Homex Development Corp. 20-F 2007
Incluye Cambios de Milbank, CMV, la revision de Jaime Cortez y Bylaws actualizados de la ultima reunion del consejo, GNG, Milbank al 25/junio
SECURITIES AND EXCHANGE
STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
For the fiscal year ended December 31, 2006
REPORT PURSUANT TO SECTION 13 OR 15(d) OF
for the transition period from to
o SHELL COMPANY REPORT PURSUANT TO SECTION 13
Date of event requiring this shell company report: N/A
Commission File Number: 1-32229
Desarrolladora Homex, S.A.B. de C.V.
Boulevard Alfonso Zaragoza M. 2204 Norte
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Securities registered or to be
registered pursuant to Section 12(g) of the Act:
Securities for which there is a
reporting obligation pursuant to Section 15(d) of the Act:
Indicate the number of outstanding shares of each of the issuers classes of capital or common stock as of the close of the period covered by the annual report:
335,869,550 Common Shares, without par value
Indicate by check mark whether the registrant is a well known seasoned issue as defined in Rule 405 of the
Yes x No o
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.
Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark which financial statement item the registrant has elected to follow:
Item 17 o Item 18 x
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x
* Not for trading but only in connection with the registration of American Depositary Shares, pursuant to the requirements of the Securities and Exchange Commission.
PRESENTATION OF FINANCIAL INFORMATION
Throughout this annual report, unless the context otherwise requires, the terms we, us, our, the Company and Homex refer to Desarrolladora Homex, S.A.B. de C.V. and its subsidiaries, including Controladora Casas Beta, S.A. de C.V. and its subsidiaries, which we acquired through a merger on July 1, 2005. In this annual report, Controladora Casas Beta, S.A. de C.V. is sometimes referred to as Beta. Effective June 28, 2006, our name is Desarrolladora Homex, S.A.B. de C.V. to reflect a change in corporate form. See Item 10. Additional Information.
This annual report includes our audited consolidated financial statements as of December 31, 2005 and 2006 and for each of the three years ended December 31, 2004, 2005 and 2006. Our consolidated financial statements and other financial information included in this annual report, unless otherwise specified, are restated in constant pesos as of December 31, 2006.
We prepare our financial statements in constant pesos and in accordance with Mexican Financial Reporting Standards, referred to as MFRS, which differ in certain significant respects from accounting principles generally accepted in the United States, referred to as U.S. GAAP. See Notes 26, 27 and 28 to our audited consolidated financial statements for information relating to the nature and effect of such differences and for a quantitative reconciliation of our majority net income and majority stockholders equity according to MFRS to consolidated net income and consolidated stockholders equity according to U.S. GAAP.
Under Bulletin B-10, issued by the Mexican Institute of Public Accountants, we are required to present our respective financial information in inflation-adjusted monetary units to allow for more accurate comparisons of financial line items over time and to mitigate the distortive effects of inflation on our financial statements. Unless otherwise indicated, all financial information in this annual report has been restated in pesos of constant purchasing power as of December 31, 2006. The Mexican National Consumer Price Index, or NCPI, increased 4.053276% from December 31, 2005 to December 31, 2006.
We are also required to determine any gain or loss in our respective monetary positions to reflect the effect of inflation on monetary assets and liabilities under MFRS. This is done by subtracting monetary liabilities from monetary assets and then adjusting net monetary position by the appropriate inflation rate for the period with the resulting monetary gain or loss reflected in earnings.
Pursuant to MFRS, we recognize revenues from the sale of homes based on the percentage of completion method of accounting, which requires us to recognize revenues as we incur the cost of construction. In this annual report, we use sell and refer to homes sold in connection with homes where:
· the home buyer has submitted all required documents in order to obtain financing from the mortgage lender;
· we establish that the home buyer will obtain the required financing from the mortgage lender;
· the home buyer has signed a purchase application; and
· the home buyer has made a down payment, where down payments are required.
We use deliver and refer to homes delivered in connection with homes for which title has passed to the buyer and for which we have received the sale proceeds.
Unless otherwise specified, references to US$, U.S. dollars and dollars are to the lawful currency of the United States. References to Ps. and pesos are to the lawful currency of Mexico. References to UDI and UDIs are to Unidades de Inversion, units of account whose value in pesos is indexed to inflation on a daily basis by Banco de Mexico, Mexicos central bank and published periodically.
This annual report contains translations of various peso amounts into U.S. dollars at specified rates solely for the convenience of the reader. You should not understand these translations as representations that the peso amounts actually represent these U.S. dollar amounts or could be converted into U.S. dollars at the rate indicated. Unless otherwise indicated, we have translated U.S. dollar amounts in this annual report at the exchange rate of Ps.10.84 to US$1.00, which was buying rate published by Banco de Mexico, expressed in pesos per U.S. dollar, on December 31, 2006. On June 30, 2007, such noon buying rate was Ps. 10.79 to US$1.00.
Unless otherwise indicated, references to UDIs are to UDIs at the Banco de Mexico UDI conversion rate of Ps.3.79 to UDI 1.00 on December 31, 2006. On June 30, 2007, Banco de Mexicos UDI conversion rate was Ps. 3.82 to UDI 1.00. Industry And Market Data
Market data and other statistical information used throughout this annual report are based on independent industry publications, government publications, reports by market research firms or other published independent sources. Some data are also based on our estimates, which are derived from our review of internal surveys, as well as independent sources. Although we believe these sources are reliable, we have not independently verified the information and cannot guarantee its accuracy or completeness.
MARKET SHARE AND OTHER INFORMATION
Other Information Presented
The standard measure of area in the real estate market in Mexico is the square meter (m2). Unless otherwise specified, all units of area shown in this annual report are expressed in terms of square meters, acres or hectares. One square meter is equal to approximately 10.764 square feet. Approximately 4,047 square meters (or 43,562 square feet) are equal to one acre and one hectare is equal to 10,000 square meters (or approximately 2.5 acres).
FORWARD LOOKING STATEMENTS
This annual report and the documents incorporated by reference into this annual report contain forward-looking statements. We may from time to time make forward-looking statements in our periodic reports to the SEC on Form 6-K, in our annual report to shareholders, in prospectuses, press releases and other written materials and in oral statements made by our officers, directors or employees to analysts, institutional investors, representatives of the media and others. Words such as believe, anticipate, plan, expect, intend, target, estimate, project, predict, forecast, guideline, should and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying these statements. Examples of these forward-looking statements include:
· projections of revenues, net income (loss), earnings per share, capital expenditures, dividends, capital structure or other financial items or ratios;
· statements of our plans, objectives or goals, including those relating to anticipated trends, competition, regulation, government housing policy and rates;
· statements about our future economic performance or that of Mexico; and
· statements of assumptions underlying these statements.
You should not place undue reliance on forward-looking statements, which are based on current expectations. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Our future results may differ materially from those expressed in forward-looking statements. Many of the factors that will determine these results and values are beyond our ability to control or predict. All forward-looking statements and risk factors included in this annual report are made as of the date on the front cover of this annual report, based on information available to us as of such date, and we assume no obligation to update any forward-looking statement or risk factor.
SELECTED FINANCIAL DATA
The following tables present our selected consolidated financial information as of and for the periods indicated. Certain information presented in these tables does not include our Beta subsidiary which we acquired on July 1, 2005. Information as of December 31, 2005 and 2006 and for each of the three years ended December 31, 2004, 2005 and 2006 are derived from and should be read together with our audited consolidated financial statements provided in this annual report beginning on page F-1. Our consolidated financial statements and other financial information included in this annual report, unless otherwise specified, are restated in constant pesos as of December 31, 2006.
The information in the following tables should also be read together with Item 5. Operating and Financial Review and Prospects
Our consolidated financial statements are prepared in accordance with Mexican Financial Reporting Standards (MFRS), which differs in certain significant respects from U.S. GAAP. Notes 26, 27 and 28 to our audited consolidated financial statements provide information relating to the nature and effect of such differences as they relate to us and provide a reconciliation to U.S. GAAP of consolidated net income and consolidated stockholders equity.
