001.  At the end of 2001,the balance of PLDT’s investments in Piltel amounted to Php948 millionrepresenting PLDT’s equity in net assets of Piltel as of that date.

 

Until all amounts owed to creditors participating in the debtrestructuring plan have been paid or discharged, PLDT will not be permitted todemand or receive any payment, redemption, or distribution in respect of anypresent and future liability owed by Piltel to PLDT or any affiliate of PLDT,subject to specified exceptions.  These liabilities include amounts owed onPiltel preferred shares owned by PLDT and other financial indebtedness owed byPiltel to PLDT or any affiliate of PLDT, but exclude payments due in respect oftransactions having arm’s-length terms and/or in which the pricing is based onmarket terms.  These severe long-term restrictions significantly impairPiltel’s ability to transfer funds to PLDT.  As of June 30, 2004 and December 31, 2003, Piltel hadreported a capital deficiency of Php21,430 million and Php22,239 million,respectively.  

 

The ASC approved the adoption of SFAS 28/IAS 28, “Accounting forInvestments in Associates,” which became effective in the Philippines for financial statements covering periodsbeginning on or after January 1, 2002.  Under SFAS 28/IAS28, an investment in an associate should be accounted for under the equitymethod, except when it operates under severe long-term restrictions thatsignificantly impair its ability to transfer funds to the parent company.  Suchinvestments should be accounted for at cost in accordance with the originalSFAS 10, “Summary of Generally Accepted Accounting Principles on Investments”.The change in method of accounting for investments in Piltel from equity methodto cost method did not have any effect on our financial statements (see *NewAccounting Standards Effective Subsequent to**June 30, 2004**, IAS 27, “Consolidated and Separate Financial Statements*”).

 

In addition, PLDT is subject tocontractual restrictions in the amount of financial support it can provide toPiltel under the Letter of Support.  PLDT issued a Letter of Support for thebenefit of Piltel and its creditors under which PLDT has agreed to cover anyfunding shortfalls of Piltel up to a maximum amount of US$150 million less allamounts paid or committed to be paid to or on behalf of Piltel by PLDT on orafter March 23, 2000.  Under the Letter of Support, PLDT willprovide funding to Piltel in the event that the cash flows from Piltel’soperations falls short of amounts required by it to discharge in full itsobligations to any creditor of Piltel or any of its operating and financingsubsidiaries and affiliates.  PLDT is subject to contractual restrictionslimiting the amount of financial support it can provide to Piltel subsequent tothe US$150 million Letter of Support.  The remaining undrawn balance under theLetter of Support was US$50 million, approximately Php2,823 million as of June 30, 2004 and Php2,793 million as of December 31, 2003, respectively after taking into account PLDT’s investments inPiltel as of and subsequent to March 23, 2000.  The continued operations of Piltel as a going concernis dependent upon amounts available to it under the Letter of Support and itsability to generate sufficient cash flows to meet its obligations on a timelybasis, to comply with the provision of the restructuring agreements asdiscussed in *Note 12 – Long-term Debt*.

 

Piltel wrote down assets aggregatingPhp13,984 million, Php16,791 million and Php1,438 million in 2001, 2002 and2003, respectively.  With the sustained success of Piltel’s and other cellularoperators’ prepaid GSM service, impairment losses of Php13,984 million in 2001and Php4,737 million in 2002 were recognized pertaining to Piltel’s AdvancedMobile Phone System, or AMPS, and Code Division Multiple Access System, or CDMAnetworks as the revenues generated from its AMPS/CDMA postpaid and prepaidservices could no longer support the cost of operating the network.  Inaddition, impairment losses amounting to Php12,054 million in 2002 and Php1,438million in 2003 were recorded in respect of its Executive Order, or E.O. 109,assets.  Of the E.O. 109 asset impairment in 2002, Php7,742 million was writtenoff on account of the termination of the E.O. 109 limited mobility service inFebruary 2003 as revenues from the E.O. 109 prepaid or limited mobilityservice, which uses N-AMPS cellular technology, were likewise unfavorablyaffected by the continued success of Piltel’s and other cellular operators’prepaid GSM service.  The remaining E.O. 109 asset impairment losses ofPhp4,311 million and Php1,438 million in 2002 and 2003, respectively, pertainedto the E.O. 109 fixed wireline network, which brought down the net book valueof these assets to their recoverable values, which recoverable values wereestimated using the net present value of future cash flows from the E.O. 109postpaid service.

 

In 2002, the level of operation of Piltel indicated that it wasunlikely that residual amounts may be realized by PLDT from its investments inPiltel.  Piltel had a total negative net worth of Php19,100 million as ofDecember 31, 2002 as a result of continuing losses of Piltel and impairmentlosses in respect of its AMPS/CDMA and E.O. 109 assets aggregating Php16,791million in 2002.  Accordingly, in 2002, PLDT had written down Php1,519 million,representing the balance of PLDT’s investment in Piltel amounting to Php948million as of December 31, 2001 and Php571 million drawings under the Letter ofSupport in 2002, and recorded a liability on its balance sheet of approximatelyPhp2,676 million in respect of the undrawn balance of the Letter of Supportamounting to US$50 million as of December 31, 2002.  See *Note 25 – OtherMatters*for Piltel debt exchange transaction.

 

***Investmentof ACeS******Philippines******in AIL***

 

Asof June 30, 2004, ACeS Philippines has a 20% investment in AIL, acompany incorporated under 

thelaws of the island of Bermuda.  AIL owns the Garuda I satellite and the relatedsystem control equipment in Batam, Indonesia.

 

In December 1998, AIL and its 95% owned subsidiary, PTAsia Cellular Satellite, entered into an Amended and Restated Credit Agreement,or Amended Agreement, to amend the original Credit Agreement entered into by PTAsia Cellular Satellite and its bank creditors in 1997.  Under the AmendedAgreement, AIL has, among others, assigned to the banks as collateral all ofits tangible properties, including the Garuda Satellite, the system controlfacilities and system control equipment.  On September 30, 2002, PT Asia CellularSatellite, AIL, as guarantor, P.T. Bank Internasional Indonesia, as securityagent, and various banks signed a Rescheduling Agreement, which amended theterms of the Amended and Restated Credit Agreement dated December 29, 1998,moving the principal repayment dates to agreed periods with the final maturitydate on January 31, 2012 (see *Note 15 – Related Party Transactions)*.

 

In2003, AIL has incurred recurring significant operating losses, negativeoperating cash flows, and significant levels of debt.  The financial conditionof AIL was partly due to the National Service Providers’, or NSPs, inability togenerate the amount of revenues originally expected as the growth in subscribernumbers have been significantly lower than budgeted.  These factors raisesubstantial doubt about AIL’s ability to continue as a going concern.  On thisbasis, we recognized an impairment provision in respect of our investment inAIL amounting to Php1,614 million and groundstation equipment of ACeS Philippines in relation to the business of AILamounting to Php974 million (see *Note 8 –Property, Plant and Equipment*).

***Investment of Mabuhay Satellite in 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 to MSHL in consideration for SS/L’s 35%equity interest in MSHL and Mabuhay Satellite is required to pay SS/L US$19million for a 65% equity interest in MSHL.

 

In 2000, SS/Lfiled a Notice of Default and Termination against Mabuhay Satellite arisingfrom the latter’s failure to amicably resolve its unpaid obligation to SS/Lunder the JVA.  In 2002, the arbitration panel handed down its decision andprovided for payment by Mabuhay Satellite to SS/L of the principal amount ofUS$10 million plus accrued interest at 9% per annum.  On June 30, 2003, MabuhaySatellite and SS/L concluded a US$15 million settlement agreement under whichMabuhay Satellite leased two transponders on a life-term basis to SS/L and hadoffset the lease charges due from SS/L and its receivables from Loral SkynetNetwork Services, Inc. (formerly known as the Loral Cyberstar, Inc.), amongothers, for a full and final settlement of the arbitration decision.  Theagreement was subsequently approved by Mabuhay Satellite’s creditors in March2004.

 

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.  Given the temporary nature of thejoint venture, Mabuhay Satellite accounts for its investment in MSHL under thecost method.

*** ***

 

 

**10. Notes Payable**

** **

On April 28, 2003 and May 14, 2003, PLDT issued, at adiscount, Php1,600 million and Php400 million One-Year Peso Notes, respectively,under its Php2 billion Peso Notes programregistered with the Philippine Securities and Exchange Commission.  Netproceeds of the issue totaled Php1,803million. The Php1,600 million One-Year Peso Note matured on April 22, 2004 andthe Php400 million One-Year Peso Note matured on May 11, 2004.  

 

Asof June 30, 2004, Vocativ, a wholly-owned call center of ePLDT, had anoutstanding Php150 million short-term bankloan facility.  It is anticipated that this short-term facility would be repaidfrom the proceeds of a prospective Php150million 5-year term loan being arranged by the same lender for Vocativ.

 

 

 

**11. Accrued Expenses and Other CurrentLiabilities**

 

This account consists of:

 

 

**Consolidated**

** **

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003  (As restated – Note 3)

** **

**June 30, 2004****(Unaudited)**

December 31, 2003  (As restated – Note 3)

 

** **

(in million pesos)

 

Accrued utilities and other expenses (Note 3)

**3,987**

3,679

 

**1,391**

1,315

Accrued interest on various loans (Notes 10 and 12)

**2,221**

2,302

 

**1,994**

2,013

Unearned revenues on sale of prepaid cards

**2,239**

1,712

 

**466**

439

Accrual for payment for unused sick leave and  other employee benefits

**1,674**

2,628

 

**615**

653

Accrued taxes and other expenses

**764**

1,314

 

**156**

617

Current portion of provision for onerous contract  and assessments (Note 21)

**561**

394

 

**561**

394

Others

**1,736**

1,425

 

**801**

404

 

**13,182**

13,454

 

**5,984**

5,835

 

 

 

**12. Long-term Debt******

** **

This account consists of outstanding indebtedness ofthe following:

 

** **

**Consolidated**
 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

            (in million pesos)
PLDT

**122,717**

132,242

Smart

**18,790**

20,586

Mabuhay Satellite

**4,413**

4,722

ePLDT

**175**

105

Maratel

**18**

26

 

**146,113**

157,681

Less current portion

**22,273**

23,742

 

**123,840**

133,939

 

After giving effect to the anticipated application ofexisting refinancing facilities, the scheduled maturities of our outstandinglong-term debt as of June 30, 2004 are as follows:

 

*** ***

**U.S. Dollar Loans**

**JP****Y Loans**

**Php Loans**

**Total**

**Year**

**In U.S. Dollar**

**In Php**

**In JP****Y**

**In Php**

**In Php**

**In Php**

** **

(in millions)

***Consolidated***

 

 

 

 

 

 

2004(1)

150

8,407

2,014

1,040

839

10,286

2005

469

26,349

6,818

3,522

880

30,751

2006

441

24,766

6,816

3,521

826

29,113

2007

476

26,740

3,178

1,642

–

28,382

2008

69

3,898

1,589

821

–

4,719

2009 and onwards

813

42,052

–

–

810

42,862

 

 

 

 

 

 

 

***Non-Consolidated***

 

 

 

 

 

 

2004(1)

76

4,297

2,014

1,040

802

6,139

2005

322

18,068

6,818

3,522

780

22,370

2006

305

17,159

6,816

3,521

770

21,450

2007

419

23,540

3,178

1,642

–

25,182

2008

69

3,893

1,589

821

–

4,714

2009 and onwards

813

42,052

–

–

810

42,862

 

(1) July 1, 2004 through December 31, 2004

*** ***

***PLDT***

 

PLDT’saggregate outstanding indebtedness is broken down as follows:

 

**Description**

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

(in millions)

**U.S. Dollars**

** **

** **

 

 

Export Credit Agencies-Supported Loans:

** **

** **

 

 

Kreditanstalt für Wiederaufbau, or KfW

**US$378**

**Php21,266**

US$398

Php22,099

Japan Bank for International Cooperation, or JBIC/

 Co-financing Banks

**55**

**3,067**

65

3,644

Others 

**116**

**6,524**

136

7,569

 

**549**

**30,857**

 599

33,312

Fixed Rate Notes

**1,311**

**70,000**

1,414

75,420

Term Loans

**145**

**8,152**

167

9,290

 

**US$****2,005**

**109,009**

US$2,180

118,022

** **

**Japanese Yen**

** **

** **

 

 

JBIC’s Overseas Investment Loan, or OIL

**JP¥****9,760**

**5,042**

JP¥9,760

5,068

Nippon Export and Investment Insurance of Japan, or NEXI, Supported Loan

**1,560**

**806**

–

–

Term Loans 

**9,095**

**4,698**

10,914

5,668

** **

**JP¥****20,415**

**10,546**

JP¥20,674

10,736

** **

**Philippine Pesos**

** **

** **

 

 

Peso Fixed Rate Corporate Notes

** **

**2,180**

 

2,180

Term Loans

** **

**982**

 

1,304

 

** **

**3,162**

 

3,484

 

** **

**122,717**

 

132,242

Less current portion

** **

**13,918**

 

15,850

 

** **

**Php108,799**

 

Php116,392

 

Theeffective average interest rates applicable to the above indebtedness are asfollows:

 

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

** **

 

Dollar-denominated loans

**8.2%**

8.1%

Yen-denominated loans

**3.3%**

2.2%

Peso-denominated loans

**14.1%**

13.7%

 

*ExportCredit Agencies-Supported Loans*

 

In orderto obtain imported components for our network infrastructure in connection withour expansion and service improvement programs, we have obtained loans extendedand/or guaranteed by various export credit agencies.  These financings accountfor a significant portion of PLDT’s indebtedness.

 

KfW, aGerman state-owned development bank, is our largest single creditor.  As of June 30, 2004, we owed US$378 million aggregate principal amount of debt to KfW, asfollows:

 
- US$282 million provided under various export credit agency-backed facilities, of which US$185 million was in connection with our expansion and service improvement programs and US$97 million in connection with the US$149 million refinancing facility discussed below; and

 
- US$96 million provided for the 15% downpayment portion and credit facilities without guarantee/insurance cover from the export credit agencies, of which US$27 million was in connection with the US$149 million refinancing facility discussed below.

 

On January 25, 2002,PLDT signed two loan agreements with KfW, which provided PLDT with a US$149million facility to refinance in part the repayment installments under itsexisting loans from KfW due from January 2002 to December 2004.  The facilityis composed of a nine-year loan, inclusive of a three-year disbursement periodand a two-year grace period during which no principal is payable.  It partlyenjoys the guarantee of HERMES, the export credit agency of the FederalRepublic of Germany.  Disbursements under this facility, which are made as theKfW loans to be repaid fall due, are currently available.  We have drawn US$124million (Php6,974 million) under this facility as of June 30, 2004.  

 

Aftergiving effect to the refinancing facility, US$18 million of our KfW loans willmature in 2004, US$82 million in 2005, US$57 million in 2006, US$78 million in2007, US$58 million in 2008 and US$85 million in 2009 and onwards.  Principalamortization on these loans is generally payable in equal semi-annualinstallments.

 

PLDT has also obtained loans extended and/orguaranteed by other export credit agencies, including JBIC (formerly known asthe Export-Import Bank of Japan), the Export-Import Bank of the United States,or Ex-Im Bank, and the respective export credit agencies of France, Italy,Israel, Sweden, Denmark, Canada, Australia, Singapore and the United Kingdom,in the aggregate outstanding principal amount of US$171 million and US$201million as of June 30, 2004 and December 31, 2003, respectively.  Of theamounts outstanding under these loans, US$32 million will mature in 2004, US$52million in 2005, US$42 million in 2006, US$32 million in 2007, US$8 million in2008 and US$5 million in 2009 and onwards.

 

*Fixed Rate Notes*

 

PLDT has seven series of non-amortizing fixed ratenotes outstanding as of June 30, 2004, as follows:

 

**Principal Amount**

 

**Issue Date**

**Interest Rate**

** **

**Maturity**

 

 

 

 

 

 

US$134,245,000

 

July 31, 1995

9.875%

 

August 1, 2005

US$164,574,000

 

June 28, 1996

9.250%

 

June 30, 2006

US$196,800,000

 

March 6, 1997

7.850%

 

March 6, 2007

US$91,388,000

 

May 2, 2002

10.625%

 

May 15, 2007

US$175,000,000

 

April 13, 1999

10.500%

 

April 15, 2009

US$250,000,000

 

May 2, 2002

11.375%

 

May 15, 2012

US$300,000,000

 

March 6, 1997

8.350%

 

March 6, 2017

 

*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 the JBIC’s OIL program.  The loan, which was drawn on July 31, 2002, willbe amortized semi-annually beginning March 21, 2005and will mature on March 21, 2008.