Pursuant to MFRS, our consolidated financial statements and the selected consolidated financial data set forth below restate the components of stockholders equity using NCPI factors and record gains and losses in purchasing power from holding monetary assets or liabilities. Under MFRS, non-monetary assets, with the exception of inventories and fixed assets of non-Mexican origin, are restated using the NCPI factors. Inventories are restated at current replacement costs while fixed assets of foreign origin are restated by the inflation rate of the country of origin prior to translation to pesos at the period-end exchange rate. MFRS also requires restatement of all financial statements to pesos of constant purchasing power as of the date of the most recent balance sheet presented, and accordingly all data in the consolidated financial statements and in the selected consolidated financial data set forth below have been restated in pesos of constant purchasing power as of December 31, 2006. The effects of inflation accounting under MFRS, other than for the use of a specific index for the restatement of fixed assets of foreign origin, have not been reversed in the reconciliation to U.S. GAAP.
On May 15, 2004, one of our affiliates, Econoblock, S.A. de C.V., merged with one of our subsidiaries, Desarrolladora de Casas del Noroeste, S.A. de C.V., or DECANO assuming all the rights and obligations of the merged company. Because the companies were under common control, the merger was recorded by recognizing the assets and liabilities transferred at their carrying amounts in the accounts of the transferring entity at the date of transfer, in a manner similar to a pooling of interests, based on the guidance provided by Statement of Financial Accounting Standards No. 141, Business Combinations, issued by the Financial Accounting Standards Board, and in accordance with Bulletin A-8, Supplemental Application of International Accounting Standards issued by the Mexican Institute of Public Accountants. Therefore, the accompanying financial statements of the merged company are included as if the merger had taken place as of the beginning of the earliest period presented. See Note 2 to our consolidated financial statements.
For fiscal year ended December 31, 2004, our gross profit margin under U.S. GAAP was significantly different from our gross profit margin under MFRS as a result of differences resulting from the application of the percentage of completion method of revenue recognition under MFRS, which requires that we recognize revenue as we incur the costs of construction, and the completed contract method of revenue recognition under U.S. GAAP, which requires that we recognize revenue upon collection of the sales price from the customer. Accordingly, for fiscal year ended December 31, 2004, the application of the proceeds from our initial public offering, completed in June 2004, to raw materials, labor and infrastructure costs incurred in connection with our housing development projects resulted in greater amount of revenue recognized and a higher gross profit margin in 2004 under MFRS compared to U.S. GAAP.
Except for ratios, percentages, per share, per ADS, and operating data, all amounts are presented in thousands of constant pesos.
For additional information regarding financial information presented in this annual report, see Presentation of Financial and Other Information.
Homex Selected Consolidated Financial Information.
(1) For U.S. GAAP purposes, sales are recognized when title passes to the home buyer, as opposed to the percentage-of-completion method of accounting used for MFRS purposes, under which we recognize income from homes we sell as we incur the cost of their construction.
(2) Represents interest income, interest expense, monetary position gains and losses, and foreign exchange gains and losses.
(3) Assumes all common shares are represented by ADSs. Each ADS represents six common shares. Any discrepancies between per share and per ADS amounts in the table are due to rounding.
(4) Employee statutory profit-sharing expense is classified as an operating expense under U.S. GAAP.
(5) Interest capitalized as part of the cost of inventories is included in operating expense under U.S. GAAP.
(6) Represents gross profit divided by total revenues.
(7) Represents operating income divided by total revenues.
(8) Represents net income divided by total revenues.
(9) EBITDA is not a financial measure computed under Mexican or U.S. GAAP. EBITDA derived from our MFRS financial information means MFRS net income excluding (i) depreciation and amortization (ii) net comprehensive financing costs (which is composed of net interest expense (income), foreign exchange gain or loss and monetary position gain or loss), and (iii) income tax expense and employee statutory profit-sharing expense.
EBITDA derived from our U.S. GAAP financial information means U.S. GAAP net income excluding (i) depreciation and amortization, (ii) interest expense and monetary position gain or loss, and (iii) income tax expense. EBITDA does not exclude interest income (Ps. 59,182 in 2006)
We believe that EBITDA can be useful to facilitate comparisons of operating performance between periods and with other companies in our industry because it excludes the effect of (i) depreciation and amortization which represent a non-cash charge to earnings, (ii) certain financing costs, which are significantly affected by external factors, including interest rates, foreign currency exchange rates, and inflation rates, which have little or no bearing on our operating performance, and (iii) income tax expense and, for EBITDA derived from our MFRS financial information, employee statutory profit-sharing expense.
EBITDA is also a useful basis of comparing our results with those of other companies because it presents operating results on a basis unaffected by capital structure. You should review EBITDA, along with net income (loss) and cash flow from operating activities, investing activities and financing activities, when trying to understand our operating performance. While EBITDA may provide a useful basis for comparison, our computation of EBITDA is not necessarily comparable to EBITDA as reported by other companies, as each is calculated in its own way and must be read in conjunction with the explanations that accompany it. While EBITDA is a relevant and widely used measure of operating performance, it does not represent cash generated from operating activities in accordance with Mexican or U.S. GAAP and should not be considered as an alternative to net income, determined in accordance with Mexican or U.S. GAAP, as an indication of our financial performance, or to cash flow from operating activities, determined in accordance with MFRS or U.S. GAAP, as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs.
EBITDA has certain material limitations as follows: (i) it does not include interest expense, which, because we have borrowed money to finance some of our operations, is a necessary and ongoing part of our costs and assisted us in generating revenue; (ii) it does not include taxes, which are a necessary and ongoing part of our operations; and (iii) it does not include depreciation, which, because we must utilize property and equipment in order to generate revenues in our operations, is a necessary and ongoing part of our costs. Therefore, any measure that excludes any or all of interest expense, taxes and depreciation and amortization has material limitations.
Reconciliation of Net Income (Loss) to EBITDA Computed from Our Mexican Financial Reporting Standards Financial Information.
Reconciliation of Net Income to EBITDA Computed from Our U.S. GAAP Financial Information.
(10) Net debt is not a financial measure computed under MFRS. We compute net debt as the sum of all debt less cash and cash equivalents, each of which is computed in accordance with MFRS. Management uses net debt as a measure of our total amount of leverage, as it gives effect to cash accumulated on our balance sheets. Management believes net debt provides useful information to investors because it reflects our actual debt as well as our available cash and cash equivalents that could be used to reduce this debt. Net debt has certain material limitations in that it assumes the use of our cash and cash equivalents to repay debt that is actually still outstanding and not to fund operating activities or for investment.
Reconciliation of Total Debt to Net Debt Derived from Our Mexican Financial Reporting Standards Financial Information.
A vote by the majority of our shareholders present at a shareholders meeting determines the declaration, amount, and payment of dividends. Under Mexican law, dividends may only be paid from retained earnings and if losses for prior fiscal years have been paid.
We have not paid dividends since we were formed in 1989 and we do not currently expect to pay dividends. We intend to devote a substantial portion of our future cash flow to funding working capital requirements and purchasing land. We may consider adopting a dividend policy in the future based on a number of factors, including our results of operations, financial condition, cash requirements, tax considerations, future prospects, and other factors that our board of directors and our shareholders may deem relevant, including the terms and conditions of future debt instruments that may limit our ability to pay dividends. We may also consider instituting a share repurchase program.
EXCHANGE RATE INFORMATION
The following table sets forth, for the periods indicated, the period-end, average, high and low exchange rate between the peso and U.S. dollar. The average annual rates presented in the following table were calculated by using the average of the exchange rates on the last day of each month during the relevant period. The data provided in this table is based on buying rates published by the Banco de Mexico. All amounts are stated in pesos, and we have not restated the rates in constant currency units. We make no representation that the Mexican peso amounts referred to in this annual report could have been or could be converted into U.S. dollars at any particular rate or at all.
(1) Rates shown are the actual low and high, on a day-by-day basis for each period.
(2) Average of month-end rates.
On June 30, 2007, Banco de Mexicos UDI conversion rate was Ps. 3.82 to UDI 1.00. Industry And Market Data
Except during a liquidity crisis lasting from September through December 1982, Banco de Mexico has consistently made foreign currency available to Mexican private sector entities (such as us) to meet their foreign currency obligations. Nevertheless, in the event of renewed shortages of foreign currency, it is possible that foreign currency will not continue to be available to private sector companies or that foreign currency that we may need to service foreign currency obligations or to import goods will not be available for purchase in the open market without substantial additional cost.
Risk Factors Related to Our Business
Decreases in the Amount of Mortgage Financing Provided by Mexican Government-Sponsored Agencies on which We Depend, or Disbursement Delays, Could Result in a Decrease in Our Sales and Revenues
The home building industry in Mexico has been characterized by a significant shortage of mortgage financing. Historically, the limited availability of financing has restricted home building and contributed to the current shortage of affordable entry-level housing. Substantially all financing for affordable entry-level housing in Mexico is provided by government-administrated housing funds such as:
· the National Workers Housing Fund Institute, or INFONAVIT (Instituto del Fondo Nacional para la Vivienda de los Trabajadores), which is financed primarily through mandatory contributions from the gross wages of private sector workers, and securitization of mortgages in the capital markets;
· the Social Security and Services Institute Public Sector Workers Housing Fund, or FOVISSSTE (Fondo para la Vivienda y la Seguridad y Servicios Sociales para los Trabajadores del Estado), which is financed primarily through mandatory contributions from the gross wages of public sector workers; and
· public mortgage providers such as the Federal Mortgage Society, or SHF (Sociedad Hipotecaria Federal, S.N.C., Institucion de Banca de Desarrollo), which is financed through its own funds as well as funds provided by the World Bank and a trust managed by Banco de Mexico.
See BusinessThe Mexican Housing Market.
The amount of funding available and the level of mortgage financing from these sources is limited and may vary from year to year.
These government-sponsored entities have significant discretion in terms of the allocation and timing of disbursement of mortgage funds. We depend on the availability of mortgage financing provided by these government-sponsored entities for substantially all of our sales of affordable entry-level housing, which sales represented 78.4% of our revenues and 72.4% of our operating income for 2006, and 78.1% of our revenues and 79.8% of our operating income for 2005.
Accordingly, our financial results are affected by policies and administrative procedures of INFONAVIT, FOVISSSTE, and SHF, as well as by the Mexican governments housing policy. The availability of mortgage financing granted by INFONAVIT AND FOVISSSTE has increased significantly during the past five years as compared to historical levels while financing from the SHF has decreased due to a change in policy at SHF in 2005. From 2002 through 2006, the amount of mortgage financing granted in terms of number of homes by these government-sponsored entities increased by 87.3% according to Softec, S.C. (Softec). However, future Mexican government housing finance policy may limit or delay the availability of mortgage financing provided by these agencies or otherwise institute changes, including changes in the methods by which these agencies grant mortgages and, in the case of INFONAVIT, the geographic allocation of mortgage financing, that could result in a decrease in our sales and revenues.
Disruptions in the operations of government-sponsored lenders, for any reason, may occur and result in a decrease in our sales and revenues.
Decreases or delays in the amount of funds available from INFONAVIT, FOVISSSTE, SHF or other sources, or substantially increased competition for these funds, could result in a decrease in our sales and revenues. These funds may not continue to be allocated at their current levels or in regions in which we have or can quickly establish a significant presence.
A Slowdown in the Mexican Economy Could Limit the Availability of Private-Sector Financing in Mexico, on which We Depend for Our Sales of Middle-Income Housing, which Could Result in a Decrease in Our Sales and Revenues
One of our principal strategies is to expand our operations in the middle-income and residential housing sector while maintaining our margins and without adverse affecting our financial condition. Our expansion into this market depends on private sector lenders, such as commercial banks and Limited Purpose Financial Companies and Multiple Purpose Financial Companies (Sociedades Financieras de Objeto Limitado o de Objetivo Múltiple, or sofoles or Sofomes), which provide a substantial majority of mortgage financing for the middle-income sector. The availability of private sector mortgage financing in Mexico has been severely constrained in the past as a result of volatile economic conditions in Mexico, the level of liquidity and stability of the Mexican banking system, and the resulting adoption of more stringent lending criteria and bank regulations. From 1995 through 2001, commercial bank mortgage lending was generally unavailable in Mexico. However, during the same period a number of sofoles were formed, serving the mostly middle-income market. Since 2002, private sector lenders have gradually increased their mortgage financing activities as a result of improved economic conditions and increasing consumer demand. However, it is possible that the amount of mortgage financing provided by private sector entities for the middle-income housing market will not increase or be maintained at current levels.
We Experience Significant Seasonality in Our Results of Operations
The Mexican affordable entry-level housing industry experiences significant seasonality during the year, principally due to the operational and lending cycles of INFONAVIT and FOVISSSTE. The programs, budgets, and changes in the authorized policies of these mortgage lenders are approved during the first quarter of the year. Payment by these lenders for home deliveries is slow at the beginning of the year and increases gradually through the second and third quarters with a rapid acceleration in the fourth quarter. We build and deliver affordable entry-level homes based on the seasonality of this cycle because we do not begin construction of these homes until a mortgage provider commits mortgage financing to a qualified home buyer in a particular development. Accordingly, we also tend to recognize significantly higher levels of revenue in the third and fourth quarters and our debt levels tend to be highest in the first and second quarters. We anticipate that our quarterly results of operations and our level of indebtedness will continue to experience variability from quarter to quarter in the future.
We May Experience Difficulty in Finding Desirable Land Tracts or Increases in the Price of Land May Increase Our Cost of Sales and Decrease Our Earnings
Our continued growth depends in large part on our ability to continue to be able to acquire land and to do so at a reasonable cost. As more developers enter or expand their operations in the Mexican home building industry, land prices could rise significantly and suitable land could become scarce due to increased demand or decreased supply. A resulting rise in land prices may increase our cost of sales and decrease our earnings. We may not be able to continue to acquire suitable land at reasonable prices in the future.
Increases in the Price of Raw Materials May Increase Our Cost of Sales and Reduce Our Net Earnings
The basic raw materials used in the construction of our homes include concrete, concrete block, steel, bricks, windows, doors, roof tiles and plumbing fixtures. Increases in the price of raw materials, including increases that may occur as a result of shortages, duties, restrictions, or fluctuations in exchange rates, could increase our cost of sales and reduce our net earnings to the extent we are unable to increase our sales prices. It is possible that the prices of our raw materials will increase in the future.
Because We Recognize Income From Sales of Homes Under the Percentage-of-Completion Method of Accounting Before Receiving Cash Revenue, Failed Closings Could Result in a Shortfall of Actual Cash Received and Require an Adjustment to Revenue Previously Recorded
In accordance with MFRS, and consistent with industry practice in Mexico, we recognize income from the sale of homes based on the percentage-of-completion method of accounting, which in Mexico requires us to recognize income as we incur the cost of construction. See Note 3 to our consolidated financial statements for a discussion of the percentage-of-completion method. However, we do not receive the proceeds from these sales until the homes are delivered. As a result, there is a risk that revenue in respect of the income recognized for accounting purposes will not be received due to the failure of a sale to close. Historically, an immaterial amount of our home sales have failed to close.
Loss of Services of Our Key Management Personnel Could Result in Disruptions to Our Business Operations
Our management and operations are dependent in large part upon the contributions of a small number of key senior management personnel, including Eustaquio Tomás de Nicolás Gutiérrez our chairman, and Gerardo de Nicolás Gutiérrez our chief executive officer. We do not have employment or non-compete agreements with or maintain key-man life insurance in respect of either of these individuals. Because of their knowledge of the industry and our operations and their experience with Homex, we believe that our future results will depend upon their efforts, and the loss of the services of any of these individuals for any reason could result in disruptions to our business operations.
Competition from Other Home Builders Could Result in a Decrease in Our Sales and Revenues
The home building industry in Mexico is highly competitive. Our principal competitors include public companies like Corporacion GEO, S.A. de C.V., Consorcio ARA, S.A. de C.V., URBI Desarrollos Urbanos, S.A. de C.V. and SARE, S.A. de C.V. and non-public homebuilders like Grupo SADASI, and RUBA Our ability to maintain existing levels of home sales depends to some extent on competitive conditions, including price competition, competition for available mortgage financing, and competition for available land. Competition is likely to continue or intensify. Competitive conditions may prevent us from achieving our goal of increasing our volumes of sales, or increased competition may result in a decrease in our sales and revenues.