 

*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¥1,560 million was drawn and remained outstanding as of June 30, 2004.  

* *

*Php**2,770 Million Peso Fixed Rate Corporate Notes*

 

In connection with PLDT’s service improvement andexpansion programs, PLDT has entered into two loan agreements, pursuant to eachof which PLDT issued fixed rate corporate notes in three tranches.  Interest oneach tranche is payable semi-annually.

 

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

 

Underthe second loan agreement, PLDT borrowed an aggregate amount of Php1,270 million, of which Php360 million matured on June 9, 2003, Php100 million will mature on June 9, 2005, and Php810 million on June 9, 2010.

 

*Term Loans*

 

*LocalExchange Transfer 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. These loans were amended in August and September2001 to increase the maximum total debt to earnings before interest, incometax, depreciation and amortization, or EBITDA ratio that PLDT on anon-consolidated basis is permitted to maintain during the terms of therespective loans.  Approximately US$92 million of these loans was outstandingas of June 30, 2004.  The FMO loan will mature on September 1, 2007,and the EKN and ECGD loans on December 31, 2007. 

* *

*MulticurrencyRefinancing Facility*

* *

OnSeptember 4, 2002, PLDT signed a loan agreement with a syndicate of banks for aUS$145 million syndicated multicurrency term loan facility consisting ofJapanese yen and U.S. dollar commitments of JP¥10,914 million and US$53million, respectively.  This facility was split into two tranches.  Tranche A was drawn on June 18, 2003 in the amount ofJP¥7,723 million and US$34 million to refinance a portion of the outstandingprincipal balance of the Japanese yen syndicated term loan which matured on thesame date.  Tranche B was drawn on December 22, 2003in the amount of JP¥3,191 million and US$19 million to refinance a portion ofUS$52 million principal amount outstanding under the U.S. dollar term loanwhich matured on the same date.  US$44 million and JP¥9,095 million of thisloan are outstanding as of June 30, 2004.  Thissyndicated facility is amortized semi-annually beginning June 2004 and willmature in December 2006.

 

*US$12 Million Term Loan Facility*

* *

On May 29,2003, PLDT obtained a US$12 million term loan facility from DEG-DeutscheInvestitions und Entwicklungsgesellschaft mbH, of which US$8 million (Php462million) was drawn as of June 30, 2004.  This loan is amortized semi-annually beginningJune 2004 in the amount of US$1 million each amortization.  US$7 million ofthis loan is outstanding as of June 30, 2004.

* *

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

 

In connection with the Asia Pacific Cable Network 2project, PLDT entered into a loan agreement with Citibank, N.A., as facilityagent, and a syndicate of banks in the aggregate principal amount of Php1,700 million, of which about Php982 million was outstanding as of June 30, 2004.The loan, which is funded under the JBIC Facility for Private SectorDevelopment of the Development Bank of the Philippines, will mature on October26, 2005 and since April 2002, is payable in quarterly installments as setforth 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%

 

*Covenants*

 

Our debtinstruments contain restrictive covenants, including covenants that prohibit usfrom paying common dividends, and require us to comply with specified financialratios and other financial tests, calculated in conformity with accountingprinciples generally accepted in the Philippines, at relevant measurementdates, principally at the end of each quarterly period.

 

Thefinancial tests under our debt instruments, as amended, include maintaining apositive tangible net worth and compliance with the following ratios:

 
- interest coverage ratio, calculated on a non-consolidated basis and excluding PLDT’s equity share in net earnings or losses of investees, of not less than 180% or 200%;

 
- total debt to EBITDA on a non-consolidated basis of not more than 5.0:1 from March 31, 2004 to June 30, 2004, not more than 4.5:1 from September 30, 2004 to December 31, 2004 and not more than 4.0:1 from March 31, 2005 and thereafter;

 
- long-term indebtedness to appraised value of equity/tangible net worth on a non-consolidated basis ranging from not more than 1.1:1 to not more than 3.0:1; 

 
- current ratio on a non-consolidated basis, ranging from not less than 0.9:1 to not less than 1.2:1;

 
- debt service coverage ratio on a non-consolidated basis of at least 1.1:1; and

 
- debt to free cash flow ratio on a non-consolidated basis of not more than 5.5:1 from March 31, 2004 to June 30, 2004, not more than 5.0:1 from September 30, 2004 to June 30, 2005, not more than 4.5:1 from September 30, 2005 to June 30, 2006, and not more than 4.0:1 from September 30, 2006 onwards.

 

In addition, some of PLDT’s debt instruments containcovenants requiring PLDT to comply with specified financial tests on aconsolidated basis calculated in conformity with accounting principlesgenerally accepted in the Philippines. These include:

 
- long-term debt to appraised value of equity/tangible net worth of not more than 2.33:1;

 
- total debt to EBITDA of not more than 4.5:1 in 2004 and not more than 4.0:1 in 2005 and thereafter; 

 
- current ratio ranging from not less than 0.75:1 to 0.9:1; and

 
- interest coverage ratio of not less than 200%.

 

For purposes of deriving appraised value of equity/tangible net worth,we determined the revaluation surplus in respect of PLDT’s properties.  PLDT’sproperties in service as of December 31, 1997 were reappraised by anindependent firm of appraisers to reflect their sound value, as part of NTC’sfinancial reporting requirements, based on the December 29, 1997 exchange rateof Php40.116 to US$1.00.  As of December 31, 1997, the soundvalue was Php225,966 million and the revaluation surplus was Php82,723million.  This reappraisal was approved by the NTC on January 28, 2000under NTC Case No. 98-183.  As of June 30, 2004and December 31, 2003, the revaluation surplus on PLDT’s 1997 appraisedproperties still in service, net of a 5% disallowance factor, amounted to Php35,187 million and Php38,441 million,respectively.

 

Theprincipal factors that can negatively affect our ability to comply with thesefinancial ratios and other financial tests are depreciation of the pesorelative 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.  Sinceapproximately 97% of PLDT’s total debt is denominated in foreign currencies,principally in U.S. dollars, many of these financial ratios and other tests arenegatively affected by any weakening of the peso.  As of June 30, 2004, the peso depreciated by 1% to Php56.176 to US$1.00, from Php55.586 to US$1.00 as of December 31, 2003.  The peso hasbeen subjected to significant fluctuations.  In 2003, the peso depreciated toPhp55.075 to US$1.00 on March 12, 2003 then recovered to a high of Php52.021 to US$1.00 on May 8, 2003 only todepreciate again to a low of Php55.767 to US$1.00 on November 27, 2003.During the first half of 2004, the peso appreciated to a high of Php55.142 on January 6, 2004 butdepreciated to a low of Php56.429 on March 22, 2004.

 

PLDT’sability to maintain compliance with financial covenant requirements measured ona non-consolidated basis is principally affected by the performance of itsfixed line business.  PLDT cannot be assured of the benefit of net revenues andcash flows generated by Smart and PLDT’s other investees in assisting incomplying with non-consolidated covenants.

 

We havemaintained compliance with all of our financial ratios and covenants asmeasured under our loan agreements and other debt instruments.  However, ifnegative factors adversely affect our financial ratios, we may be unable tomaintain compliance with these ratios and covenants or be unable to incur newdebt.  Under some of our loan agreements, certain of our financial ratios willcontinue to become more restrictive as the loans near maturity.  Inability tocomply with our financial ratios and covenants could result in a declaration ofdefault and acceleration of some or all of our indebtedness.  The terms of someof our debt instruments have no minimum amount for cross-default.

 

Under PLDT’s loan agreements that require maintenanceof an interest coverage ratio of at least 180%, interest coverage ratio is theratio of (x) our after-tax net income for the 12 months immediately precedingthe calculation date after: (a) adding back interest charges, depreciation,amortization and other non-cash charges (including equity share in net earningsor losses of investees but excluding provision for doubtful accounts) andprovision for income taxes, and (b) deducting capitalized subscriberacquisition costs, to (y) the estimated aggregate interest charges payableduring the 365-day period following the calculation date on all of PLDT’sindebtedness outstanding on such calculation date.

 

UnderPLDT’s loan agreements that require maintenance of an interest coverage ratioof at least 200%, interest coverage ratio is the ratio of (x) our after-tax netincome after adding back reserves for higher plant replacement costs, incometaxes, interest charges, depreciation, amortization and non-cash charges(including equity share in net earnings or losses of investees and provisionfor doubtful accounts) during 12 consecutive months within the 15 calendarmonths immediately preceding the calculation date, to (y) the sum of (a) theestimated aggregate interest charges on all indebtedness, net of interestcapitalized to construction, plus (b) dividends on mandatorily redeemablepreferred stock, in each case scheduled to be paid during the 12 monthsfollowing the calculation date.

 

Non-consolidatedtotal debt to EBITDA is the ratio of (x) PLDT’s total indebtedness (notincluding amounts payable by PLDT to Piltel under the Letter of Support) to (y)net income for the preceding 12 months, after adding back interest accrued onall indebtedness, depreciation, amortization and other non-cash charges (includingequity share in net earnings or losses of investees, but excluding provisionfor doubtful accounts) and provision for income taxes and deducting anycapitalized subscriber acquisition costs. 

 

Non-consolidatedlong-term indebtedness to appraised value of equity (or under some covenants,to tangible net worth) is the ratio of (x) PLDT’s aggregate indebtedness (orportion of such indebtedness) due more than one year following the calculationdate and par value of all mandatorily redeemable preferred stock to (y) the sumof the aggregate par value of all of PLDT’s outstanding common and ConvertiblePreferred Stock (other than preferred stock subject to mandatory redemption),paid-in capital in excess of the par value of such stock, PLDT’s retainedearnings, reserve for higher plant replacement costs and revaluation incrementarising from independent certified appraisals of PLDT’s telephone plantapproved by the NTC.  

 

Non-consolidatedcurrent ratio is the ratio of (x) non-consolidated current assets to (y)non-consolidated current liabilities, excluding from current liabilities 50% ofthe portion of long-term indebtedness due within one year of the calculationdate.  

 

Debt service coverage ratio is the ratio of (x) PLDT’scash flow from operations after adding back interest charges (to the extentpreviously deducted) plus (1) dividends received from investees, cash receivedupon any redemption of redeemablepreferred stock issued by Smart, any cash received under PLDT’s SubscriberInvestment Plan, or SIP, and interest income received less (2) capitalexpenditures (excluding capitalized interest) and investments in investees forthe 12 months immediately preceding the calculation date plus (3) PLDT’sclosing cash balance as of the last day of the calculation date to (y) the sumof the projected interest charges and principal debt repayments (excluding debtto be repaid with a refinancing facility) during the 12 months following thecalculation date.

 

Debt to free cash flow ratio is the ratio of (x)PLDT’s debt less PLDT’s closing cash balance of the last day of the calculationperiod to (y) PLDT’s cash flow from operations after adding back interestcharges (to the extent previously deducted) plus (1) dividends received frominvestees, cash received upon any redemption of redeemable preferred stockissued by Smart, any cash received under PLDT’s SIP and interest incomereceived less (2) capital expenditures (excluding capitalized interest) andinvestments in investees for the 12 months immediately preceding the calculationdate.  

 

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:

 
- incurring additional indebtedness; 

 
- prepaying other debt; 

 
- making investments; 

 
- extending loans; 

 
- extending guarantees or assuming the obligations of other persons;

 
- paying dividends or other distributions or redeeming, repurchasing or otherwise acquiring shares of PLDT’s capital stock; 

 
- disposing of all or substantially all of its assets or of assets in excess of specified thresholds of its tangible net worth;

 
- entering into management contracts providing for the management of its business or operations by a third party;

 
- creating any lien or security interest; 

 
- permitting set-off against amounts owed to PLDT;

 
- merging or consolidating with any other company;

 
- entering into transactions with stockholders and affiliates; and

 
- entering into sale and leaseback transactions. 

 

Under theindenture of PLDT’s 10.625% Notes due 2007 and 11.375% Notes due 2012, PLDT isrequired to comply with a number of additional covenants, including covenantsthat, subject to certain exceptions, restrict PLDT’s ability to (a) incur debtunless its ratio of debt to EBITDA (calculated on a non-consolidated basisbased on definitions provided in the same indenture, except under certaincircumstances), after giving effect to the incurrence of such debt, would beless than 5.0 to 1 from January 1, 2004 to December 31, 2004 and 4.5 to 1thereafter and (b) pay dividends, repurchase or redeem its capital stock, makeinvestments and prepay subordinated debt, among other things.  Subject tocertain exceptions, these covenants also restrict our ability to sell assetsand to use the proceeds of these asset sales.  

 

Underthe terms of the US$149 million facility with KfW, PLDT is prohibited from paying anydividends on common stock until after December 31, 2004.In addition, under the terms of PLDT’s US$145 million multicurrency termfacility agreement and JP¥5,615 million syndicated term loan facility, PLDT isrestricted from distributing dividends to common stockholders unless (i) nodefault has occurred which is continuing, and (ii) its debt to free cash flowratio, after giving effect to the distribution of such dividends and, undercertain circumstances, other adjustments to PLDT’s closing cash balance, wouldbe less than 4.0:1.  Under other loan agreements, PLDT may not declare or paydividends on any of its capital stock without the prior written consent of thelenders (i) if PLDT is in default in the payment of any amounts due and payableunder such loan agreement or after the occurrence and during the continuance ofany other event of default or potential event of default under such agreements,(ii) if after giving effect to such action the current ratio would be less than1.2:1 or (iii) in an amount greater than PLDT’s net income after taxes duringthe fiscal year to which such payment or distribution relates.  

 

In case ofa change in control of PLDT, PLDT may be required to repurchase or prepaycertain indebtedness.  Under the terms of the 10.625% Notes due 2007 and11.375% Notes due 2012, we are required to offer to purchase all outstandingnotes due 2007 and notes due 2012 for cash at a price of 101% of theirprincipal amounts plus accrued interest in the event that (a) the aggregate ofNTT Communications’ and First Pacific’s direct and indirect voting interest inPLDT’s outstanding capital stock having voting rights falls below 35% of suchcapital stock and (b) any person or, in certain instances, group of persons,which is not controlled directly or indirectly by First Pacific or NTTCommunications acquires a direct or indirect voting interest in PLDT’soutstanding capital stock having voting rights which equals or exceeds 35% ofsuch capital stock and (c) if a rating agency at such time maintains a ratingon either series of notes, the rating agency downgrades its credit rating onthe series within 90 days (or more, in certain circumstances) following noticeof the occurrence of the events specified in (a) and (b) above.

 

Underthe terms of PLDT’s JPY9,760 million loan from JBIC, in the event of anyproposed sale or transfer of PLDT’s stock that would result in NTTCommunications holding less than 14.95% of PLDT’s voting stock, we will berequired to prepay, immediately upon effectiveness of such sale or transfer,all principal outstanding under the loan, together with accrued interest.However, prepayment will not be required if, following such sale or transfer,(a) NTT Communications continues to have prior approval rights with respect toall matters as to which NTT Communications has approval rights under the stockpurchase agreement pursuant to which it acquired its shares in PLDT or (b)JBIC, in its sole discretion, determines that NTT Communications’ participationin the expansion of Smart’s GSM network capacity to extend PLDT’s cellularbusiness in Smart would not be reduced below its level of participation as ofthe date of the loan agreement.

 

Under the terms of both PLDT’s US$145 millionmulticurrency term facility agreement and JPY5,615 million syndicatedterm loan facility, if any lender so requests in writing, PLDT shall prepay infull such lender’s participation in the loan within 45 days from notificationof the change in control and no later than the date on which PLDT is requiredto repurchase its 10.625% Notes due 2007 and 11.375% Notes due 2012 (“Bonds”)from bondholders accepting the change in control offer.  A change in control isdeemed to occur when (a) the aggregate of NTT Communications’ and FirstPacific’s direct and indirect voting interest in PLDT’s outstanding capitalstock having voting rights falls below 35% of such capital stock and (b) anyperson or, in certain instances, group of persons, which is not controlleddirectly or indirectly by First Pacific or NTT Communications acquires a director indirect voting interest in PLDT’s outstanding capital stock having votingrights which equals or exceeds 35% of such capital stock and (c) if a ratingagency at such time maintains a rating on the Bonds, the rating agencydowngrades its credit rating on the Bonds within 90 days (or more, in certaincircumstances) following notice of the occurrence of the events specified in(a) and (b) above.