Changes in Building and Zoning Regulations to which We Are Subject Could Cause Delays in Construction and Result in Increased Costs
The Mexican housing industry is subject to extensive building and zoning regulation by various federal, state, and municipal authorities. These authorities oversee land acquisition, development and construction activities, and certain dealings with customers. The costs associated with obtaining building and zoning permits, paying purchase or development fees and taxes, securing utility service rights and titling new homes are substantially higher in Mexico than in other countries and vary significantly from region to region in Mexico. We are required to obtain the approval of numerous federal, state, and local governmental authorities for our development activities. Changes in local circumstances or applicable law or regulations of such entities may require modifying or applying for additional approvals or changing our processes and procedures to comply with them. It is possible that these factors could cause delays in construction and result in increased costs.
Changes to Environmental Laws and Regulations to which We Are Subject Could Cause Delays in Construction and Result in Increased Costs
Our operations are subject to Mexican federal, state, and municipal environmental laws and regulations. Changes to environmental laws and regulations, or stricter interpretation or enforcement of existing laws or regulations, could cause delays in construction and result in increased costs.
Our Uninsured Housing Developments under Construction Could Suffer Unforeseen Casualties, which Could Result in Significant Losses to Us
We do not generally obtain liability insurance to cover housing developments under construction unless it is required by providers of construction financing. In the event that our uninsured housing developments suffer unforeseen casualties, we may experience significant losses.
Reduction in distributions from our operating subsidiaries could limit our ability to pay dividends and service our debt obligations
We are a holding company with no substantial operations and no significant assets other than the common shares of our majority-owned subsidiaries. We depend on receiving sufficient funds from our subsidiaries for virtually all our internal cash flow, including cash flow to pay dividends and service our debt obligations. As a result, our cash flow will be affected if we do not receive dividends and other income from our subsidiaries. The ability of our subsidiaries to pay dividends and make other transfers to us is limited by requirements that need to be satisfied under Mexican law. This ability may also be limited by credit agreements entered into by our subsidiaries.
Risk Factors Related to Mexico
Adverse Economic Conditions in Mexico May Result in a Decrease in Our Sales and Revenues
We are a Mexican company with substantially all of our assets located in Mexico and all of our revenues derived from operations in Mexico. As such, our business may be significantly affected by the general conditions of the Mexican economy.
Mexico experienced a period of slow growth from 2001 through 2003 primarily as a result of the downturn in the U.S. economy. In 2004, GDP grew by 4.2% and inflation increased to 5.2%. During 2005, GDP grew by 3% and inflation decreased to 3.3%. Finally in 2006, GDP grew by 4.5% and inflation increased to 4.1%.
Mexico also has, and is expected to continue to have, high real and nominal interest rates. The interest rates on 28-day Mexican government treasury securities (Certificados de la Tesoreria de la Federacion) averaged approximately 6.8%, 9.2% and 7.0% for 2004, 2005 and 2006 respectively. Accordingly, to the extent that we incur peso-denominated debt in the future, it could be at high interest rates.
If the Mexican economy falls into a recession or if inflation and interest rates increase significantly, consumer purchasing power will be decreased and demand for housing may decrease. In addition, a recession could affect our operations to the extent that we are unable to reduce our costs and expenses in response to falling demand. These factors could result in a decrease in our sales and revenues.
Fluctuations of the Peso Relative to the U.S. Dollar Could Result in an Increase in Our Cost of Financing and Limit Our Ability to Make Timely Payments on Foreign Currency Denominated Debt
Because substantially all of our revenues are and will continue to be denominated in pesos, if the value of the peso decreases against the U.S. dollar, our cost of financing will increase. Severe depreciation of the peso may also result in disruption of the international foreign exchange markets. This may limit our ability to transfer or convert pesos into U.S. dollars and other currencies for the purpose of making timely payments of interest and principal on our securities and any U.S. dollar-denominated debt that we may incur in the future. While the Mexican government has not restricted the right or ability of Mexican or foreign individuals to convert pesos into U.S. dollars or to transfer other currencies out of Mexico since 1982, the Mexican government could institute restrictive exchange rate policies in the future.
Political Events in Mexico May Result in Disruptions to Our Business Operations and Decreases in Our Sales and Revenues
The Mexican government exercises significant influence over many aspects of the Mexican economy. In addition, we depend on Mexican government housing policy, especially with regard to the operation of government-sponsored mortgage providers, for a large portion of our business. As a result, the actions of the Mexican government concerning the economy and regulating certain industries could have a significant effect on Mexican private sector entities, including Homex, and on market conditions, prices, and returns on Mexican securities.
The Mexican national elections held on July 2, 2000 ended 71 years of rule by the Institutional Revolutionary Party (Partido Revolucionario Institucional) with the election of President Vicente Fox Quesada, a member of the National Action Party (Partido Accion Nacional), resulted in the increased representation of opposition parties in the Mexican national congress and in municipal and gubernatorial positions. As a result of these elections and legislative elections held on July 6, 2003, no political party had a majority in the Mexican national congress. This shift in political power transformed Mexico from a one-party state to a multi-party democracy.
Presidential and Federal Congressional elections were held in Mexico on July 2, 2006. On July 6, 2006, the Federal Electoral Institute declared that Felipe Calderón Hinojosa, the presidential candidate of Partido de Acción Nacional ("PAN"), obtained 35.89% of the popular vote, while Andrés Manual López Obrador, presidential candidate of the Alianza por el Bien de Todos ("ABT"), received 35.31% of the popular vote. As a result of the elections, the Mexican Congress is currently divided politically, with PAN representing the largest group but failing to obtain majority control. On December 1, 2006, Mr. Calderón was officially sworn in as President before the Mexican Congress.
Mr. Calderón's presidency may also bring significant changes in laws, public polices and/or regulations that could affect Mexico's political and economic situation, which could adversely affect our business. Social and political instability in Mexico or other adverse social or political developments in or affecting Mexico could adversely affect us and our ability to obtain financing. It is also possible that political uncertainty may adversely affect Mexican financial markets.
We cannot provide any assurance that future political developments in Mexico, over which we have no control, will not have an unfavorable impact on our financial position or results of operations.
Developments in Other Countries May Result in Decreases in the Price of Our Securities
As is the case with respect to securities of issuers from other emerging markets, the market value of securities of Mexican companies is, to varying degrees, affected by economic and market conditions in other emerging market countries. Although economic conditions in these countries may differ significantly from economic conditions in Mexico, investors reactions to developments in any of these other countries may have an adverse effect on the market value of securities of Mexican issuers. In recent years, for example, prices of both Mexican debt securities and Mexican equity securities dropped substantially as a result of developments in Russia, Asia, and Brazil.
In addition, the direct correlation between economic conditions in Mexico and the United States has sharpened in recent years as a result of the North American Free Trade Agreement and increased economic activity between the two countries. As a result, economic downturns in the United States could have a significant adverse effect on the Mexican economy, which, in turn, could affect our financial condition and results of operations.
We Are Subject to Different Corporate Disclosure and Accounting Standards than U.S. Companies
A principal objective of the securities laws of the United States, Mexico, and other countries is to promote full and fair disclosure of all material corporate information. However, there may be less or different publicly available information about foreign issuers of securities than is regularly published by or about U.S. issuers of listed securities.
Risk Factors Related to Our Common Shares and ADSs
Future Issuances of Shares May Result in a Decrease of the Market Price of the ADSs and Common Shares
In the future, we may issue additional equity securities for financing and other general corporate purposes, although there is no present intention to do so. Any such sales or the prospect of any such sales could result in a decrease of the market price of the ADSs and common shares.
Future Sales of Our Shares by Our Principal Shareholders May Result in a Decrease of the Share Price of Our Securities
Our principal shareholders, including the de Nicolás family and Equity International Properties, hold 46% of our outstanding share capital. Actions by these shareholders with respect to the disposition of the shares they beneficially own, or the perception that such actions might occur, may decrease the trading price of our shares on the Mexican Stock Exchange and the price of the ADSs on the New York Stock Exchange. None of our principal shareholders is subject to any contractual restrictions that limit their right to dispose of their common shares.
Preemptive Rights May be Unavailable to Holders of Our ADSs, Which May Result in a Dilution of ADS Holders Equity Interest in Our Company
Under Mexican law if we issue new shares for cash as part of a capital increase, we must grant preemptive rights to our shareholders, giving them the right to purchase a sufficient number of shares to maintain their pro-rata interest unless we issue shares in a public offering. However, we may not be legally permitted to offer ADS holders in the United States the right to exercise preemptive rights in any future issuances of shares unless we file a registration statement with the U.S. Securities and Exchange Commission, or SEC, with respect to that future issuance of shares; or the issuance qualifies for an exemption from the registration requirements of the U.S. Securities Act of 1933, or Securities Act. At the time of any future
capital increase, we will evaluate the costs and potential liabilities associated with filing a registration statement with the SEC, the benefits of enabling U.S. holders of ADSs to exercise preemptive rights, and any other factors that we consider important in determining whether to file a registration statement to permit the exercise of mandatory preemptive rights. It is possible that we will not file such a registration statement. As a result, the equity interests of ADS holders would be diluted to the extent that ADS holders cannot participate in a future capital increase.
Under the terms of the ADSs, you may instruct the depositary, JPMorgan Chase Bank, to vote the ordinary shares underlying our ADSs, but only if we request the depositary to ask for your instructions. Otherwise, you will not be able to exercise your right to vote unless you withdraw the common shares underlying the ADSs and vote such common shares. However, you may not receive sufficient notice of a shareholders meeting to permit you to withdraw your common shares to allow you to cast your vote with respect to any specific matter. In addition, the depositary and its agents may not be able to send out or receive your voting instructions on time or carry them out in the manner you have instructed. As a result, you may not be able to exercise your right to vote.
In addition, Mexican law and our bylaws require shareholders to deposit their common shares with our secretary or with a Mexican custodian and provide evidence of their status as shareholders in order to attend shareholders meetings. ADS holders will not be able to meet this requirement and accordingly are not entitled to attend shareholders meetings. ADS holders will also not be permitted to vote the common shares underlying the ADSs directly at a shareholders meeting or to appoint a proxy to do so without withdrawing the common shares. Please see Description of American Depositary Receipts of this prospectus for further discussion regarding the deposit agreement and your voting rights.
Minority Shareholders Have Different Rights Against Us, Our Directors, or Our Controlling Shareholders in Mexico
Under Mexican law, the protections afforded to minority shareholders are different from those afforded to minority shareholders in the United States. For example, under Mexican Law, there are unclearly defined grounds on which a minority shareholder may bring an action against directors for breach of their fiduciary duty as permitted in most jurisdictions in the United States. The grounds for shareholder derivative actions under Mexican law are extremely limited, which effectively bars most of these kinds of suits in Mexico. Procedures for class action lawsuits do not exist under Mexican law. Therefore, it may be more difficult- for minority shareholders to enforce their rights against us, our directors, or our controlling shareholders than it would be for minority shareholders of a U.S. company.
It May Be Difficult to Enforce Civil Liabilities Against Us or Our Directors, Executive Officers and Controlling Persons
We are organized under the laws of Mexico. A majority of our directors, executives officers and controlling persons reside outside the U.S., all or a significant portion of the assets of our directors, executive officers and controlling persons, and substantially all of our assets, are located outside the U.S., and certain of the experts named in this annual report also reside outside the United States. As a result, it may be difficult for you to effect service of process within the United States upon these persons or to enforce against them or us in U.S. courts judgments predicated upon the civil liability provisions of the federal securities laws of the United States. We have been advised by our Mexican counsel. Cortes, Muñiz y Núñez Sarrapy, S.C., that there is doubt as to the enforceability, in original actions in Mexican courts, of liabilities predicated solely on U.S. federal securities law and as to the enforceability in Mexican courts of judgments of U.S. courts obtained in actions predicated upon the civil liability provisions of U.S. federal securities laws. See Limitation of Liability.
HISTORY AND DEVELOPMENT
Desarrolladora Homex, S.A.B. de C.V. is a corporation (sociedad anónima bursatil de capital variable) registered in Culiacán, Sinaloa, Mexico under the Mexican Companies Law (Ley General de Sociedades Mercantiles) on March 30, 1998 with an indefinite corporate existence. Our full legal name is Desarrolladora Homex, S.A.B. de C.V. Our principal executive offices are located at Boulevard Alfonso Zaragoza M. 2204 Norte, Fraccionamiento Bonanza, 80020, Culiacán Sinaloa, México. Our telephone number is +52 (667) 759-5800. Our legal domicile is Boulevard Alfonso Zaragoza Maytorena 2204 Norte, 80020, Culiacán, Sinaloa, México.
Our company traces its origins to 1989 and established its current structure in 1998. Beginning in 1999, various strategic investors including, in 2002, EIP, an entity affiliated with Equity Group Investments, L.L.C., an investment company founded by Samuel Zell, chairman of EIP, made equity investments in our company. These strategic investors have assisted us in developing and refining our operating and financial strategies. In addition, this increased access to equity financing has allowed us to accelerate our growth.
Our operations do not require substantial capital expenditures, as we lease, on a short-term basis, most of the construction equipment we use and subcontract a substantial portion of the services necessary to build the infrastructure of our developments. In 2006 we spent Ps.291.4 million on capital expenditures, primarily to purchase construction equipment and to support growth and to partially fund the corporate headquarters. Our purchases of land are treated as additions to inventory and not as capital expenditures.
We are a vertically-integrated home development company engaged in the development, construction and sale of affordable entry-level, middle-income and upper-income housing in Mexico. During 2006 we sold 44,132 homes, an increase of 39.7% over 2005 in which we sold 31,594 homes, an increase of 50.1% over the 21,053 homes sold in 2004. As of December 31, 2006 we had 67 developments under construction in 28 cities located in 18 Mexican states. We had total land reserves under title of approximately 53.0 million square meters as of December 31, 2006 on which we estimate we could build approximately 238,455 affordable entry level homes and approximately 26,621 medium income homes.
· We believe that we have grown faster than the three other largest publicly traded Mexican home development companies over the past three-year period ended December 31, 2006, based on:
· number of homes sold, reflected by our compounded annual growth rate of 44.8% versus a 14.4% average compounded annual growth rate for these other three companies;
· revenues, reflected by our compounded annual growth rate of 50.6% versus a 19.3% average compounded annual growth rate for these other three companies; and
· net income, reflected by our average compounded annual growth rate of 34.3% versus a 16.9% average compounded annual growth rate for these other three companies.
In addition, we believe our geographic diversity is one of the strongest among home builders in Mexico, reflected by our operations as of December 31, 2006 in 28 cities located in 18 Mexican states. Furthermore, our sales are not concentrated in a limited number of areas, compared to our competitors. In 2006, 30% of our revenues originated in the Mexico City
Metropolitan Area, the largest city in Mexico, and 18% in Guadalajara, the second largest city. The remaining revenues were originated in 26 cities.
From time to time, we evaluate investments in real estate projects and companies outside Mexico with a view toward replicating our business model in other jurisdictions. To this end, we may also enter into real estate development joint ventures and strategic alliances with the assistance of knowledgeable local partners. Such investments, if any, are not expected to be material in terms of cost or management time.
Mexicos developer-built housing industry is divided into three tiers according to cost: affordable entry-level, middle-income, and residential. We consider affordable entry-level homes to range in price between Ps.150,000 and Ps.400,000 (US$13,840 and US$36,905), middle-income homes to range in price between Ps.400,000 and Ps.1,850,000 (US$36,905 and US$170,688) and residential homes to have a price above Ps.1,850,000 (US$170,688). We currently focus on providing affordable entry-level and middle-income housing for our clients.
Our affordable entry-level developments range in size from 500 to 20,000 homes and are developed in stages typically comprising 300 homes each. During 2006, our affordable entry-level homes had an average sales price of approximately Ps.254,000 US$24,475. A typical affordable entry-level home consists of a kitchen, living-dining area, one to three bedrooms, and one bathroom. We are able to deliver a completed affordable entry-level home in approximately seven to ten weeks from the time a buyer obtains a mortgage approval. Currently, our largest affordable entry-level housing developments are located in the cities of Guadalajara, Monterrey, Nuevo Laredo, Tijuana, and the State of Mexico.
Our middle-income developments range in size from 400 to 2,000 homes and are developed in stages typically comprising 200 homes each. During 2006, our middle-income homes had an average sales price of approximately Ps.666,000 US$61,448. A typical middle-income home consists of a kitchen, dining room, living room, two or three bedrooms, and two bathrooms. We are able to deliver a completed middle-income home in approximately twelve to fourteen weeks from the time a buyer obtains a mortgage approval. In response to the increase in demand for middle-income housing in Mexico and the higher margins generally obtainable from middle-income housing developments, we launched nine middle-income developments in 2006 in the cities of Los Cabos, Cd. Juárez, Culiacán, Hermosillo, Morelia, Pachuca, Tuxtla, Vallarta and Veracruz. In 2006, 21.5% of our revenue was attributable to sales of middle-income housing compared to 21.9% in 2005.