 

PLDT’sdebt instruments contain customary and other default provisions that permit thelender to accelerate amounts due or terminate their commitments to extendadditional funds under the debt instruments. These default provisions include:

 

•        cross-defaults andcross-accelerations that permit a lender to declare a default if PLDT is indefault under another debt instrument; in some cases, the cross-defaultprovision is triggered upon a payment or other default permitting theacceleration of PLDT’s debt, whether or not the defaulted debt is accelerated.In other cases, the cross-default provision requires the defaulted loan to beaccelerated.  In some debt instruments, the cross-default provision will betriggered only if the principal amount of the defaulted indebtedness exceeds athreshold amount specified in these debt instruments;

 

•        failure by PLDT to meet certainfinancial ratio covenants referred to above;

 

•        the occurrence of any materialadverse change in circumstances that a lender reasonably believes materiallyimpairs PLDT’s ability to perform its obligations under its debt instrumentwith the lender; 

 

•        the revocation, termination oramendment of any of the permits or franchises of PLDT in any mannerunacceptable to the lender;

 

•        the abandonment, termination oramendment of the project financed by a loan in a manner unacceptable to thelender;

 

•        the nationalization or sustaineddiscontinuance of all or a substantial portion of PLDT’s business; and

 

•        other typical events of default,including the commencement of bankruptcy, insolvency, liquidation or winding upproceedings by PLDT.

*** ***

***Smart***

 

Smart’s long-term debt consists of:

 

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

** **

(in millions)

 

U.S. Dollars

**US$335**

**Php18,790**

US$361

Php20,053

Philippine Pesos

** **

**–**

 

533

 

** **

**18,790**

 

20,586

Less current portion

** **

**7,498**

 

7,104

 

** **

**Php****11,292**

 

Php13,482

 

Smart’sbank loan facilities, which are being used to finance its purchases oftelecommunications equipment, are availed of through one or more drawdowns.

 

*US$224Million Term Loan Facilities*

 

Theloan facilities for Phases 1 to 4 of the GSM network expansion, under whichUS$84 million was outstanding as of June 30, 2004,are repayable in ten equal semi-annual installments with final repayments duein October 2005 and April 2006.

 

*US$195Million Term Loan Facility*

 

On June 8, 2001, Smartsigned its GSM Phase 5A financing comprised of US$195 million loans.  TheUS$195 million loans, of which US$101 million was outstanding as of June 30, 2004, arepayable over five to six years, with final repayments due in September 2006,March 2007 and June 2007.  

 

*Php1Billion Term Loan Facility*

 

On June 14, 2001, Smartsigned its GSM Phase 5A financing of Php1,000million term loan.  The outstanding balance under this facility of Php467million was prepaid on June 28, 2004.

 

*US$6Million Term Loan Facility*

 

On September 25, 2001,Smart obtained a US$6 million term loan facility from Electro Banque S.A.,which was later on assigned to Alcatel SVF 1999A-Trust fee effective December 3, 2002.The loan facility, of which US$2 million was outstanding as of June 30, 2004, ispayable semi-annually, with final repayment due in May 2005.

 

*US$11 Million Term Loan Facility*

 

On October 26, 2001, Smart obtained a US$11 millionterm loan facility from Credit Lyonnais S.A., of which the undrawn balance ofUS$4 million was cancelled upon expiry of the availability period on April 26, 2003.  Theloan facility, comprised of three tranches, of which US$4 million wasoutstanding as of June 30, 2004, is payable semi-annually with final repayments duein January 2007, November 2007 and May 2008.

 

*US$100 Million Term Loan Facility*

 

On December 13, 2001, Smart signed its GSM Phase 5Bfinancing of US$100 million, of which US$51 million was outstanding as of June 30, 2004.  Theloan is payable over five years with final repayment due in September 2006.

 

*Php300Million Term Loan Facility*

 

On January 9, 2002,Smart signed a loan facility in the amount of Php300million.  This loan has been fully drawn and is payable quarterly with finalrepayment in February 2007.  However, the outstanding balance of Php280 million was prepaid on November 4, 2003. 

 

*US$7Million Term Loan Facility*

 

On April14, 2002, for the purpose of financing the purchase of certain equipment, Smartobtained a US$7 million term loan facility from Bayerische Hypo-und VereinsbankAktiengesellschaft pursuant to the standard loan agreement No. 1 dated August14, 2002 under the €50 million Framework Agreement for the financing ofindividual export contracts dated November 8 and 13, 2001.  The loan, which hasan outstanding balance as of June 30, 2004 of US$5 million, is payable semi-annuallywith final repayment due in September 2007.

 

*US$100 Million Term Loan Facility*

 

On November 28, 2002, Smart signed a US$100 million termloan facility supported by NEXI, of which US$60 million was drawn on November 28, 2003.Smart availed of the US$40 million remaining balance 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.

 

Facilitiesunder GSM Phases 1 to 4, the Finnish Export Credit plc tranche of GSM Phase 5Afacility and GSM Phase 5B facility are covered by guarantees from Finnvera, theFinnish export credit agency, for 95% of political risk and 50% of commercialrisk.  The NEXI Supported Untied term loan facility is covered by NEXI for97.5% of political risk and 50% of commercial risk.

 

Intereston Smart’s dollar-denominated loans is either fixed or based on LIBOR pluspremium.

 

Smart is subject to loan covenants that restrict itsability to pay dividends, redeem preferred stock, make distributions to PLDT orotherwise provide funds to PLDT or any affiliate without the consent of itslenders.  Some of these covenants contain an absolute prohibition on payingdividends before December 31, 2002, while others require that a portion of the loanequal to the amount of the dividend be prepaid.  On May 26, 2004, afterobtaining the relevant waivers from Finnvera and certain of its lenders priorto actual payment, Smart paid a dividend of Php11,280 million to PLDT,equivalent to 70% of Smart’s 2003 net income.  In June 2003, after receivingsimilar approvals from Finnvera and certain lenders, Smart paid dividends inthe amount of Php4,300 million to PLDT,representing 70% of Smart’s 2002 net income and in the amount of Php1,866 million in November 2003, equivalent to theremaining 30% of Smart’s 2002 net income.  Smart made its first dividendpayment of Php1,540 million to PLDT inDecember 2002 representing 40% of Smart’s net income in 2001.

 

Smart’s debt instruments also contain certainrestrictive covenants that require Smart to comply with specified financialratios and other financial tests at semi-annual measurement dates.  Thefinancial tests under Smart’s loan agreements include compliance with adebt-to-equity ratio of not more than 1.50:1 and a debt service coverage ratioof not less than 1.50:1.  Smart has maintained compliance with all of itsfinancial covenants.  The agreements also contain customary and other defaultprovisions that permit the lender to accelerate amounts due under the loans orterminate their commitments to extend additional funds under the loans.  Thesedefault provisions include:

 
- cross-defaults and cross-accelerations that permit a lender to declare a default if Smart is in default under another loan agreement.  These cross-default provisions are triggered upon a payment or other default permitting the acceleration of Smart debt, whether or not the defaulted debt is accelerated;

 
- failure by Smart to comply with certain financial ratio covenants;

 
- any reduction in PLDT’s ownership of Smart’s shares below 51% of the total of each class of Smart’s issued shares;

 
- any reduction in First Pacific’s and Metro Pacific Corporation’s collective direct and/or indirect ownership of PLDT’s common stock below 17.5% of the total common stock outstanding or 17.5% of the voting power of the total common stock outstanding; and

 
- the occurrence of any material adverse change in circumstances that the lender reasonably believes materially impairs Smart’s ability to perform its obligations under its loan agreements with the lender or that the lender believes materially impairs an applicable guarantors’ ability to perform its obligations under an applicable guaranty.

 

Inaddition, some of these loan agreements restrict Smart’s ability to enter intotransactions with affiliates except on arm’s-length terms and for valuableconsideration.

 

***Mabuhay Satellite***

 

Mabuhay Satellite’slong-term debt consists of:

 

 

**June 30, 2004****(Unaudited)**

December 31, 2003 (Audited)

 

(in millions)

U.S. Dollars

** **

** **

** **

** **

Credit Agreement 

**US$37**

**Php2,050**

US$42

Php2,319

Omnibus Agreement

**42**

**2,362**

43

2,403

 

**79**

**4,412**

85

4,722

Less current portion

**14**

**777**

13

713

 

**US$****65**

**Php****3,635**

US$72

Php4,009

 

*CreditAgreement*

 

MabuhaySatellite has an existing Credit Agreement with the Ex-Im Bank to finance aportion of the cost of purchasing the Agila II Satellite.  In 2003, Ex-Im Bankapproved, in principle, the re-profiling of Mabuhay Satellites’s US$42 milliondebt with them by extending the maturity of the loan by 1 and 1⁄2 years to July 15, 2007 andreducing the interest rate by 1%, to 5.6% from 6.6%.  The revised repaymentterms have been approved by the majority of the local creditor banks.Subsequently on January 15, 2004, Mabuhay Satellite paid US$5 million in principalamortization, thereby reducing its debt under this agreement to US$37 million.

*OmnibusAgreement*

 

MabuhaySatellite also has an existing Omnibus Agreement with a syndicate of localbanks, or the Banks, which includes issuance of irrevocable standby Letters ofCredit with an aggregate stated value not exceeding US$39 million (Php2,186 million) in favor of Ex-Im Bank, assecurity under the Credit Agreement and a term loan to Mabuhay Satellite in theaggregate amount of US$42 million (Php2,362 million), which will mature on variousdates from 2004 to 2007. 

 

As security, Mabuhay Satellite has constituted infavor of the Banks:

 
- A first mortgage on its leasehold rights under a lease agreement entered into with the Subic Bay Metropolitan Authority, or SBMA, and the components of the satellite system;

 
- An assignment of its rights under its purchase contract for the satellite system;

 
- An assignment of its rights under the transponder lease contracts to be entered into with its shareholders and other parties and the revenues therefrom; and

 
- An assignment of the applicable proceeds of insurance to be taken on the satellite system.

 

TheCredit and Omnibus Agreements impose negative covenants which, among others,restrict material changes in Mabuhay Satellite’s nature of business andownership structure, any lien upon or with respect to any of its assets or to anyright to receive income, acquisition of capital stock, declaration and paymentof dividends, merger, consolidation and sale with another entity and incurringor guaranteeing additional long-term debt beyond prescribed amounts.

*** ***

***ePLDT***

 

*Php150 Million**Term Loan Facility*

 

On March 4, 2002, ePLDT entered into a three-year loan facility withPhilippine Bank of Communications amounting to Php150million with a grace period of one year.  The loan facility was fully drawn asof December 31, 2002.  Thequarterly principal payments of Php15 millionstarted in June 2003 with a balloon payment of Php45million in March 2005.  Interest on this loan is equivalent to 91-day T-billrate plus 4% per annum payable quarterly in arrears.  The loan is secured byePLDT’s investment in an associate with a carrying value of Php629 million as of June 30, 2004 and a deed ofassignment of receivables of a subsidiary from a foreign customer.  As of June 30, 2004, theoutstanding balance of this loan amounted to Php75million, of which Php45 million will mature in2005.

 

Theloan agreement imposes negative covenants which, among other things, restrictePLDT in regard to payment of cash dividends or any other income of any capitaldistribution to PLDT, voluntary suspension of its entire business operationsfor a period of 60 consecutive days of dissolution of its legal existence, andcreation of any encumbrances on the shares pledged.

 

*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.  Php100 million was drawn from the facility andremained outstanding as of June 30, 2004.  The loan shall be repaid in nine equal quarterlyinstallments starting March 2005 and will end in March 2007.  Interest on theloan is equivalent to 90-day PHIBOR plus 3% per annum payable quarterly inarrears.  The loan is secured by a Mortgage Trust Indenture Agreement on aparcel of land with a carrying value of Php279 million as of June 30, 2004.

 

Theloan agreement also imposes special covenants which, among other things,restrict ePLDT in regard to voluntary suspension of its entire business operationsfor a period of 60 consecutive days, dissolution of its legal existence, andcreation of any encumbrances on the property pledged.

 

Theloan agreement also requires ePLDT to comply with specified financial ratiosand other financial tests at quarterly measurement dates.  The financial testsunder the agreement include, among others, compliance with a current ratio ofnot less than 1:1, an interest coverage ratio of not less than 1.5:1, debt toequity ratio of not more than 1.50:1, and a debt service coverage ratio of notless than 1.1:1.  The agreement also contains customary and other defaultprovisions that permit the lender to accelerate amounts due under the loan orterminate their commitments to extend additional funds under the loan.  As of June 30, 2004, ePLDThas complied with all of its financial covenants.

 

***Maratel***

 

Maratel’slong-term debt consists of a Php60 millionloan obtained on October 20, 1997 and a Php19 millionloan drawn on July 19, 1999.  The Php60 millionloan carries an interest rate ranging from 11.5% to 11.7% per annum and willmature on October 16, 2005, while the Php19million loan bears a fixed interest rate of 14.7% per annum and will mature onvarious dates until November 15, 2004.  As of June 30, 2004,the outstanding balances of these loans totaled Php18million, of which Php7 million will mature in2004.

 

 

**13. Deferred Credits and Other NoncurrentLiabilities**

 

This account consists of:

 

 

**Consolidated**

 

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003  (As restated – Note 3)

 

**June 30, 2004****(Unaudited)**

December 31, 2003  (As restated – Note 3)

 

** **

(in million pesos)

 

Provision for onerous contract and assessments –  net of current portion (Notes 11 and 21)

**3,805**

3,632

 

**3,805**

3,632

Accrual of capital expenditures under long-term financing (Note 20)

**3,752**

3,130

 

**3,752**

3,130

Liability under Letter of Support (Note 9)

**2,823**

2,793

 

**2,823**

2,793

Customers’ deposits

**2,216**

2,194

 

**1,933**

1,927

Advance payment under a receivable purchase facility (Note 6)

**1,848**

2,058

 

**1,848**

2,058

Related party (Note 15)

–

–

 

**4,186**

–

Capital lease liability – net of current portion 

   (Notes 3, 8, and 20)

**670**

692

 

** **

**457**

500

Others 

**416**

512

 

**380**

404

 

**15,530**

15,011

 

**19,184**

14,444

 

 

 

**14. Stockholders’ Equity**

** **

Themovement of PLDT’s capital account follows:

 

** **

** **

**Preferred Stock -**Php10 par value

** **

** **

**Common Stock –**

Php5 par value

**Series  A to EE**

**III**

**IV**

**V**

**VI**

**VII**

** **

** **

** **

**No. of Shares**

**Amount**

** **

**No. of Shares**

**Total Preferred Stock**

**Amount**

** **

(in million shares and pesos)

**Authorized**

234

Php1,170

** **

** **

** **

** **

** **

** **

823

Php8,230

**Outstanding**

** **

 

** **

** **

** **

** **

** **

** **

 

 

Balance at January 1, 2003

169

Php847

406

5

36

3

4

4

 458

Php4,584

Issuance

–

–

5

–

–

–

–

–

5

53

Conversion

–

–

(1)

–

–

–

–

–

(1) 

(21)

Balance at December 31, 2003

(Audited)

 169

Php847

 410

   5

  36

   3

   4

   4

 462

Php4,616 

 

 

 

 

 

 

 

 

 

 

 

Balance at January 1, 2004

 169

Php847

 410

   5

  36

   3

   4

   4

 462

Php4,616

Issuance

–

–

–

–

–

–

–

–

–

4

Conversion

–

1

(1)

–

–

–

–

–

(1)

(9)

Balance at June 30, 2004

(Unaudited)

 169

Php848

 409

   5

  36

   3

   4

   4

 461

Php4,611

*** ***

***Preferred Stock***

 

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

 

TheSeries A to EE 10% Cumulative Convertible Preferred Stocks earn cumulativedividends at an annual rate of 10%.  After the lapse of one (1) year from thelast day of the year of issuance of a particular series of SIP 10% CumulativeConvertible Preferred Stock any holder of such series may convert all or any ofthe shares of such SIP 10% Cumulative Convertible Preferred Stock held by himinto fully paid and non-assessable shares of Common Stock of the Corporation,at a conversion price equivalent to 10% below the average of the high and lowdaily sales price of a share of Common Stock on the PSE, or if there shall havebeen no such sales on such PSE on any day, the average of the bid and the askedprices of a share of Common Stock of the Corporation at the end of such day onsuch Exchange, in each such case averaged over a period of thirty (30)consecutive trading days prior to the conversion date, but in no case shall theconversion price be less than the price set by the Board of Directors which asof June 30, 2004, was Php5.00 per share.  The number of shares of Common Stockissuable at any time upon conversion of one share of SIP 10% CumulativeConvertible Preferred Stock shall be determined by dividing Php10.00 by thethen applicable conversion price.