We have developed specific procedures to identify land that is suitable for our needs and perform ongoing market research to determine regional demand for housing. Suitable land must be located near areas with sufficient demand, generally in areas where at least 500 homes can be built, and must be topographically amenable to housing development. We also consider the feasibility of obtaining required governmental licenses, permits, authorizations, and adding necessary improvements and infrastructure, include sewage, roads and electricity in balance with a purchase price that will maximize margins within the limits of available mortgage financing. We conduct engineering and environmental assessments, and in some cases urbanization and land composition studies, of land we consider for purchase in order to determine that it is suitable for construction. We budget the majority of our land purchases for the second half of the year to coincide with peak cash flow. As a result, our total land reserves fluctuate between our targeted 36 to 42 months of future home deliveries depending upon the time of year.
As of December 31, 2006, we had total land reserves under title of approximately 53.0 million square meters on which we estimate we could build approximately 238,455 affordable entry-level homes and 26,621 middle-income homes.
Our Relationship with Equity International Properties, Ltd.
Beginning in 1999, private investors, including in 2002, Equity International Properties, Ltd., or EIP, a privately held investment company specializing in real estate investments outside the United States, made a number of equity investments in Homex in an aggregate amount of US$32.0 million. EIP is affiliated with Equity Group Investments, L.L.C., or EGI, a privately-held investment company founded by Samuel Zell, chairman of EIP. EIP participates on our board of directors.
Standardized Business Processes
Over several years, we have developed and refined scalable and standardized business processes that allow us to enter new markets rapidly and efficiently. We have designed proprietary information technology systems that are intended to integrate and monitor our operations, including land acquisition, construction, payroll, purchasing, sales, quality control, financing, delivery, and maintenance. Our systems connect every one of our branch locations and help us monitor and control the home building process, to administer our client relations, and to oversee the financing process for our clients. This standardized model drives our growth, geographic diversification, and profitability, and is an integral component of our culture.
Efficient Working Capital Management
Our standardized processes allow us to time the construction and delivery of our homes and payment to our suppliers efficiently, which has allowed us to reduce our borrowing needs and minimize working capital requirements. We do not commence construction on a development stage until prospective buyers representing at least 10% of the planned number of homes in that stage have qualified to receive mortgage financing. We seek to maintain a short construction period of less than ten weeks for affordable entry-level housing and less than fourteen weeks for middle-income housing by using our systems to maximize the efficiency of our standardized methods. This speed allows us to maximize our working capital by minimizing overhead and coordinating payables with receivables, which greatly reduces our borrowing needs, and to minimize our costs.
We believe that we are one of the most geographically diversified home development companies in Mexico. As of December 31, 2006, our operations included 67 developments in 28 cities located in 18 Mexican states, which states represent 73% of Mexicos population, according to the Mexican Institute of Statistics, Geography and Computer Sciences, or INEGI (Instituto Nacional de Estadistica, Geografia e Informatica). Many of our developments are located in markets where no major competitors currently operate. For instance, our sales are not concentrated in limited areas, compared to our competitors. In 2006, 30% of our revenues originated in the Mexico City Metropolitan Area, the largest city in Mexico, and 18% in Guadalajara, the second largest city. The remaining revenues were originated in 26 cities. We believe that this geographic diversification reduces our risk profile as compared to our less-diversified competitors.
Experienced and Committed Management Team
Eustaquio Tomás de Nicolás Gutiérrez, our chairman, co-founded Homexs predecessor in 1989, and Gerardo de Nicolás Gutiérrez, our CEO, joined us in 1993. Our senior management team is comprised of executives with an average of 15 years experience in their respective areas of responsibility. Senior management owns an aggregate of 19.9% of our common shares. Consistent with our standardized business processes and geographic diversification, we delegate significant managerial responsibility to our seasoned team of branch managers. Upon completion of a development, we typically relocate our branch managers to another development in order to capitalize on their significant experience.
Maintain a Conservative Financial Position
We operate our business with the goal of reducing our exposure to interest rate and financing risk. We begin construction only when an approved buyer has qualified for a mortgage and, if applicable, made a down payment, thereby reducing our working capital needs. We believe the resulting financial flexibility enhances our ability to respond quickly to market opportunities and minimizes any negative effects that might result from a downturn in the economy.
Focus on Growth Consolidation and High-Return Opportunities
Our strategy is to consolidate our growth and to identify and target high return opportunities such as middle-income home sales. For the year ended December 31, 2006, 21.5% of our revenue came from middle-income home sales as compared to 21.9% in the same period in the prior year. We have developed an operating model that we believe allows us to enter underserved markets quickly and efficiently in order to take advantage of attractive opportunities offered by increased availability of public and private sector mortgage financing. In response to these opportunities, during the year ended December 31, 2006 we launched eleven new affordable entry-level developments in nine cities. Increased availability of private sector financing has also allowed us to expand our presence in the middle-income sector, which provides higher margins than affordable entry-level homes. We launched nine new middle-income developments in nine cities in 2006 We expect to continue to expand our operations in the higher margin middle-income sector.
Maintain Appropriate and Balanced Land Reserves
Our ability to identify, acquire, and improve land is critical to our success. Because the success of our operations depends, among other things, on managing our reserves efficiently, we continually review our portfolio and seek new development opportunities. We balance our need for additional land for growth with our desire to minimize leverage and avoid excessive land inventory. Our current goal is to maintain sufficient land reserves for a minimum of 36 to 42 months of future home deliveries. This time period allows us to undertake the lengthy processes necessary to prepare land for development, including identifying suitable parcels, locating adequate water supplies, obtaining required governmental permits and authorizations, and incorporating parcels into existing urban zones. We generally purchase large parcels of land in order to amortize our acquisition and infrastructure costs over a large number of homes, minimize competition, and take advantage of economies of scale. As of December 31, 2006, we had total land reserves of approximately 53.0 million square meters, which had an estimated aggregate capacity of approximately 238,455 affordable entry-level homes and approximately 26,621 middle-income homes.
Continue to Build and Contribute to Successful Communities
We seek to foster brand loyalty by enhancing the quality and value of our communities through building and donating schools, day-care facilities, parks and churches, and by providing other social services to residents of the housing we develop. We are committed to fulfilling our clients needs by responding to and meeting their demands. Through market studies, for example, we determine that home buyers prefer larger home sizes over higher priced finishing details. We allow our clients to improve these details at their own expense in order to offer more square footage per house than similarly priced homes offered by our competitors. We have also entered into agreements with furniture and appliance producers in order to offer our costumers the opportunity to furnish their homes by making purchases with credit lines that feature very attractive terms and which are mainly funded by the government and some private institutions. At the same time, we seek to become the best employer to our employees through training and educational opportunities. We seek to hire and keep talented employees and invest in training our workforce at all levels by offering programs such as middle-school equivalency courses for our construction laborers. We are committed to becoming the best customer to our suppliers by offering various payment alternatives and opportunities for cooperative growth, and through our factoring structure and other initiatives, including electronic ordering and payment systems. We believe that these factors make us a preferred home builder, employer, and customer and ultimately enhance our overall business.
We operate in geographically diverse markets throughout Mexico, from Tijuana in the north to Tapachula in the south, which represent 18 states and 28 cities as of December 31, 2006. In 2006, 30% of our revenues originated in the Mexico City Metropolitan Area, the largest city in Mexico, and 18% in Guadalajara, the second largest city. The remaining revenues were originated in 26 cities. We seek to continue operations in markets where we have a strong presence and to expand into underserved markets where demand for housing is high.
Total Homes Sold
The following table sets forth information on our historical sales by state. During 2003, 96.5% of the homes we sold were affordable entry-level homes and 3.5% of the homes we sold were middle-income homes. During 2004, 91% of the homes we sold were affordable entry-level homes and 9% of the homes we sold were middle-income homes. During 2005,
89.3% of the homes we sold were affordable entry-level homes and 10.7% of the homes we sold were middle-income homes and finally during 2006, 90.5% of the homes we sold were affordable entry-level and 9.5% of the homes we sold were middle-income homes.