 

In casethe shares of Common Capital Stock at anytime outstanding shall be subdividedinto a greater or consolidated into a lesser number of shares, then the minimumconversion price per share of Common Capital Stock shall be proportionatelydecreased or increased, as the case may be and in the case of a stock dividend,such price shall be proportionately decreased, provided, however, that in everycase the minimum conversion price shall not be less than the par value pershare of Common Capital Stock.  In the event the relevant effective date forany such subdivision or consolidation of shares or stock dividend occurs duringthe period of thirty (30) trading days preceding the presentation of any sharesof 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 CommonCapital Stock, or in case of any consolidation or merger of the Corporationwith or into another corporation, the Board of Directors shall make suchprovisions, if any, for adjustment of the minimum conversion price and thesales price utilized in calculating the conversion price as the Board ofDirectors, in it sole discretion, shall deem appropriate.

 

At PLDT’s option, the Series A to EE 10% CumulativeConvertible Preferred Stock are redeemable at par value plus accrued dividendsfive years after the year of issuance.

 

On January 27, 2004, the Board of Directors designated1 million shares of serial preferred stock as Series EE 10% CumulativeConvertible Preferred Stock for issuance throughout 2004.

 

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 common stock(equivalent to a conversion ratio of 1.7129 shares of common stock for eachshare 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.  Upon liquidation of PLDT, holders of the Series III ConvertiblePreferred Stock will be entitled to receive liquidating distributionsequivalent 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.  

 

Asof June 30, 2004, 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 Piltel.Shares of Series V, VI and VII Convertible Preferred Stocks are entitled toreceive annual dividends of Php18.70 per share, US$0.397 per share andJP¥40.7189 per share, respectively.  Each share of Series V, VI and VII PLDTConvertible Preferred Stocks is convertible at any time at the option of theholder into one PLDT’s common share.  On the date immediately following theseventh anniversary of the issue date of the Series V and Series VI ConvertiblePreferred Stocks 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 shares of PLDT’s common stock.  For 30days thereafter, the holders of these mandatorily converted common shares havethe option to sell such common shares back to PLDT for Php1,700 per share,US$36.132 per share and JP¥4,071.89 per share for Series V, VI and VII,respectively.  As of June 30, 2004, PLDT would be obligated to pay up toPhp4,379 million, US$169 million and JP¥15,644 million under the put option ifall the outstanding shares of Series V, VI and VII Convertible Preferred Stockswill be mandatorily converted and all the underlying shares of common stockwill be put to PLDT.  A total of 676,571 shares of Series V and VI ConvertiblePreferred Stocks have been converted to PLDT’s common stock as of June 30, 2004.

 

The aggregate value of the put option based onoutstanding shares as of June 30, 2004 was Php22,131 million while the marketvalue of the underlying shares of common stock was Php12,859 million based onthe market price of PLDT’s common stock of Php1,150 per share as of June 30,2004.

 

The preferred stock, except shares of Series V, VI andVII Convertible Preferred Stock, redeemed or converted into common stock shallrevert to and form part of the unissued preferred stock, and may be reissued inany other series that the Board of Directors may, from time to time, establishand designate.

 

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.

 

OnJanuary 27, 2004, the Board of Directors approved the dividend declaration of:(a) Php12.29 million on the outstanding shares of Series IV CumulativeNon-Convertible Redeemable Preferred Stock payable on March 15, 2004, to theholders of record as of February 17, 2004; and (b) Php1.00 per outstandingshare of Series DD 10% Cumulative Convertible Preferred Stock payable onFebruary 27, 2004, to the holders of record as of February 12, 2004 and SeriesCC 10% Cumulative Convertible Preferred Stock payable on March 31, 2004, to theholders of record as of February 25, 2004.  On February 19, 2004, the Board ofDirectors approved the dividend declaration of: (a) US$1.029412 per outstandingshare of Series III Convertible Preferred Stock payable on April 15, 2004, tothe holders of record as of March 17, 2004; (b) Php4.675 per outstanding shareof Series V Convertible Preferred Stock payable on April 15, 2004, to theholders of record as of March 17, 2004; (c) US$0.09925 per outstanding share ofSeries VI Convertible Preferred Stock payable on April 15, 2004, to the holdersof record as of March 17, 2004; and (d) JPY10.179725 per outstandingshare of Series VII Convertible Preferred Stock payable on April 15, 2004, tothe holders of record as of March 17, 2004.  On May 4, 2004, the Board ofDirectors approved the dividend declaration of Php12.42 million on theoutstanding shares of Series IV Cumulative Non-Convertible Redeemable PreferredStock payable on June 15, 2004, to the holders of record as of May 26, 2004.  OnJune 8, 2004, the Board of Directors approved the dividend declaration of: (a)US$1.029412 per outstanding share of Series III Convertible Preferred Stock,payable on July 15, 2004, to the holders of record as of June 25, 2004; (b) Php4.675per outstanding share of Series V Convertible Preferred Stock, payable on July15, 2004, to the holders of record as of June 25, 2004; (c) US$0.09925 peroutstanding share of Series VI Convertible Preferred Stock, payable on July 15,2004, to the holders of record as of June 25, 2004; and (d) JPY10.179725per outstanding share of Series VII Convertible Preferred Stock, payable onJuly 15, 2004, to the holders of record as of June 25, 2004.  On June 29, 2004,the Board of Directors approved the dividend declaration of Php1.00 peroutstanding share of Series A, I, R, W, AA and BB 10% Cumulative ConvertiblePreferred Stock, payable on August 31, 2004, to the holders of record as ofJuly 28, 2004.

*** ***

***Executive Stock Option Plan***

*** ***

On April 27, 1999 and December 10, 1999, the Board ofDirectors and stockholders, respectively, approved the establishment of anExecutive Stock Option Plan, or ESOP, and the amendment of the Seventh Articleof the Articles of Incorporation of PLDT denying the pre-emptive right of holdersof common stock to subscribe for any issue of up to 1,289,745 common stockpursuant to the ESOP.  The ESOP covers management executives, which includeofficers with rank of Vice President up to the President, executives with therank of Manager up to Assistant Vice President, and advisors/consultantsengaged by PLDT.  The ESOP seeks to motivate option holders to achieve PLDT’sgoals, reward option holders for the creation of shareholder value, align theoption holders’ interests with those of the stockholders of PLDT and retain theoption holders to serve the long-term interests of PLDT.  The ESOP isadministered by the Executive Compensation Committee of the Board ofDirectors.  About 1.3 million common stock of PLDT have been reserved asunderlying shares of options under the ESOP. 

*** ***

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

* *

 

**June 30,  2004****(Unaudited)**

December 31, 2003 (Audited)

Beginning balance

**900,118**

1,226,395

Exercised shares

**(79,392)**

–

Cancelled

**(20,162)**

(326,277)

Ending balance

**800,564**

900,118

 

Since thedate of the grant on December 10, 1999 up to December 31, 2003, there were no officers or executives who exercised their options.  Instead, there werecancellations of options due to officer resignations and retirements ofofficers and executives.

*** ***

Asof June 30, 2004, 79,392 shares were exercised by certain officers andexecutives at an exercise price of Php814 per share.

*** ***

***RetainedEarnings***

*** ***

Thisaccount consists of:

 

 

**Six Months Ended June 30,**

 

**2004**

2003

 

(Unaudited)

 

(in million pesos)

Appropriated for plant expansion and higher replacement costs

**435**

435

Unappropriated

**49,846**

38,663

 

**50,281**

39,098

Themost recent dividend declaration made by PLDT in respect of its common stockwas in March 2001.  PLDT continues to pay dividends in respect of its preferredstock.  The current policy of PLDT is to determine its ability to declare andpay dividends, taking into consideration the interests of its stockholders aswell as PLDT’s working capital, capital expenditure and debt servicerequirements.  Also taken into account are the prohibitions and restrictionsunder certain of PLDT’s debt instruments with respect to the declaration andpayment of dividends.  The retention ofearnings is necessary to meet the funding requirements of our businessexpansion, service improvement and development programs.  The unappropriatedretained earnings balance of PLDT as of June 30, 2004 and December 31, 2003includes net accumulated equity in net income of investees of Php12,656 million and Php12,275 million, respectively,which are not available for distribution as dividends until declared by the investees.

 

 

 

**15. RelatedParty Transactions**

** **

Companieswithin the PLDT Group are engaged in arm’s-length transactions with each otherin the ordinary course of business.  We believe that the terms of thesetransactions are comparable with those available to unrelated parties. 

 

***Transactionswith/between Related Parties***

 

Adescription of major transactions with/between related parties is as follows:

 

*a.   Telecommunications Services Provided within thePLDT Group*

 

Telecommunicationscarriers within the PLDT Group have existing intercompany agreements, such asinterconnection agreements and connectivity service agreements for leasedlines, with one another under terms similar with those agreed with othertelecommunications providers outside the PLDT Group (see *Note 25 – OtherMatters*).

 

*b.   Transponder Lease Agreement between PLDT andMabuhay Satellite*

 

On December 28, 1995, PLDT and Mabuhay Satellite enteredinto a Transponder Lease Agreement, as amended on May 10, 2000, pursuant to whichMabuhay Satellite leases to PLDT C-band transponders on board the Agila IIsatellite, in consideration of a basic rent.  This agreement has a term of tenyears commencing on December 18, 1997, unless earlier terminated in accordance with theterms thereof.  Originally, the lease covered fourteen (14) C-bandtransponders.  However, on December 18, 2000, PLDT terminated the transponderLease Agreement with respect to four transponders which service was interruptedand not restored resulting in PLDT’s inability to access and use thetransponders.  This was further reduced to eight C-band transponders on December 18, 2002 andto seven C-band transponders on July 1, 2003.  The annual basic rent for thetransponders is approximately US$13 million with US$1.8 million annual leaseper transponder.

 

Underan Acknowledgment and Consent Agreement dated January 4, 1996, PLDTacknowledged and consented to Mabuhay Satellite’s:  (i) transfer and assignmentof all amounts payable by PLDT under the Transponder Lease Agreement; and (ii)grant of a continuing security interest of first priority in all of MabuhaySatellite’s rights, title and interest in, to and under the Transponder LeaseAgreement, in favor of the collateral agent for the benefit of the lenders whoare parties to the Omnibus Credit and Security Agreement dated December 14,1995 as amended.

 

Total fees under this agreement amounted to Php341 million and Php385million for the six months ended June 30, 2004 and 2003, respectively.Outstanding obligations of PLDT under this agreement amounted to Php26 million as of June 30, 2004 and December 31, 2003.

 

*c.   Facilities Management Agreement between PLDT andPiltel*

* *

OnJuly 19, 2001, PLDT entered into a Facilities Management Agreement with Piltelunder which PLDT undertakes the management, operation and maintenance ofPiltel’s regional telecommunication and E.O. 109 network operations andservices, including E.O. 109 fixed line build-out installations, public callingoffices and payphone facilities and the systems required to support these services.

 

Theagreement covers Piltel’s regional telecommunication services in Baguio, PuertoPrincesa, Masbate, and Boac and E.O. 109 services in Alabel, Banga,Dapitan, Davao, Digos, Dipolog, General Santos, Kiamba, Koronadal,Pagadian, Polomolok and Surallah in Mindanao.

Underthe agreement, PLDT also undertakes the management of the computer system,billing, revenue assurance and inter-carrier settlements reporting of Piltel’sregional telecommunication services in Olongapo and Subic.

 

Themonthly management fee payable by Piltel is based on cost, and for costcomponents where margin is allowed, 15% will be applied.  All third partyinvoices will be passed on to Piltel at cost, including value-added tax.

 

The agreement supersedes the Facilities ManagementAgreement between PLDT and Piltel, dated May 12, 2000, under which PLDTundertook the management, maintenance and operation of the regionaltelecommunication services of Piltel, including public calling offices andpayphone operations located in Baguio City, Puerto Princesa, Boac and Masbate.This new agreement is effective for three years from July 2001 to July 2004.

 

Totalmanagement fees under this agreement amounted to Php35 million and Php41million for the six months ended June 30, 2004 and 2003, respectively.Outstanding receivables of PLDT under this agreement amounted to Php367 million and Php329 million as of June 30, 2004 and December 31, 2003, respectively.

 

*d.   Facilities Management Agreement between Pilteland**Subic**Telecom*

 

On September 5, 2001, Piltel and Subic Telecom entered into a FacilitiesManagement Agreement of the regional telephone network, customer operations,network operations and payphones of Piltel in Subic and Olongapo City.  Themonthly management fee payable by Piltel is based on cost, and for costcomponents where margin is allowed, 15% will be applied.  In addition, Piltelwill pay a monthly variable cost per account in the amount of Php44 for repairs and maintenance.  All third partyinvoices are passed on to Piltel at cost, including value-added tax.

 

This agreement supersedes the facilities managementagreement entered into by Piltel and Subic Telecom as of May 29, 2000.  Thisnew agreement is effective for three years until September 2004.

 

Total management fees under these agreements amountedto Php11 million for the six months ended June 30, 2004 and2003.  Outstanding receivables of Subic Telecom under this agreement amountedto Php51 million and Php11 million as of June 30, 2004 and December 31, 2003, respectively.

 

*e.   Agreements between Smart and Piltel*

 

In connection with the integration of theiroperations, Smart and Piltel have entered into the following agreements:

 

•           An agreement for the co-location,or sharing, of cellular sites selected at the option of Smart, whereby Piltelis paid a usage fee of Php45,000 per shared site per month, subject to a 10%annual increase.  Co-location expenses under this agreement amounted to Php80million and Php53 million for the six months ended June 30, 2004 and 2003,respectively.  In December 2003, Smart made an advance payment of co-locationfees under this agreement amounting to Php783 million covering the period from January 1, 2004 up toDecember 31, 2008.  The advance payment was based on the rateapplicable to 2003 on which the annual escalation rate was applied over thefive-year period and discounted at 10%;

 

•        An agreement whereby Smart managesthe operation of Piltel’s cellular system.  This agreement is divided intothree sub-agreements as follows:

 
A Facilities Management Agreement under which Smart operates, maintains and manages the physical facilities and technical services of Piltel’s existing cellular system. Piltel pays Smart a fixed monthly fee of Php4 million and a variable monthly fee of Php13,735 per site covered by the agreement.  Additional fees of Php186,878 per month and Php624 per site per month are payable at the end of each calendar year upon rendition of the services in accordance with the agreement.  This agreement was amended in May 2001 to include the management, operation and maintenance of Piltel’s prepaid wireless telecommunications network in the E.O. 109 areas in Mindanao including the business and central offices, base stations, and public calling offices of Piltel located in South Cotabato, Saranggani and General Santos, Davao City, Davao del Sur, Zamboanga del Norte, Zamboanga del Sur and Misamis Occidental.  In November 2003, the agreement was further amended to eliminate the monthly fixed costs of Php4 million and the additional fees of Php186,878 per month and increase the monthly variable cost to Php27,470 per site and the additional fees to Php1,248 per site per month;  

 
A Customer Service Management Agreement under which Piltel outsources the operation of its customer service and billing functions for its cellular system to Smart for a fixed monthly fee of Php9 million and a variable cost of Php17 per prepaid cellular subscriber.  An additional fee of Php399,926 per month and Php1 per prepaid subscriber per month is payable at the end of each calendar year upon rendition of the services in accordance with the agreement; and

 
An Administrative Support and Management Services Agreement under which Smart provides administrative support and services to Piltel including payroll administration and training, finance and financial accounting, audit, legal, purchasing and materials management, public affairs, information technology, rates and tariffs administration, sales and marketing, product development and carrier services for a fixed monthly fee of Php8 million.  An additional fee of Php353,764 per month is payable at the end of each calendar year upon rendition of the services in accordance with the agreement. 

 

Thisagreement was amended in December 2002 to include the provision of sales anddistribution services for Piltel’s products and services.  Piltel pays Smartthe residual percentage discount between Piltel’s prescribed distributordiscount rate and the discount rate that Smart gives to its retailers andwholesalers for the sale of prepaid cards and the residual commission betweenPiltel’s prescribed discount and the discount that Smart extends to itsretailers and wholesalers for phonekit and SIM pack sales.

 

Totalmanagement fees under the three sub-agreements totaled Php460 million and Php346million for the six months ended June 30, 2004 and 2003, respectively.  Underthese agreements, outstanding receivables of Smart as of June 30, 2004 and December 31, 2003amounted to Php221 million and Php906 million, respectively.

 

•           A Facilities Service Agreementunder which Piltel accesses Smart’s existing GSM network and facilities toenable Piltel to offer prepaid cellular service using GSM technology inexchange for approximately 50% of Piltel’s revenues, net of interconnectionexpenses.  Total facility fees under this agreement amounted to Php2,814million and Php1,823 million for the six months ended June 30, 2004 and2003, respectively.  Under this agreement, outstanding receivables of Smartamounted to Php1,219 million and Php633 million as of June 30, 2004 and December 31, 2003,respectively. 

 

•           A Billing Service Agreement forthe printing and delivery of the billing statements of Piltel’s LECsubscribers.  Under the agreement, Piltel agrees to pay Smart an average ofPhp4.60 per bill printed and an average of Php5.40 per bill delivered.  Totalfees under this agreement amounted to Php3 million and Php2 million for the six months ended June 30, 2004 and 2003,respectively.

 

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

* *

InMarch 1997, PLDT entered into a Founder NSP Air Time Purchase Agreement with PTAsia Cellular Satellite (assigned and transferred to AIL), as amended inDecember 1998, under which PLDT was granted the exclusive right to sell ACeSservices in the Philippines.  In exchange, the Air Time Purchase Agreement statesthat PLDT has to purchase from PT Asia Cellular Satellite at least US$5 millionworth of air time annually over ten years, commencing on the commercialoperations date, which has been set as January 1, 2002.The commercial operations date is defined as the earlier of:

 

•        the day on which PT Asia CellularSatellite places the Garuda I satellite in commercial operation; and

 

•        the date of final acceptance ofthe Garuda I satellite and associated equipment under the terms of theSpacecraft Contract, dated August 28, 1995, between PT Asia Cellular Satelliteand Martin Marietta Overseas Corporation.

 

However,the commercial operations date may not occur without the consent of PLDT ifthere is a constructive total loss or partial loss of the satellite under itslaunch insurance contract and the satellite cannot provide commercial servicein the Philippines. 

 

In the event that PT Asia Cellular Satellite’saggregate billing revenue is less than US$45 million in any given year, the AirTime Purchase Agreement states that PLDT has to make supplemental air timepurchase payments not to exceed US$15 million per year during the ten-yearterm.

 

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.

 

In March 2003, PLDT, together with theother founder NSPs, entered into a Standstill Agreement with AIL suspending theapplication and enforcement of the minimum and supplemental air time paymentsunder the original Air Time Purchase Agreement.  In lieu of these payments, theparties agreed that AIL shall provide PLDT and the other founder shareholders,with unlimited use of air time for the year 2003 in exchange for a fixed fee inthe amount of US$3.8 million for PLDT.  Moreover, PLDT was also obliged topurchase from AIL 13,750 satellite phone units for the year 2003 at US$395F.O.B. per unit, subject to quarterly price adjustments.  The parties to theStandstill Agreement also agreed to negotiate in good faith and use their bestefforts to reach an agreement on a revised Air Time Purchase Agreement beforeNovember 15, 2003 that will cover, among other matters, the amended minimum andsupplemental air time payment provisions subject to the approval of AIL’screditors.

 

On February 10, 2004, notwithstanding the on-goingnegotiations, AIL advised PLDT of the termination of the Standstill Agreementand the reinstatement of the terms under the original Air Time PurchaseAgreement following the lapse of the November 15, 2003 deadline set for thenegotiation of a revised Air Time Purchase Agreement.  On June 21, 2004, AILalso sent PLDT a letter citing PLDT in default under the Air Time PurchaseAgreement for non-payment of outstanding amounts and for repudiation of itsobligations thereunder.  See *Note 21 –Provisions and Contingencies* for further discussion.

 

PLDTalso entered into a Founder NSP Operating Agreement with PT Asia CellularSatellite 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 all of PT Asia CellularSatellite’s rights under the Founder NSP Air Time Purchase Agreement andFounder NSP Operating Agreement.

 

Underan Acknowledgment of Assignment of Air Time Purchase Agreement entered into onDecember 29, 1998, by and among PLDT, P.T. Bank Internasional Indonesia and AIL,PLDT consented to the assignment by AIL of the Founder NSP Air Time PurchaseAgreement to P.T. Bank Internasional Indonesia, as security agent, for thebenefit of the secured parties under the Security Agreement dated as ofDecember 29, 1998, which was executed in connection with the Amended andRestated Credit Agreement dated December 29, 1998 among PT Asia CellularSatellite, AIL, P.T. Bank Internasional Indonesia and various other banks.

 

On September 30, 2002, PT Asia Cellular Satellite,AIL, as guarantor, P.T. Bank Internasional Indonesia, as security agent, andvarious other banks signed a Rescheduling Agreement, which amended the terms ofthe Amended and Restated Credit Agreement dated December 29, 1998, moving theprincipal repayment dates to agreed periods with the final maturity date onJanuary 31, 2012.

* *

*g.   Agreements between Smart andMabuhay Satellite*

 

Smart entered into transponder lease agreement withMabuhay Satellite for the use of transponders aboard its satellite, Agila II.The monthly rent for the transponders is on a tiered-pricing scheme permegahertz based on the actual usage of Smart.

 

Total fees under this agreement amounted to Php49million and Php24 million for the six months ended June 30, 2004 and 2003,respectively.  Outstanding obligations of Smart under this agreement amountedto Php10 million and Php13 million as of June 30, 2004and December 31, 2003, respectively.

 

*h.   Agreements between Smart and ACeS**Philippines*

 

On July 18, 2000, Smart entered into a ServiceDistribution Agreement with ACeS Philippines under which ACeS Philippinesappointed Smart as an authorized service provider of ACeS Global MobilePersonal Communication by Satellite Services, or GMPCS Services, in thePhilippines having the task of exerting its best efforts to market and sellaccess to usage of the said services to prospective subscribers.  

 

Anamendment to this Service Distribution Agreement was made on February 16, 2001,whereby Smart shall remit to ACeS Philippines a Facility Usage Fee based on a revenuesharing formula.  ACeS Philippines shall in turn pay Smart’s charges for thepayphone-related services.  

 

Also on February 16, 2001, Smart entered into aFacilities Management Agreement, or FMA, and Administrative Support andManagement Services Agreement, or the Service Agreement, with ACeSPhilippines.  In exchange for its services, Smart shall receive fixed andvariable monthly fees from ACeS Philippines.  Under the FMA, Smart undertakesthe management, maintenance and operation of the ACeS GMPCS Services, which arecurrently ready and available for actual use or operation.  Under the ServiceAgreement, Smart shall provide certain administrative support and services incertain aspects of ACeS Philippines’ business operations such as payroll administrationand training, finance, audit, legal, purchasing and materials management,public affairs, information technology, sales and marketing, ACeS PhilippinesNSP relations, AIL relations and other support services.

 

Totalfees under these agreements, net of ACeS’ share, amounted to Php41 million andPhp36 million for the six months ended June 30, 2004and 2003, respectively.  Smart’s outstanding obligation to ACeS amounted toPhp36 million as of June 30, 2004 while Smart had no outstanding obligation as of December 31, 2003. 

* *

*h.   Other Transactions*

 

Equity investments in subsidiaries and associates arediscussed in *Note 9 – Investments.*

 

The following is a summary of related party accountswith subsidiaries eliminated from the consolidated balance sheets as of June 30, 2004(unaudited) and December 31, 2003 (audited) and from the consolidated statements ofincome for the six months ended June 30, 2004 and 2003 (unaudited):

 

 

**2004**

2003

 

(in million pesos)

Balance Sheets:

 

*** ***

Receivables – net

**4,702**

8,269

Other noncurrent assets 

**4,272**

86

Accounts payable 

**1,725**

5,060

Accrued expenses and other current liabilities

**130**

367

Deferred credits and other noncurrent liabilities

**7,119**

2,928

 

 

**2004**

2003

 

(in million pesos)

Statements of Income:

** **

 

Wireless revenues

**478**

382

Fixed line revenues

**340**

197

Information and communications technology revenues

**132**

15

Rent expense

**694**

397

Maintenance expense and others 

**312**

197

Other income – net

**56**

9

 

The following is a summary of related party accountswith Piltel as of June 30, 2004 (unaudited) and December 31, 2003(audited) and for the six months ended June 30, 2004and 2003: 

 

 

**2004**

2003

 

(in million pesos)

Balance Sheets:

** **

*** ***

Payables – net

**857**

1,214

Statements of Income:

** **

 

Wireless revenues

**2,088**

1,199

Fixed line revenues (expenses)

**9**

(83)

Miscellaneous income

**506**

387

*** ***

***Transactions with Major Stockholders, Directors andOfficers***

 

Transactions to which PLDT or its subsidiary was aparty, in which a director or key officer or owner of more than 10% of thecommon stock 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 adirect or indirect material interest in PLDT or its subsidiary, as of June 30,2004 and December 31, 2003 and for the six months ended June 30, 2004 and 2003are as follows:

 

*a.   Agreements with NTTCommunications and/or its Affiliates*

 

PLDT is a party to the following agreements with NTTCommunications and/or its affiliates:

 

•        *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 the submarine cable repair andother allied 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.  Underthe agreement, PLDT shall pay NTT WEMC a fixed annual standing charge of US$2million, excluding cost for the use of a remotely operated submersible vehicleat US$5,000 for every day of use and repair cost computed at US$19,000 per dayof actual 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 NTTCommunications under which PLDT and NTT Communications agreed to cooperativearrangements for conventional international telecommunications services toenhance their respective international businesses.

 

Total fees under these agreements amounted to Php146 million and Php147 million for the six monthsended June 30, 2004 and 2003, respectively.  As of June 30, 2004 and December 31, 2003,outstanding obligations of PLDT amounted to Php31million and Php40 million, respectively.

 

*b.   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 ofCMTS for a period of five years, subject to renewal upon mutual agreementbetween the parties.  The agreement provides for quarterly payments oftechnical service fees equivalent to 2% of the net revenues of Smart.  InJanuary 2003, the agreement was amended, reducing the technical service fees tobe paid by Smart to ALBV to 1% of net revenues effective January 1, 2003.

 

Smart also has an existing ServicesAgreement with ALBV for a period of 25 years starting January 1, 1999,which shall automatically expire unless renewed by mutual agreement of bothparties.  Under the agreement, ALBV provides advice and assistance to Smart insourcing capital equipment and negotiating with international suppliers,arranging international financing and other services therein consistent withand for the furtherance of the objectives of the services.  Service agreementfees were paid for the whole 25-year period.

 

ALBVis a subsidiary of the First Pacific Group.

 

Totalfees under these agreements amounted to Php214 million and Php147 million forthe six months ended June 30, 2004 and 2003, respectively.  Outstanding obligations ofSmart under the Technical Service Agreement amounted to Php119 million andPhp228 million as of June 30, 2004 and December 31, 2003, respectively.

 

*c.   Agreements relating to insurance companies.*Gotuaco del Rosario and Associates, or Gotuaco*,* acts asthe broker for certain insurance companies to cover certain properties of thePLDT Group.  Insurance premiums are remitted to Gotuaco and the broker’s feesare settled between Gotuaco and the insurance companies.  In addition, PLDT hassigned an insurance policy with Malayan Insurance Co. Inc., or Malayan, whereinpremiums are directly paid to Malayan.  Total payments to Gotuaco and Malayancovering the 12-month period ending July 31, 2004 amountedPhp324 million.  Two directors of PLDT have adirect/indirect interest in or serve as director/officer of Gotuaco andMalayan.

 

 

 

**16. Employees’ Benefit Plans**

 

***PLDT***

 

PLDT has a trustee-managed, non-contributory definedbenefit plan, or the Benefit Plan, providing for retirement and death benefitsand service terminal pay to substantially all permanent and regular employees.Benefits under the Benefit Plan are based on final salary and length ofservice.

 

PLDT’s actuarial valuation is done on an annualbasis.  Based on the latest actuarial valuation dated February 2004, theactuarial present value of accrued liability, net pension cost and averageassumptions used in developing the valuation at December 31, 2003:

 

 

(in million pesos)

Actuarial accrued liability

(5,971)

Assets at fair value

3,927

Unfunded actuarial accrued liability

(2,044)

Unrecognized:

 

Net transition liability

2,296

Net experience adjustment

1,535

Prepaid pension cost as of December 31, 2003

1,787

Accrual of pension cost

(302)

Contributions

418

Prepaid pension cost as of June 30, 2004

1,903

 

The weighted average assumptions used to determinepension benefits for 2004 are as follows:

 

 

2003

Discount rate

9%

Rate of increase in compensation

7%

Rate of return on plan assets

9%

 

Net pension cost was computed as follows:

 

 

**Six Months Ended June 30,**

 

**2004**

2003

** **

(Unaudited)

** **

(in million pesos)

Normal cost

**176**

234

Interest cost

**16**

20

Amortization of:

** **

 

Unrecognized net transition liability

**76**

82

Unrecognized net experience adjustments

**34**

(8)

** **

**302**

328

 

Inaddition to PLDT’s cash contribution in relation to the manpower rightsizingprogram in June 2003, PLDT contributed to the PLDT BTF its investment inconvertible notes of Unilink and a real property in Makati City. 

 

***Smart***

 

Smart has a trustee-managed, tax-qualified ProvidentPlan providing for retirement, death or service terminal pay to substantiallyall permanent and regular employees.  Under the Provident Plan, Smartcontributes to the provident fund for the credit of each member’s PersonalRetirement Account, or PRA, a percentage of such member’s monthly salary.  Netearnings of the Provident Fund are credited every nine months to the PRAs ofthe members based on their proportionate share in the total value of theProvident Fund as of the end of the preceding period.

 

InOctober 2003, Smart’s board of directors approved enhancements to theretirement plan.  The enhanced retirement plan gives a member the option tocontribute to the fund up to a maximum of 10% of his monthly salary.  On top ofits current contribution, Smart will provide an additional contribution up to50% of the member’s contribution, depending on his tenure in the company.

 

Anybenefit payable under this Plan shall be in lieu of or in compliance with, butnot in addition to, the payment of similar benefits Smart is required to payits employees under existing or future laws, employment contracts or collectivebargaining agreements, it being understood that the employee shall be entitledonly to the higher of the benefits and not to both.

 

Contributionsby Smart to the Provident Plan charged to operations amounted to Php45 million and Php35 million for the six monthsended June 30, 2004 and 2003, respectively.

 

 

 

**17. Other Expenses – Net**

 

This account consists of:

 

 

**Consolidated**

 

**Non-Consolidated**

 

**Six Months Ended June 30,**

 

**2004**

2003

 

**2004**

2003

 

(Unaudited)

 

(in million pesos)

Hedge cost and foreign exchange losses – net 

   (Notes 12 and 23)

**746**

663

 

**625**

508

Manpower rightsizing cost, or MRP (Note 16)

**187**

1,411

 

**183**

1,411

Miscellaneous expenses – net (Notes 11 and 21)

**117**

2,550

 

**255**

1,445

 

**1,050**

4,624

 

**1,063**

3,364

 

Overthe past years, PLDT has been implementing MRP in line with its continuingeffort to reduce the cost base of the fixed line business.  The MRP costcharged to operations in the first half of 2004 and 2003 amounted to Php183 million and Php1,411 million, representing258 and 1,681 employees affected by the program, respectively; unrecognizedpast service costs, which are normally amortized over the estimated remainingworking lives of employees, in respect of employees who availed of the manpowerreduction program are recognized as loss on settlement.