THE MEXICAN HOUSING MARKET
We have obtained the following information from public sources, including publications and materials from the Mexican Ministry of Social Development, or SEDESOL (Secretaria de Desarrollo Social), the Mexican Population Council, or CONAPO (Consejo Nacional de Poblacion), INEGI, INFONAVIT, SHF, the Mexican Home Building and Development Industry Chamber of Commerce, or CANADEVI (Camara Nacional de la Industria de Desarrollo y Promocion de la Vivienda), CONAVI.and SOFTEC, S.C. We have not independently verified any of the information provided in this section.
The housing market in Mexico is influenced by several social, economic, industry, and political factors, including demographics, housing supply, market segmentation, government policy, and available financing.
National demographic trends drive demand for housing in Mexico. These trends include:
· sustained growth of a relatively young population;
· a high rate of new household formation;
· a high urban area growth rate; and
· a decrease in number of occupants per home.
According to INEGI, Mexico had a population of approximately 103.2 million in 2005, or approximately 25.2 million households. CONAPO estimates that there will be approximately 26.6 million households by the end of 2007 and approximately 28.6 million for 2010.
Mexico experienced a period of particularly high population growth during the 1970s and 1980s. The children born during this boom are contributing to the current increased demand for housing. The target consumer group for our homes is typically between 25 and 50 years old. In 2005, the 25-50 year-old age group represented approximately 38 million people or 35% of Mexicos total population. CONAPO estimates that by 2020, this age group will represent 46 million or 38% of Mexicos total population. The growth of this group is expected to contribute to increased housing demand in Mexico.
In 2001, CONAVI housing statistics indicated there was a shortage of 4.3 million homes in Mexico. This figure included the need for:
· 1.8 million new homes to accommodate multiple households currently living in a single home and households living in homes that must be replaced; and
· 2.5 million substandard homes in need of extensive repair and possible replacement. In addition, there are expected to be approximately 28.6 million households in Mexico by the end of 2010 and 31.9 million households by 2015.
CONAVI estimates that the growth of the Mexican population will generate a sustained demand for new homes of at least 766,000 units per year into the near future. To address the immediate shortage of 5.9 million homes as well as the anticipated new demand, the Mexican government has committed to financing and/or building at least 750,000 units a year in 2007.
In general, Mexicos developer-built (as opposed to self-built) housing market is divided into three sectors according to cost: affordable entry-level, middle-income and residential. The developer-built housing market includes homes built by contractors and developers, which are generally financed by mortgage providers. These homes are built with official permits, have municipal services, and are located on land that is registered and titled by the buyer. Developers must obtain proper zoning permits, install infrastructure, obtain any necessary financing commitments from lenders, and clear title to the land.
We categorize Mexicos developer-built housing market in the table below:
Housing Market Sectors
Government Policy and Available Financing
The size of the developer-built market depends to a great extent on the availability of mortgage financing. Due to liquidity crises occurring in the last twenty years, Mexico has experienced fluctuations in the availability of mortgage financing, particularly from private sector sources. As a result, the supply of affordable entry-level and middle-income housing has also remained low during this period.
During the 1980s, Mexican government policy focused on encouraging investment by the private sector, reducing development costs, and stimulating construction. Government-sponsored funds provided mortgage loan guarantees and direct payment and savings procedures. In 1994, Mexico experienced an economic crisis that led to the devaluation of the Mexican peso and a steep rise in interest rates. Smaller housing development companies went out of business, and the industry experienced a sharp fall in home sales between 1995 and 1996 due to diminished commercial bank lending.
Following the 1994 economic crisis, government policy sought to counterbalance the shortage of available financing and the increases in interest rates that resulted by focusing primarily on providing mortgages and construction financing via government-sponsored funds in the affordable entry-level sector. Government funds no longer provided development or sales activities and functioned instead as true savings-and-loan programs. Legislative reforms with regard to community-owned agricultural territories (ejidos), which made it possible to sell these formerly restricted properties, also increased the potential supply of land available for development. During this period, the government authorized sofoles that underwrite mortgages with funds and guarantees provided by government agencies, private investment, national, foreign or development bank loans, or through the Mexican capital markets. Furthermore, the government encouraged industry growth and private sector lending by supporting consolidation in the housing development industry.
Between 1997 and 1998, home sales stabilized, growing slightly in 1997 due to improving economic conditions. During 1999 and 2000, mortgage financing increased due to stabilizing economic conditions. The level of available financing grew as a result of Mexican government policies implemented following the crisis. Presidents Fox administrations goal was to provide 750,000 new mortgages per year by 2006. The administration set forth four objectives to achieve this growth:
· make more adequate land available, including infrastructure such as sewage and utilities;
· increase deregulation of the home building industry;
· encourage consolidation within the industry; and
· increase financing opportunities available to qualified home buyers.
In conjunction with these efforts, the Mexican legislature amended existing tax regulations in order to allow individuals to deduct a portion of their mortgage loan interest payments from their personal income taxes beginning in 2003, which the administration expects will lead to increased mortgage financing activity.
As of December 31, 2006, 680,268 mortgages were granted.
Current president Felipe Calderon has expressed that he will continue to support and promote the housing industry under three main lines: urban development, very affordable housing and home improvement. This administration goal is to provide 1,000,000 mortages per year by year 2010.
Sources of Mortgage Financing
Four principal sources provide mortgage financing for Mexicos housing market:
· Mortgage providers financed by mandatory employer or member contributions to public funds, including:
· INFONAVIT, serving private sector employees,
· FOVISSSTE, serving public sector employees, and
· SHF, which provides financing to credit-qualified homebuyers through financial intermediaries such as commercial banks or sofoles through funds from the World Bank, the Mexican government, and its own portfolio;
· Commercial banks and sofoles using their own funds; and
· Direct subsidies from public housing agencies and state housing trusts, including the Mexican Fund for Popular Housing, or Fonhapo (Fideicomiso Fondo Nacional de Habitaciones Populares).
According to CONAVI, these mortgage providers originated 680,268 home mortgages in 2006.
INFONAVIT was established by the Mexican government, labor unions, and private sector employees in 1972 as a mutual fund for the benefit of private sector employees. INFONAVIT functions as a savings and loan that provides financing primarily for affordable entry-level housing to credit-qualified home buyers. INFONAVIT makes loans for home construction, acquisition, or improvement to workers whose individual monthly earnings are generally less than five times the minimum monthly wage. It is funded through payroll contributions by private sector employers on behalf of their employees equal to 5% of their employees gross wages.
Home buyers qualify for INFONAVIT loans according to a point system whereby points are awarded based on income, age, amount of monthly contributions, and number of dependents, among others. INFONAVIT is phasing in a requirement that mortgage loan applicants make a down payment of between 5% to 10% of a homes total value, depending on price. The total loan amount may equal 100% of the cost of a home up to a maximum of between 300 and 350 times the monthly minimum wages, depending on geographical region. Repayment is calculated based on the borrowers wages, for a term of up to thirty years, and is made by direct wage deductions by employers. INFONAVIT generally grants loans at variable annual interest rates, which are indexed to inflation and based on a borrowers income. INFONAVIT allows for a one-year grace period with no interest or principal payments in the event of job loss and seeks direct repayment from the borrower after this period.
INFONAVIT has a program called Apoyo INFONAVIT that is directed at assisting higher-income borrowers obtain mortgage financing. Apoyo INFONAVIT customers can use the amounts contributed via payroll deductions to their INFONAVIT accounts as collateral for mortgage loans held by private sector lenders. In addition, these clients can apply their monthly INFONAVIT contributions toward the monthly mortgage payments owed to private sector lenders.
INFONAVIT recently inaugurated a new program called Cofinanciamiento, or Cofinavit, which is meant to assist high-income borrowers in a manner similar to the Apoyo INFONAVIT program. This new program enables Cofinavit customers to obtain a mortgage loan granted by INFONAVIT in conjunction with a commercial bank or a sofol. In addition, the customers can use their individual contributions in their INFONAVIT accounts as part of the financing or as collateral for the mortgage loan.
In addition, during late 2004 and early 2005, INFONAVIT initiated a new mortgage financing system, enabling INFONAVIT to expedite the issuance of mortgages in response to public demand by reducing documentation necessary for initial processing, permitting INFONAVIT to achieve its year-end goals. In addition, this new system enhances transparency and quality of service in connection with mortgage services.