 

Thedecision to implement the MRP was anchored on the challenges being faced by thefixed line business as significant changes in technology, increasingcompetition, and shifting market preferences to cellular use have reshaped thefuture of the fixed line business.  The MRP was implemented under the New LaborCode and is in compliance with all other relevant labor laws and regulations.  

 

 

 

**18. Income Taxes**

 

Thenet components of deferred income tax recognized in the balance sheets follow:

 

 

**Consolidated**

** **

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003  (As restated – Note 3)

** **

**June 30, 2004****(Unaudited)**

December 31, 2003  (As restated – Note 3)

 

** **

(in million pesos)

 

Net assets

**663**

244

 

–

–

Net liabilities

**(6,246)**

(5,988)

 

**(6,246)**

(5,988)

 

The components of net deferred tax assets andliabilities are as follows:

 

 

**Consolidated**

** **

**Non-Consolidated**

 

**June 30, 2004****(Unaudited)**

December 31, 2003  (As restated – Note 3)

** **

**June 30, 2004****(Unaudited)**

December 31, 2003  (As restated – Note 3)

 

(in million pesos) 

Net assets – net:

** **

 

 

 

 

Allowance for doubtful accounts

**659**

634

 

–

–

Unearned revenues on sale of prepaid cards

**542**

394

 

–

–

Allowance for inventory losses

**188**

189

 

–

–

Unamortized past service cost

**6**

6

 

–

–

Interest charges capitalized –net of amortization

**(528)**

(555)

 

–

–

Foreign exchange differential capitalized –  net of depreciation

**(507)**

34

 

 

–

 

–

Provisions for unrealizable assets

**–**

13

 

 

 

Others

**303**

(471)

 

–

–

 

**663**

 244

 

–

–

 

** **

 

 

 

 

Net liabilities – net:

** **

 

 

 

 

Allowance for doubtful accounts

**3,334**

2,890

 

**3,334**

2,890

Unamortized past service cost

**1,132**

1,139

 

**1,132**

1,139

Provisions for unrealizable assets

**451**

451

 

**451**

451

Unearned revenues on sale of prepaid cards

**149**

140

 

**149**

140

Allowance for inventory losses

**76**

76

 

**76**

76

Accrued business tax and others

**52**

90

 

**52**

90

Foreign exchange differential capitalized – net of depreciation

**(5,718)**

 

(4,972)

 

**(5,718)**

 

(4,972)

Interest charges capitalized – net of amortization

**(4,664)**

(4,766)

 

**(4,664)**

(4,766)

Taxes and duties capitalized – net of amortization

**(614)**

(646)

 

**(614)**

(646)

Others

**(444)**

(390)

 

**(444)**

(390)

 

**(6,246)**

(5,988)

 

**(6,246)**

(5,988)

 

Thebenefit of NOLCO amounting to Php2,146 millionas of June 30, 2004 can be claimed as deductions against taxable incomeuntil 2006.

 

Provisionfor income tax consists of:

 

 

**Consolidated**

** **

**Non-Consolidated**

 

**Six Months Ended June 30,**

 

**2004**

2003

** **

**2004**

2003

 

(Unaudited)

 

(in million pesos)

Current

**4,187**

1,178

** **

**–**

–

Deferred

**(167)**

(32)

** **

**215**

(401)

 

**4,020**

1,146

** **

**215**

(401)

 

Thecurrent provision for income tax-current for the six months ended June 30, 2004 and2003, on a consolidated basis, mainly represents the subsidiaries’ income taxunder the regular corporate income tax.  The benefit of MCIT as of June 30, 2004 can beclaimed as deductions against income tax payable until 2006.

 

The reconciliation between the provision for incometax at the applicable statutory tax rates and the actual provision for incometax follows:

 

** **

**Consolidated**

** **

**Non-Consolidated**

 

**Six Months Ended June 30,**

 

**2004**

2003

 

**2004**

2003

 

(Unaudited)

 

(in million pesos)

Provision at statutory tax rate

**5,135**

868

 

**3,911**

443

Tax effects of:

** **

 

 

** **

 

Income not subject to tax

**(1,298)**

(2,356)

 

**(3)**

(3)

Income subject to final tax

**(172)**

(113)

 

**(56)**

(48)

Income subject to lower tax rate

**(66)**

(45)

 

–

–

Non–deductible expenses 

**184**

660

 

**78**

231

Equity share in net losses (income) of investees 

**14**

517

 

**(3,715)**

(1,024)

Others

**223**

1,615

–

–

Actual provision for (benefit from) income tax

**4,020**

1,146

 

**215**

(401)

 

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.

 

On December 22, 2000,the Philippine Board of Investments, or BOI, approved ePLDT’s registration as anew information technology service firm in the field of services related to itsinternet data center on a pioneer status.  As such, ePLDT enjoys, among otherincentives, a six-year income tax holiday from January 2001.

 

On May 3, 2001, the BOIawarded Smart pioneer status for its GSM expansion projects entitling it to athree-year tax holiday up to May 2004.  The tax incentive is availed on thebasis of incremental income generated from the said expansion project.  Inaddition, on July 12, 2001, the BOI awarded Smart pioneer status for its paymentinfrastructure projects entitling it to enjoy a six-year tax holiday.  In thiscase, the tax incentive is availed for the entire taxable income of theproject. 

 

Smart’s deferred income tax assets and liabilities asof June 30, 2004 and December 31, 2003 have been reduced to the extentthat part or all of that deferred tax assets are no longer probable to beutilized.

 

As of June 30, 2004 and December 31, 2003, tax incentives availed amounted to Php4,611 million and Php4,130 million, respectively.

 

 

 

**19. Earnings Per Common Share**

 

The following table presents informationnecessary to calculate the earnings per share:

 

** **

**Six Months Ended June 30,**

 

**2004**

 

2003

 

**Basic**

**Diluted**

 

Basic

Diluted

 

(Unaudited)

 

(in million pesos)

Net income

**12,008**

**12,008**

 

1,785

1,785

Less dividends on preferred shares

**882**

**559**

 

847

847

Net income applicable to common shares

**11,126**

**11,449**

 

938

938

 

** **

** **

 

 

 

 

(In Thousands, Except Per Share Amounts)****

Outstanding common shares, beginning

**169,516**

**169,516**

 

169,361

169,361

Effect of issuance of common shares during the period

**40**

**40**

 

24

24

Weighted average number of shares under ESOP during the period

**–**

**49**

 

**–**

**–**

Common shares equivalent of preferred shares deemed dilutive:

** **

** **

 

 

 

Preferred Stock Series A to EE

**–**

**4,431**

 

–

–

Preferred Stock Series V

**–**

**2,576**

** **

**–**

**–**

Preferred Stock Series VI

**–**

**4,764**

** **

**–**

**–**

Preferred Stock Series VII

**–**

**3,842**

** **

**–**

**–**

Weighted average number of common shares, end

**169,556**

**185,218**

 

169,385

169,385

Earnings per common share

**Php65.62**

**Php61.81**

 

Php5.54

Php5.54

 

Series A to EE, V, VI and VII Convertible PreferredStocks were deemed dilutive based on a calculation of the required dividends onthese preferred shares divided by the number of equivalent common sharesassuming such preferred shares are converted into common shares, including theeffect of shares under ESOP, and compared against the basic EPS.  Since theamount of dividends on the Series A to EE, V, VI and VII Convertible PreferredStocks over its equivalent number of common shares decreased the basic EPS,these Convertible Preferred Stocks were deemed dilutive.  

 

 

 

**20. Contractual Obligations and CommercialCommitments**

** **

***Contractual Obligations***

 

The following table discloses the PLDT Group’scontractual obligations outstanding as of June 30, 2004: 

 

 

**Payments Due by Period**

 

**Total**

**Within 1 year**

**2****-3**

**years**

**4****-5**

**years**

**After 5 years**

 

(in million pesos)

 

 

 

 

 

 

Long-term debt obligations

146,113

22,236

70,734

20,885

32,258

Long-term lease obligations: 

 

 

 

 

 

Operating lease

5,433

1,304

2,362

924

843

Capital lease

1,354

532

657

165

–

Unconditional purchase obligations(1)

12,587

3,615

2,256

2,784

3,932

Other long-term obligations

22,131

–

–

14,049

8,082

Total contractual cash obligations 

187,618

27,687

76,009

38,807

45,115

 

(1)   The amounts disclosed in the table above are basedon the original Air Time Purchase Agreement with AIL.  In 2003, a Standstill Agreement was executed tocover, among other matters, the amended minimum and supplemental air timepayment provisions for the year 2003.  

*** ***

Fora discussion of our long-term debt obligations, see *Note 12*– *Long-term Debt*.

 

*Long-termOperating Lease Obligations*

 

*TransponderLease Agreement*.   As discussed in *Note 15 – Related Party Transactions*, PLDT and Mabuhay Satellite entered into aTransponder Lease Agreement on December 28, 1995 as amended on May 10, 2000.  Thisagreement is for a period of ten years commencing on December 18, 1997,unless earlier terminated in accordance with the terms thereof.  The annualbasic rent for the transponders was US$13 million as of June 30, 2004, andPLDT’s aggregate remaining obligation under this agreement was approximately Php2,477million as of that date. 

 

*DomesticFiber Optic Network Submerged Plant Agreement*.   As discussed in *Note 15 – Related Party Transactions*, PLDTentered into an agreement with NTT World Engineering Marine Corporation on July 4, 2000, for thesubmarine cable repair and other allied services in relation to the maintenanceof PLDT’s DFON submerged plant for a period of five years up to July 4, 2005.  Underthe agreement, PLDT shall pay NTT World Engineering Marine Corporation a fixedannual standing 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 of June 30, 2004, PLDT’saggregate remaining obligation under this agreement was approximately Php128 million.

 
**
*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 of June 30, 2004, PLDT’s aggregateremaining obligation under these contracts amounted to approximately Php36 million.

* *

*License Agreement with Mobius Management Systems (**Australia**)Pty Ltd., or Mobius.*PLDT enteredinto a license agreement with Mobius pursuant to which Mobius has granted PLDTa non-exclusive, non-assignable and non-transferable license for the use ofcomputer software components.  Under the 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 of June 30, 2004, PLDT’saggregate remaining obligation under this agreement was approximately Php55 million.

 

*OtherLong-term Operating Lease Obligations*.The PLDT Group has various long-term lease contracts for periods ranging fromtwo to ten years covering certain offices, warehouses, cell sitestelecommunication equipment locations and various office equipment.  Inparticular, Smart has lease obligations aggregating Php2,666 million as of June 30, 2004 inrespect of office and cell site rentals with over 2,000 lessors nationwide.

 

*Long-termCapital Lease Obligations.*

 

*MunicipalTelephone Projects*.   In 1993, PLDTentered into two lease agreements with the Philippine Department ofTransportation and Communications, or DOTC, covering telecommunications facilitiesin Bohol and Batangas established under the Municipal Telephone Act.  Underthese 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 of June 30, 2004, PLDT’s aggregate remaining obligation under thisagreement was approximately Php914 million.In case of cancellation, PLDT is liable to pay Php100million under each of the two contracts 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 hasinfused more than Php200 million for upgrades and maintenance to keep thesystem operable.  Further, the****enactment of R.A. No. 7925, which negatedthe DOTC’s warranty to grant PLDT the exclusive right to providetelecommunication services in the areas stipulated, prevented PLDT fromachieving 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.  As of the date of this report, the DOJ has not yet responded tothe DOTC’s referral.  As of June 30, 2004, 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 Php144 million and Php 508 million,respectively.

 

*OtherLong-term Capital Lease Obligations*.The PLDT Group has various long-term lease contracts for a period of threeyears covering various office equipment.  In particular, Smart has capitallease obligations aggregating Php436 million in respect of office equipment.

 

*UnconditionalPurchase Obligations*

 

*AirTime Purchase Agreement with AIL.*Asdiscussed in *Note 15 – 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 states that PLDT has to purchase from AIL a minimum of US$5 millionworth of air time annually over ten years commencing on the date of thecommercial operations of the Garuda I satellite.  In the event AIL’s aggregatebilling revenue is less than US$45 million in any given year, the Air TimePurchase Agreement also states that PLDT has to make supplemental air time purchasepayments not to exceed US$15 million per year during the ten-year term.

 

Asof June 30, 2004, PLDT’s aggregate remaining minimum obligation underthe original Air Time Purchase Agreement was approximately Php12,030 million.  See *Note 15 – Related PartyTransactions* and *Note 21 – Provisions and Contingencies*for furtherdetails relating to the Air Time Purchase Agreement with AIL.

 

*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.  

 

Effective July 1, 2003, VeriSign has agreed to amend the Agreementand issued Addendum 6 to write-off all past due invoices and payments owed toVeriSign, which were invoiced or scheduled to be invoiced under the agreementprior to this Addendum 6.  All royalty payments and annual support fees duethrough June 2003 will be part of the write-off in the amount of US$0.8million.  For contract year 4 (September 2003-August 2004), the annual support fee will be reduced from US$0.3 million to US$40,000 and forcontract years 5-7 (September 2004-August 2007) from US$0.3 million to US$0.16million.  In addition, VeriSign agreed to reduce the affiliate revenue sharingrates from 50% of suggested retail price to 25% of suggested retail price forboth enterprise and internet products for 12 months starting July 2003 andnegotiable thereafter.  As of June 30, 2004, ePLDT’s aggregateremaining minimum obligation under this agreement was approximately Php18 million pertaining to annual support fee.

 

EffectiveJuly 1, 2004, Verisign has agreed to amend the Agreement andissued Addendum 8 as extension of Addendum 6.  Annual support fee for year 5(September 2004 to August 2005) will remain at US$40,000 and affiliate revenuesharing rates will remain at 25%.

 

*LicensePurchase Agreement with I-Contact Solutions Pte. Ltd.*  On April 2, 2003, iPlus Intelligent Network Inc., oriPlus, a wholly-owned subsidiary of ePLDT and the Philippines’ pioneer inIP-based IT response center, entered into an Application Services Provider, orASP, and Reseller Contract with I-Contact Solutions Pte. Ltd., or I-Contact, ofSingapore.  Under the agreement, iPlus will purchase licenses of the CosmoCallUniverse TM IP-based contact center solution.  CosmoCall Universe supports multi-channel customerinteractions including telephone, web chat, web voice, web video, webcollaboration, e-mail and voicemail in one high capacity, high availability,multi-tenant platform.  CosmoCall Universe is a complete, unified contactcenter suite that includes ACD, IVR, CTI, predictive dialing, multimediarecording and a complement of other management applications.  Theaggregate value of these licenses is US$2.1 million and these licenses will bedelivered quarterly over a two-year period.  Further to the agreement,I-Contact will appoint iPlus as the exclusive reseller and ASP for thePhilippine market and will provide iPlus with all the necessary support interms of sales, marketing, and technical services.Effective March 30, 2004, I-Contact has agreedto amend the Contract and waived all financial obligations and committed seatsrequirement over the two-year period.  iPlus will pay all its remainingobligations pertaining only to the 300 seats delivered by I-Contact.  As of June 30, 2004, iPlus’ aggregate remaining obligation under thisagreement was US$0.45 million (approximately Php25 million).

 

*OtherUnconditional Purchase Obligations.*The PLDT Group has various purchase contracts for periods ranging from two tothree years covering the use of a fraud management system and satellite hub andremote very small aperture terminal, or VSAT, network systems.

 

*Other Long-term Obligations*

 

*Mandatory Conversion and Purchase of Shares*.   As discussed in *Note 9 – Investments* and *Note14 – Stockholders’ Equity*, as of June 30, 2004, PLDT had issued a total of3 million shares of Series V Convertible Preferred Stock, 5 million shares ofSeries VI Convertible Preferred Stock and 4 million shares of Series VIIConvertible Preferred Stock in exchange for a total of 59 million shares ofSeries K Class I Convertible Preferred Stock of Piltel pursuant to the debtrestructuring of Piltel.

 

Each share of Series V, VI, and VII ConvertiblePreferred Stocks is convertible at any time at the option of the holder intoone PLDT common share.  On the date immediately following the seventhanniversary of the issue date of the Series V and Series VI ConvertiblePreferred Stocks 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 shares of PLDT’s common stock.  Under aput option exercisable for 30 days, holders of common shares received onmandatory conversion 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 pershare for Series V, VI and VII, respectively.  

 

Asof June 30, 2004, 145,320 shares of Series V Convertible PreferredStock and 531,251 shares of Series VI Convertible Preferred Stock had beenconverted to PLDT’s common shares.  The aggregate value of the put option basedon outstanding shares as of June 30, 2004 was Php22,131million, of which Php14,049 million is payableon June 4, 2008 and Php8,082 million on June4, 2009, if all of the outstanding shares of Series V, VI and VII ConvertiblePreferred Stocks were mandatorily converted and all the underlying shares ofcommon stock were put to PLDT.  The market value of the underlying share ofcommon stock was Php12,859 million, based onthe market price of PLDT’s common stock of Php1,150per share as of June 30, 2004.

 

***Commercial Commitments***

 

As of June 30, 2004, our outstanding commercialcommitments, in the form of letters of credit, amountedto Php5,099 million.  These commitments willexpire within one year.

 

In October 1998, Smart entered into a Frame Supply Contract withNokia Telecommunications OY for thesupply of hardware, software and documentation for its GSM cellular network.In the same month, Smart and Nokia (Philippines), Inc., or Nokia, signed a Frame Services Contractthat covers the design, planning, installation, commissioning, integration,acceptance testing, training and handling over of the GSM network.  In August2001, Smart issued a Master Purchase Order, or MPO, in the amount of US$200million in favor of Nokia for the purchase of additional equipment to expandits GSM cellular network.  The US$200 million MPO was completed in November2003.  On May 30, 2003, Smart entered into a Technical Support ServicesAgreement, or TSSA, with Nokia in the amount of US$8 million.  This TSSA hasbeen fully served as of December 31, 2003.

InJanuary 2004, Smart signed a new MPO in favor of Nokia amounting to US$117million (Phase 7 under the Frame Supply Contract between Smart and Nokia).Smart is, however, under no legal obligation to incur these expenditures.

 

On June 23, 2004, Smartsigned a TSSA with Nokia in the amount of US$10 million which is valid until December 31, 2004.

 

Asof June 30, 2004, Smart had no guarantee obligations, standby repurchaseobligations or other commercial commitments.

 

* *

 

**21. Provisions and Contingencies**

** **

*NTC supervision and regulation fees, or SRF*

** **

Since 1976, PLDT has received assessments from NTC forpermit, SRF and other charges pursuant to Section 40 of Commonwealth Act 146,otherwise known as the Public Service Act.  As of June 30, 2004, PLDT has paid,since 1994, a total amount of Php1,483 millionin SRF, of which Php1,301 million was paidunder protest.

 

PLDT iscontesting the manner by which these assessments were calculated and the basisfor such calculations.  The case is now with the Supreme Court and upon therules and practice of court, now stands submitted for decision.

 

Smarthas similarly received assessments from NTC for permit, SRF and other charges whichwere paid under protest.  Total payments amounted to Php122 million in 2003 andPhp114 million in 2002.

 

We havemade 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 financial statements as of June 30, 2004.

*** ***

*Localbusiness and franchise 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. 

 

TheLocal Government 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 businesses withintheir 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 PublicTelecommunications Policy Act, or R.A. No. 7925, which took effect on March 16,1995, and the grant of local franchise and business taxes exemption privilegesto other franchise holders subsequent to the effectivity of R.A. No. 7160,implicitly restored its local franchise and business taxes exemption privilegeunder Section 12 of R.A. No. 7082, or the PLDT Franchise pursuant to Section 23thereof 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.

 

Byvirtue of the BLGF Ruling, PLDT stopped paying local franchise and businesstaxes starting with the fourth quarter of 1998 and has filed with certain LGUsclaims for tax refund covering the period from the second quarter of 1995 tothe third quarter of 1998.  PLDT has received assessments for local franchiseand business tax from several cities and provinces following PLDT’s decision tostop payment of local franchise and business taxes.  

 

Following a decision of the Supreme Court on March 25, 2003, ajudgment in the amount of Php4 million against PLDT involving the City of Davao becamefinal and executory on April 9, 2003, pursuant to which PLDT was not exempt from the localfranchise tax.  Although PLDT believes that it is not liable to pay localfranchise and business taxes, PLDT has taken steps to arrive at compromisesettlements with several LGUs in order to maintain and preserve its goodstanding and relationship with these LGUs.  PLDT has paid a total amount of Php277 million as of June 30, 2004 for local franchisetax covering the fourth quarter of 1998 to 2004 to certain LGUs who have agreedto a compromise settlement. 

 

PLDTcontinues to contest assessments amounting to Php5,142 million, a number ofwhich were based on the gross revenues of PLDT derived from its operationswithin the entire Philippines.  PLDT claims that assuming that it is liable forlocal franchise tax, R.A. No. 7160 provides that local franchise tax shall bebased on the gross receipts of the preceding year received or collected forservices rendered within the jurisdiction of the taxing authority.  Therefore,the use by some LGUs of gross revenues as the basis for computation offranchise tax is in gross violation of the law because it pertains to allincome earned regardless of whether it was received or not, unlike grossreceipts which are essentially the amount of money or its equivalent actuallyor constructively received.  Moreover, gross revenues refer to all incomeearned by PLDT within and outside the jurisdiction of the local taxingauthority; thus, the use thereof as a basis of computation will exceptionallyoverstate the franchise tax.

 

Ina petition recently filed with the Supreme Court involving another LGU, PLDThas appealed to the Supreme Court for a re-examination of its decision in theCity of Davao case in light of the strong dissenting opinion in that caseconcurred in by four (4) other Justices of the Supreme Court.

 

Smarthas, 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.

 

Wehave made a reasonable estimate of the amount necessary to pay or settle the contestedassessment in the event of an unfavorable judgment against us and have made theappropriate provisions in our financial statements as of June 30, 2004.

*** ***

*AirTime Purchase Agreement with AIL*

*** ***

InMarch 1997, PLDT entered into a Founder NSP Air Time Purchase Agreement with PTAsia Cellular Satellite (assigned and transferred to AIL), as amended inDecember 1998.  The agreement states that PLDT has to purchase at least US$5million worth of air time annually over ten years commencing on the date of theGaruda satellite’s commercial operations and has to make supplemental air timepurchase payments not to exceed US$15 million per year during the ten-year termin the event revenues generated are less than US$45 million in any given year.The air time payment obligations shallremain in effect until all indebtedness incurred by AIL have been fully repaid.  See *Note 15 – Related Party Transactions* and *Note20 – Contractual Obligations and Commercial Commitments* for detaileddiscussion of the terms of the agreement.

 

TheGaruda satellite was launched on February 12, 2000 and was available for servicebeginning October 1, 2000.  Pre-commercial operations began on January 1, 2001 andfull commercial operations began on January 1, 2002.

 

We believe that the payment obligations under the Air Time Purchase Agreement exceed the economic benefits expected to be receivedunder it as a result of the delay in the launch of the satellite,unavailability of competitive handsets and competitions from cellular GSMservices, occurrence of a partial satellite loss, changes in the primarybusiness of AIL and other factors affecting its business.  Accordingly, westarted negotiations with AIL for the revision of the payment obligations underthe Air Time Purchase Agreement in 2000.

 

As aresult of these negotiations, the effective date of Air Time Purchase Agreementbecame January 1, 2002.  In 2002, billings for satellite air time were reducedto actual air time usage, less amount for marketing assistance to serviceproviders.  In March 2003, PLDT, together with the founder NSPs, entered into aStandstill Agreement with AIL.  Payments made to AIL under the Air TimePurchase Agreement based on billings of actual usage and the StandstillAgreement amounted to US$1 million in 2002, US$3.8 million in 2003 and US$0.4million for the first quarter of 2004.  

 

OnFebruary 10, 2004, AIL advised PLDT of the termination of the StandstillAgreement and the reinstatement of the terms under the original Air TimePurchase Agreement effective January 1, 2002 following the lapse of thedeadline set in the Standstill Agreement for the establishment of a revised AirTime Purchase Agreement.  

 

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.

 

Asof June 30, 2004, PLDT’s aggregate remaining minimum obligation underthe original Air Time Purchase Agreement was approximately Php12,030 million.

 

Wemade a reasonable estimate of the amount necessary in the event such obligationwould be settled and have made the appropriate provisions in our financialstatements as of December 31, 2004 with due consideration of AIL’s existingindebtedness and of PLDT’s share as one of the founder NSPs.  Total indebtednessof AIL amounted to US$195 million as of January 1, 2003.

* *

 

 

**22. Foreign Currency**–**Denominated Monetary Assets andLiabilities**

 

PLDT’s and its subsidiaries’ foreign currency–denominated monetary assets and liabilities and theirpeso equivalents follow:

 

 

**June 30, 2004****(Unaudited)**

 

December 31, 2003 (Audited)

 

**U.S. Dollar**

**Peso Equivalent**

 

U.S. Dollar

Peso Equivalent

 

(in millions)

***Consolidated***

*** ***

*** ***

*** ***

*** ***

*** ***

Assets:

** **

** **

 

** **

** **

Cash and cash equivalents

**US$294**

**Php16,503**

 

US$146

Php8,098

Receivables – net

**176**

**9,871**

 

195

10,855

Other current assets

**–**

**9**

 

–

–

 

**470**

**26,383**

 

341

18,953

Liabilities:

** **

** **

 

 

 

Notes payable

–

–

 

3

150

Accounts payable

**87**

**4,863**

 

60

3,322

Accrued expenses and other current liabilities

**74**

**4,086**

 

25

1,342

Long-term debt

**2,606**

**142,758**

 

2,819

153,542

Deferred credits and other noncurrent liabilities

**217**

**12,228**

** **

209

11,613

**2,984**

**163,935**

 

3,116

169,969

Net foreign currency – denominated liabilities

**US$****2,514**

**Php137,552**

 

US$2,775

Php151,016

 

** **

** **

 

 

 

***Non-Consolidated***

** **

** **

 

 

 

Assets:

** **

** **

 

 

 

Cash and cash equivalents

**US$199**

**Php11,198**

 

US$54

Php3,014

Receivables – net

**123**

**6,892**

 

134

7,463

Other current assets

**–**

**9**

 

–

–

 

**322**

**18,099**

 

 188

10,477

Liabilities:

** **

** **

 

 

 

Accounts payable

**10**

**572**

 

16

874

Accrued expenses and other current liabilities

**59**

**3,346**

 

7

386

Long-term debt

**2,193**

**119,555**

 

2,373

128,757

Deferred credits and other noncurrent liabilities

**218**

**12,228**

** **

209

11,613

**2,480**

**135,701**

 

2,605

141,630

Net foreign currency – denominated liabilities

**US$****2,158**

**Php117,602**

 

US$2,417

Php131,153

 

Intranslating the foreign currency-denominated monetary assets and liabilitiesinto peso amounts, the exchange rates used were Php56.176to US$1.00 and Php55.586 to US$1.00, thePhilippine peso-U.S. dollar exchange rates as of June 30, 2004 and December 31, 2003, respectively.

 

Asat August 3, 2004, the peso–dollarexchange rate was Php55.853 to US$1.00.  Usingthis exchange rate, our net foreign currency–denominated liabilities as of June 30, 2004would have decreased by Php812 million and Php697 million on a consolidated andnon-consolidated basis, respectively.

 

 

 

**23. Financial Instruments**

** **

***PLDT***

*** ***

*Long-term Currency Swaps*

*** ***

PLDT entered into long-term principal-only currencyswap agreements with various foreign counterparties to hedge the currency riskon its fixed rate notes maturing in 2009, 2012 and 2017.  As of June 30, 2004 and December 31, 2003,these long-term currency swaps have an aggregate notional amount of US$725million.  Under the swaps, PLDT effectively exchanges the principal of its U.S.dollar-denominated fixed rate notes into peso-denominated loan exposures atagreed swap exchange rates.  The agreed swap exchange rates are reset to thelowest US$/Php spot exchange rate during the term of the swaps, subject to aminimum exchange rate.  In March and April 2004, PLDT entered into amendmentsto keep the lowest reset exchange rate and unwind the downward resettablefeature of US$550 million of its long-term principal-only currency swap agreementsin order to lower the running hedging cost of the swaps.  As of June 30, 2004 and December 31, 2003,the outstanding swap contracts have an average exchange rate of Php51.177 and Php51.22,respectively.  The semi-annual fixed or floating swap cost payments that PLDTis required to make to its counterparties averaged to about 2.52% and 2.10% perannum as at June 30, 2004 and December 31, 2003, respectively.  

 

Dueto the amounts of PLDT’s foreign currency hedging requirements and the largeinterest differential between the Philippine Peso and the US$, the coststo book long-term currency swaps can be significant.  In order to manage suchhedging costs, PLDT utilizes structures that include currency option contracts,credit linkage, and fixed to floating coupon-only swaps.  

 

Thecurrency swap agreement relating to the 2009 fixed rate notes has beenstructured to include currency option contracts.  If the US$/Php spot exchangerate on maturity date settles beyond an agreed threshold, PLDT will have topurchase US$ at the minimum exchange rate plus the excess above the agreedthreshold rate.  On the other hand, if on maturity, the US$/Php spotexchange rate is lower than the minimum exchange rate, PLDT will have theoption to purchase at the prevailing US$/Php spot exchange rate. 

 

InMarch 2004, PLDT amended an additional US$150 million of the long-term currencyswaps to include credit-linkage with PLDT as the reference entity. Thespecified credit events include bankruptcy, failure to pay, obligationacceleration, moratorium/repudiation, and restructuring of PLDT bonds or all orsubstantially all of PLDT’s obligations.  Upon the occurrence of any of thesecredit events, subject to agreed threshold amount where applicable, theobligations to both PLDT and its counterparty under the swap contractsterminate without further settlements to either party, including anymark-to-market value of the swaps. As of June 30, 2004and December 31, 2003, US$725 million and US$575 million of PLDT’slong-term currency swaps, respectively, have been structured to includecredit-linkage with PLDT as the reference entity.  

 

Aportion of our currency swap agreements to hedge our 2017 fixed rate notescarry fixed rate swap cost payments.  To effectively lower the running cost ofsuch swap agreements, PLDT, in April 2003, entered into an agreement to swapthe coupon on US$125 million of its 2012 fixed rate notes into a floating rateJP¥ amount.  Under this agreement, PLDT is entitled to receive the fullequivalent of the fixed coupon provided the US$/JP¥ exchange rate stays above a predeterminedlevel.  Below this level, only a fraction of the fixed coupon will be due toPLDT.  In order to mitigate the risk of the JP¥ strengthening below the agreedthreshold, PLDT, in December 2003, entered into an overlay swap transaction toeffectively lower the portion of the coupon indexed to the US$/JP¥ rate.Both swap agreements include a credit-linkage feature with PLDT as thereference entity.

 

Asof June 30, 2004 and December 31, 2003, the estimated mark-to-marketvalue of the outstanding swaps amounted to net loss positions of Php1,667 million and Php1,227million, respectively.

 

*ForwardExchange Contracts*

 

PLDThad the following outstanding short-term forward exchange contracts to buy US$and sell Pesos as of June 30, 2004 and December 31, 2003: 

 

 

**June 30,**

**2004**

**(Unaudited)**

** **

December 31,

2003

(Audited)

Aggregate notional amount (in millions)

**US$76**

** **

US$125

Weighted average forward rate

** **

** **

 

(net of discount for prepaid forward contracts)

**Php56.26 to US$1**

** **

Php55.90 to US$1

 

Asof June 30, 2004, PLDT also has outstanding short-term forwardexchange contracts to buy JP¥ and sell US$ with aggregate notional amount ofJP¥400 million and a weighted average forward rate of JP¥110.16 to US$1.00.

 

Prepaidforward contracts totaled US$5.5 million as of June 30, 2004.

 

Theestimated net mark-to-market gain/(loss) on all the outstanding forwardexchange contracts amounted to about Php6 millionand (Php11 million) as of June 30, 2004 and December 31, 2003, respectively.

*** ***

*Short-TermCurrency Option Contracts*

 

PLDTutilized structures incorporating currency options to hedge the maturingprincipal on its fixed rate notes due June 2004 and August 2005 and othershort-term US$ and JP¥ foreign currency obligations.  As of June 30, 2004, PLDThas outstanding currency option contracts amounting to US$73 million and JP¥863million.  

 

Theestimated mark-to-market gain on the outstanding currency options contractsamounted to about Php277 million and Php247 million as of June 30, 2004 and December 31, 2003,respectively.

*** ***

***Smart***

 

*Forward Exchange Contracts*

 

Smart has the following outstanding short-term forwardbuy US$ contracts as of June 30, 2004 and December 31, 2003:

 

 

**June 30,**

**2004**

**(Unaudited)**

** **

December 31,

2003

(Audited)

Aggregate notional amount (in millions)

**US$121**

** **

US$72

Weighted average forward rate

** **

** **

 

(net of discount for prepaid forward contracts)

**Php56.06 to US$1**

** **

Php56.71 to US$1

 

Thirdcurrency forward contract in JPY as of June 30, 2004 amounted to JPY92.3million at forward rate of Php0.512 per JPY1.00.

Prepaidforward contracts totaled US$65 million as of June 30, 2004.

 

Thenet mark-to-market gain on the outstanding forward contracts as of June 30, 2004amounted to Php28 million and the net mark-to-market loss on the outstandingforward contracts as of December 31, 2003 amounted to Php51 million.   

 

 

 

**24. ReportableSegments**

 

Operatingsegments are components of an enterprise about which separate financialinformation is available that is evaluated regularly by management in decidinghow to allocate resources and in assessing performance.  Generally, financialinformation is required to be reported on the basis that it is used internallyfor evaluating segment performance and deciding how to allocate resources tosegments.

Wehave organized our business into three main segments:

 
- Wireless — wireless telecommunications services provided through our cellular service provider, Smart, and satellite and VSAT operators, namely PLDT’s subsidiaries Mabuhay Satellite, ACeS Philippines and Telesat;

 
- Fixed Line — fixed line telecommunications services primarily provided through PLDT.  We also provide fixed line services through PLDT’s subsidiaries Clark Telecom, Subic Telecom, Maratel, BCC which together account for approximately 1% of our consolidated fixed lines in service, and PLDT Global; and

 
- Information and Communications Technology — information and communications infrastructure and services for internet applications, internet protocol-based solutions and multimedia content delivery provided by PLDT’s subsidiary ePLDT, internet access services provided by ePLDT’s subsidiary Infocom, and e-commerce, call centers and IT-related services provided by other investees of ePLDT, as described in  Note 9 – Investments. 

 

Thesegment assets as of June 30, 2004 and December 31, 2003 and results ofoperations of our reportable segments for the six months ended June 30, 2004 and 2003 reported under Philippine GAAP are as follows:

** **

 

**Wireless**

**Fixed Line**

**Information and  Communications Technology**

** **

** **

**Eliminations**

**Total**

 

(in million pesos)

*As of and for the six months ended**June 30, 2004**(Unaudited)*

Operating revenues:

31,710

23,723

1,114

(950)

55,597

External revenues

31,231

23,384

982

–

55,597

Inter-segment revenues

479

339

132

(950) 

–

Operating expenses:

16,317

16,715

1,029

(1,006)

33,055

External expenses

15,841

16,241

973

–

33,055

Inter-segment expenses

476

474

56

(1,006)

–

Operating income

15,390

7,143

9

–

22,542

Segment assets

84,651

265,510

3,404

(53,329)

300,236

Segment liabilities

41,167

153,689

3,088

(8,974)

188,970

Net cash flows provided by (used in):

 

 

 

 

 

Operating activities

20,127

14,733

124

26

35,010

Investing activities

(9,415)

8,631

(169)

(10,543)

(11,496) 

Financing activities

(14,100)

(16,824)

55

10,517

(20,352) 

Equity share in net losses (income) of investees, including goodwill and provision for permanent decline in value of investment

47

(11,611)

(5)

11,612

  43

Provision for doubtful accounts

480

1,394

(9)

–

1,865

Depreciation and amortization

6,117

6,980

148

–

13,245

Impairment losses

–

85

–

–

  85

Capital expenditures

(8,823)

(2,678)

(75)

–

(11,576)

* *

*As of December 31, 2003 (As restated – Note 3) and  for the six months ended**June 30, 2003**(Unaudited)*

Operating revenues:

22,875

23,059

879

(594)

46,219

External revenues

22,493

22,862

864

–

46,219

Inter-segment revenues

382

197

15

(594)

–

Operating expenses:

14,810

16,692

1,020

(603)

31,919

External expenses

14,610

16,289

1,020

–

31,919

Inter-segment expenses

200

403

–

(603)

–

Operating income (losses)

7,883

6,573

(156)

–

14,300

Segment assets 

82,631

264,017

3,050

(52,316)

297,382

Segment liabilities 

39,085

163,688

2,856

(8,353)

197,276

Net cash flows provided by (used in):

 

 

 

 

 

Operating activities

12,425

10,588

(243)

311

23,081

Investing activities

(3,823)

2,637

(167)

(4,346)

(5,699) 

Financing activities

(8,517)

(13,064)

455

4,036

(17,090) 

Equity share in net losses (income) of investees, including goodwill and provision for permanent decline in value of investment 

1,614

(3,201)

1

3,202

1,616

Provision for doubtful accounts

370

1,521

11

–

1,902

Depreciation and amortization

4,944

6,571

181

–

11,696

Impairment losses

964

–

265

–

1,229

Capital expenditures

(3,743)

(1,546)

(51)

–

(5,340)

 

 

 

**25. Other Matters**

** **

a.   Interconnection Agreements

 

PLDT has existing interconnection agreements with nineInternational Gateway Facilities, or IGF operators, six Inter ExchangeCarriers, or IXCs, six Cellular Mobile Telephone Systems, or CMTS operators, 70LECs (including members of the Philippine Association of Private TelephoneCompanies, Inc.), and 12 paging and trunk radio operators.  Theseinterconnection agreements include provisions for settlement and payment ofcharges.  Settlements with interconnecting IGF operators and CMTS operators forlocal calls are in the form of access charges.  Settlement with interconnectingIXCs and LECs for toll calls are based on hauling and access charges, and tosome extent, revenue sharing.  Settlement also involves payment of accesscharges, but settlement for toll calls is on a revenue-sharing basis.  LEC toLEC interconnection with hauling from one service area to another service areais settled based on trunk charges, while overlay LEC to LEC interconnection ina given service area is without charges.  Paging and trunk radiointerconnection settlements are based on fixed charges.  

 
- U.S. Federal Communications Commission, or U.S FCC, Ruling versus Philippine Telecommunications Companies

 

Effective as of February 1, 2003,PLDT stopped terminating traffic sent directly by each of AT&T and MCI,because PLDT’s termination rate agreements with AT&T and MCI lapsed inDecember 2002 without either agreeing with PLDT on any provisional arrangementor final agreement on new termination rates.  In orders dated February 7 and26, 2003, the NTC confirmed that “absent any provisional or interim agreement”with U.S. carriers, there would be no provision of termination services betweenthe parties “who are thereby encouraged to seek other routes or options toterminate traffic to the Philippines.”  Upon petitions of AT&T and MCI, on March 10,2003, the International Bureau of the U.S. FCC issued an Order which directedall facilities-based carriers subject to U.S. FCC jurisdiction to suspendpayments for termination services to Philippine carriers, including PLDT, Smartand Subic Telecom, until such time as the U.S. FCC issued a Public Notice thatAT&T’s and MCI’s circuits on the U.S.–Philippine route were fullyrestored.  The Order also removed the Philippines from the list of U.S.–international routes approvedfor the provision of International Simple Resale, or ISR.  In response to theInternational Bureau’s Order, the NTC issued a Memorandum Order dated March 12,2003, directing all affected Philippine carriers “(1) not to accept terminatingtraffic via direct circuits from U.S. facilities-based carriers who do not payPhilippine carriers for services rendered; and (2) to take all measuresnecessary to collect payments for services rendered in order to preserve theviability, efficiency, sustained growth and development and continuedcompetitiveness of the Philippine telecommunications industry.”

 

OnOctober 17, 2003, based on negotiations between the NTC and the U.S. FCC toresolve the issue regarding termination rates, the NTC, in the expectation thatthe U.S. FCC would fully lift the March 10, 2003 Order, lifted its March 12,2003 Order and directed all Philippine carriers to immediately acceptterminating traffic via direct circuits from U.S. facilities-based carriers atmutually acceptable final or interim termination rates and other terms andconditions agreed upon by the parties.

 

On November 17, 2003, after Smart reached interimagreements with each of AT&T and MCI on September 30 and November 12, 2003,respectively, the International Bureau of the U.S. FCC lifted its March 10,2003 Order with respect to Smart and ordered the U.S. carriers to resume makingpayments to Smart.

On January 15, 2004, after PLDT reachedinterim agreements with each of MCI and AT&T and reopened its circuits withthese carriers on November 12, 2003 and January 9, 2004, respectively, theInternational Bureau of the U.S. FCC lifted its March 10, 2003 Order also withrespect to PLDT and ordered the U.S. carriers to resume making payments toPLDT.

 

On May 13, 2004, the U.S. FCC partially dismissed andpartially denied applications by Philippine carriers, including PLDT, andcertain U.S. carriers for review of the March 10, 2003 Order of theInternational Bureau of the U.S. FCC.  In particular, the U.S. FCC affirmed theMarch 10, 2003 Order’s finding that “Philippine carriers engaged incollective action to “whipsaw” AT&T and MCI.” 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. Department of Justice is independently“investigating the possibility of anticompetitive practices among Philippinecarriers under its authority pursuant to U.S. anti-trust laws.”  The U.S. FCC also upheld the March 10, 2003 Orderin respect of the suspension of payments for termination services to thePhilippine carriers pending restoration of the circuits.  In addition, the U.S.FCC denied a request to modify the March 10, 2003 Order of the InternationalBureau of the U.S. FCC to restore the Philippines to the list ofU.S.-international routes approved for the provision of ISR.  The U.S. FCCstated that it was dismissing this request as moot because of the U.S. FCC’srecently adopted International Settlements Policy Reform Order which eliminatedISP.

 

Although not included in the initial list of countriesexempted from the U.S. FCC’s International Settlements Policy, or ISP, the U.S.FCC identified the U.S.–Philippines route as eligible for being removed fromthe ISP in accordance with its newly established procedures for doing so.Under this procedure, the U.S. FCC asked for public comment on the removal ofthe Philippines from the ISP.  In comments filed in June and July2004, removal was reported by several Philippine and U.S. carriers,including AT&T and MCI, and was opposed by one U.S. carrier,International Access, Inc.

 

On July 6, 2004, PLDT filed with the U.S. FCC aPetition for Reconsideration of the Commission’s May 13, 2004 Order on thegrounds that the Order should have vacated as moot the International Bureau’sMarch 10, 2003 Order.

 

c.   Investigation by U.S. Department of Justice

 

In January 2004, PLDT received a grand jury subpoenaseeking documents and a PLDT employee was subpoenaed to testify before thegrand jury in connection with a criminal investigation being conducted by theU.S. Department of Justice with respect to alleged antitrust violationsrelating to the provision of international termination services in the Philippines.The U.S. Department of Justice has also requested testimony and documents fromSmart in connection with this investigation.  Further, in March 2004, PLDT(U.S.) Ltd., a subsidiary of PLDT Global, received a grand jury subpoenaseeking documents, in response to which PLDT (U.S.) Ltd. is currently producingdocuments.  In addition, in March 2004, a PLDT (U.S.) Ltd. employee received asubpoena to testify before the grand jury in connection with thisinvestigation. This employee has not yet been asked to appear before the grandjury.  At this time, the PLDT Group cannot predict the outcome of thisinvestigation.

 

d.   Piltel Debt Exchange Transaction 

 

On July 2, 2004,Smart announced that it had successfully closed the Piltel debt exchangetransaction.  This concluded the process begun in March this year when Smartinvited various creditors of Piltel to exchange their indebtedness for varioustypes of Smart debt and/or cash, as follows:

 

•        Cash settlement, at a maximumexchange price of US$0.40 for each US$1.00 equivalent of Piltel debt exchanged;

 

•        US$ Smart debt maturing inDecember 2007 at the rate of US$0.525 for each US$1.00 equivalent of Pilteldebt exchanged, with interest at US$ LIBOR plus 1% per annum, payablequarterly;

 

•        US$ Smart debt maturing inDecember 2008 at the rate of US$0.575 for each US$1.00 equivalent of Pilteldebt exchanged, with interest at US$ LIBOR plus 1% per annum, payablequarterly;

 

•        US$ Smart 10-year debt maturing inJune 2014, at par by reference to the US$1.00 equivalent of Piltel debtexchanged, with fixed interest at 2.25% per annum, payable quarterly; and

 

•        For Yen Trade creditor, US$ Smart10-year debt maturing in June 2014, at par by reference to the US$1.00 equivalentof Piltel debt exchanged, with fixed interest at 2.25% per annum, payablequarterly and with an option to elect, by not less than 15 months’ priornotice, for an early repayment at a discount either on December 2007 at 52.5%of the relevant debt amount or on December 2008 at 57.5% of the relevant debtamount.

 

By the end of the offer period on May 31, 2004, Smarthad received offers from Piltel’s creditors representing approximately 69.4% inaggregate of the outstanding restructured Piltel debt.  In addition, it hadreceived, from a significant portion of the Piltel creditors who did notparticipate in the transaction, waivers to certain provisions of the agreementsgoverning Piltel’s restructured indebtedness, allowing Smart to close thetransaction.  Given the high level of acceptance from the Piltel creditors, theBoard of Directors of PLDT and Smart endorsed Smart’s decision to proceed withthe Piltel debt exchange transaction.

 

As a result, Smart became Piltel’s largest creditor,holding US$289 million of Piltel’s US$417 million restructured debt.  Based onthe options chosen by the participating creditors, Smart issued US$283.2million in new debt and paid US$1.5 million in cash.

 

** **

**Allocation**

 

 

**Option**

**Amount**

**%**

**Exchange**

**Ratio (%)**

**New Debt/Cash Outlay of Smart**

 

(in millions, except percentage)

 

 

 

 

 

2014 Smart Debt

US$280.1

67.2

100.0

US$280.1

2008 Smart Debt

5.0

1.2

57.5

2.9

2007 Smart Debt

0.4

0.1

52.5

0.2

Subtotal

 285.5

  68.5

 210.0

 283.2

Cash

3.8

0.9

40.0

1.5

Total

US$289.3

  69.4

 250.0

US$284.7

 

Further,in line with the previously announced intention of Smart to acquire PLDT’sequity holdings in Piltel, Smart entered, also on July 2, 2004, into a Sale andPurchase Agreement with PLDT to acquire the latter’s 59.3 million shares ofPiltel Series K, Class I Convertible Preferred Stock for Php2,066 million.  Thepayment was settled through an offset of amounts owed to Smart by PLDT arisingprimarily from interconnection charges.  At a later stage, Smart intends toacquire the common shares held by PLDT in Piltel, thereby consolidating PLDT’swireless holdings.

 

On July 9, 2004, Smart converted a total of 4.8 million shares ofPiltel Series K, Class I Convertible Preferred Stock into 820.3 million sharesof Piltel common stock, equivalent to 32.7% of the total outstanding shares ofcommon stock of Piltel after such conversion.  Such initial conversion resultedin diluting PLDT’s ownership in Piltel to 30.5%.  Smart intends to convert itsremaining 54.5 million shares of Piltel Series K, Class I Convertible PreferredStock into 9,260 million shares of common stock from the increase in authorizedcapital stock of Piltel.  Piltel has scheduled a special stockholders’ meetingon September 3, 2004 to approve this increase.  Once all the outstandingshares of Piltel Series K, Class I Convertible Preferred Stock are fullyconverted, Smart will hold a total of 10,080 million shares of common stock ofPiltel, equivalent to 85.6% of the resulting total outstanding shares of commonstock after such conversion.  In aggregate therefore, ownership of Piltel byPLDT and Smart will be 92.1%.

 

On July 19, 2004, Smart received confirmation from SEC that theissuance of 820.3 million shares of common stock of Piltel, equivalent to 32.7%of total outstanding shares of common stock of Piltel after the initialconversion will not trigger a mandatory tender offer requirement under Section19 of the Securities Regulation Code.  The SEC also confirmed that theconversion of the remaining preferred stocks made through an increase inPiltel’s capital stock is also exempt from mandatory tender offer requirement.

 

 

 

**26. Reclassification of Accounts**

** **

Wehave reclassified certain accounts in 2003 to conform with our 2004 financialstatements presentation.