INFONAVIT has made a commitment to provide 500,000 new mortgages in 2007 and 600,000 new mortgages in 2008. In addition, this agency has agreed to guarantee mortgage loans granted to employees by commercial banks and sofoles in the case of job loss. INFONAVIT expects to continue to modernize its operations and increase available financing by focusing on reducing payment defaults, participating more closely with the private sector, and implementing a voluntary savings program. INFONAVIT has also recently begun securitizing its loan portfolio in order to contribute to the growth of the secondary mortgage market in Mexico and expand its available sources of funds.
INFONAVIT provided approximately 62.0% of all mortgage financing in Mexico during the year ended December 31, 2006.
The Mexican government established FOVISSSTE in 1972 as a pension fund on behalf of public sector employees to provide financing for affordable housing. FOVISSSTE obtains funds from Mexican government contributions equal to 5% of public sector employee wages. The Mexican government administers FOVISSSTE similarly to INFONAVIT and permits FOVISSSTE to co-finance mortgage loans with private sector lenders in order to maximize available funds.
FOVISSSTE mortgage financing is typically available for housing ranging from the affordable entry-level sector through the lower end of the middle-income sector. Eligible applicants can obtain FOVISSSTE mortgage loans to purchase new or used homes, remodel or repair existing homes, finance construction of self-built homes, and make down payments on homes not financed through FOVISSSTE. FOVISSSTE loans are granted based on seniority within the public sector and allocated on a first-come first-served basis that also takes into account wages, number of dependents, and geographic location. Once the program establishes a number of approved applicants, it allocates mortgage loans by state based on historical demand.
FOVISSSTE generally grants loans at variable interest rates, indexed to inflation, for a maximum amount of approximately US$40,000. Repayment is calculated based on the borrowers wages, for a term of up to thirty years, and is made by direct wage deductions.
FOVISSSTE has publicly announced that it is seeking to increase the total number of mortgage loans it grants to 111,000 in 2007 and 120,000 in 2008.
FOVISSSTE provided approximately 6.4% of all mortgage financing in Mexico during the year ended December 31, 2006.
SHF was created in 2002 as a public sector development bank. SHF obtains funds from the World Bank, the Mexican government, and SHFs own portfolio and provides financing through intermediaries such as commercial banks and sofoles. In turn,, financial intermediaries administer SHF-sponsored mortgage loans, including disbursement and servicing.
Traditionally, SHF has been an important source of construction financing for housing developers by providing loans to commercial banks and sofoles (which in turn make direct bridge loans to developers). As of September 1, 2004, however, SHF provided funding for bridge loans only for homes with a purchase price of up to UDI 166,667 (approximately US$52,500 as of December 31, 2006). In lieu of funding bridge loans for homes with a higher purchase price (up to UDI 500,000 (approximately US$175,000 as of December 31, 2006), SHF will provide guarantees to support efforts by commercial banks and sofoles to raise capital for the financing of bridge loans to build such homes.
In addition, SHF makes financing available to commercial banks and sofoles for the purpose of providing individual home mortgages for affordable entry-level and middle-income homes. Historically, SHF has only financed a total amount equal to 80% to 90% of a homes value, generally for a maximum of approximately UDI 500,000 (approximately US$175,000 as of December 31, 2006). Beginning in 2005, however, in order to maximize the availability of affordable entry-level mortgages, SHF has replaced its financing of mortgages for homes with a purchase price greater than UDI 150,000 (approximately US$52,500 as of December 31, 2006) with credit enhancements and loan guarantees for commercial banks and sofoles to support their capital-raising efforts for the financing of such individual mortgage loans.
In terms of total homes financed, SHF (through commercial banks and sofoles) provided approximately 9.5% of all mortgage financing in Mexico during the year ended December 31, 2006.
Commercial Bank, Sofoles and Sofomes
Commercial banks generally target the middle-income and residential markets while sofoles generally target the affordable entry-level housing market and a portion of the middle-income housing market using SHF financing, and the balance of the middle-income housing market as well as the residential housing market using other sources of funding. Sofoles provide mortgage loans to borrowers using funds from securities offerings on the Mexican stock market, loans from Mexican and foreign lenders, their own portfolios, and public agencies such as SHF. They are not allowed to accept deposits from the public.
Although commercial banks, sofoles and sofomes provide mortgage financing directly to home buyers, the financing is commonly coordinated through the home builder. In order to obtain funding for construction, a home builder must submit proposals, including evidence of title to the land to be developed, architectural plans, necessary licenses and permits, and market studies demonstrating demand for the proposed housing. On approval, lenders provide construction financing and disburse funds as each stage of the housing development advances.
Commercial bank, sofol and sofom mortgage loans are typically available for housing ranging from the upper tier of the affordable sector through the residential sector. Nevertheless, during 2006 home -buyers qualifying for these private sector mortgages were generally assumed to be those purchasing homes with a value in excess of US$25,000. Private sector lenders require down payments of approximately 20% of a homes total value and make loans at fixed or variable annual interest rates based on consumer indices and inflation.
Commercial bank, sofol and sofom mortgage loans generally mature in ten to thirty years, and payments are sometimes adjusted for increases in the monthly minimum wage and rates of inflation.
We estimate that commercial banks, sofoles and sofomes (not including SHF financing) provided approximately 16.2% of all mortgage financing in Mexico during the year ended December 31, 2006.
Other Public Housing Agencies
Other public housing agencies such as Fonhapo and the Mexican Housing and Social and Urban Development Trust Fund, or Fividesu (Fideicomiso para Promover y Realizar Programas de Vivienda y Desarrollo Social y Urbano), operate at the federal and local levels and target mainly non-salaried workers earning less than 25 times the minimum annual wage, often through direct subsidies. These agencies lend directly to organizations such as state and municipal housing authorities, housing cooperatives, and credit unions representing low-income beneficiaries, as well as to individual borrowers. Financing is made available to both the self-built and developer-built markets. The total amount of available funds depends on the Mexican government budget.
Other public housing agencies provided approximately 5.9% of all mortgage financing in Mexico during the year ended December 31, 2006.
The Mexican home development and construction industry is highly fragmented and includes a large number of regional participants and a few companies with a more national market presence, including publicly traded companies like Corporacion GEO, S.A. de C.V., Consorcio ARA, S.A. de C.V. Sare Holding, Consorcio Hogar and URBI Desarrollos Urbanos, S.A. de C.V. as well as privately-held companies such as Grupo SADASI, Pulte Mexico (now Altta Homes) and Metta which do not publicly disclose their financial information.
All things considered , we estimate that approximately 1,200 different companies operate approximately 3,000 new home developments in Mexico at any one time. The following table sets forth approximate operating information on the largest home builders in Mexico with which we compete based on public information and our estimates:
Source: Companies fourth quarter financial releases.
(AEL) AEL refers to affordable entry-level housing.
(M) M refers to middle-income housing.
(R) R refers to residential housing.
We believe that we are well positioned to capture future growth opportunities in the affordable entry-level and middle-income housing sectors because of our principal business strengths and strategies, as described above.
The Mexican affordable entry-level housing industry experiences significant seasonality during the year, principally due to the operational and lending cycles of INFONAVIT and FOVISSSTE. The programs, budgets, and changes in the authorized policies of these mortgage lenders are approved during the first quarter of the year. Payment by these lenders for home deliveries is slow at the beginning of the year and increases gradually through the second and third quarters with a rapid acceleration in the fourth quarter. We build and deliver affordable entry-level homes based on the seasonality of this cycle because we do not begin construction of these homes until a mortgage provider commits mortgage financing to a qualified home buyer in a particular development. Accordingly, we also tend to recognize significantly higher levels of revenue in the third and fourth quarters and our debt levels tend to be highest in the first and second quarters. We budget the majority of our and purchases for the second half of the year to coincide with peak cash flows. As a result, our total land reserves fluctuate between our targeted 36 to 42 months of future home deliveries depending upon the time of year. We anticipate that our quarterly results of operations and our level of indebtedness will continue to experience variability from quarter to quarter^ in the future. Mortgage commitments from commercial banks and sofoles for middle-income housing are generally not subject to significant seasonality. We expect that as the percentage of our sales from middle-income housing increases, the overall seasonality of our results of operations should diminish.
We acquire land and plan the development of the homes we build through Proyectos Inmobiliarios de Culiacan, S.A. de C.V. or PICSA. Casas Beta del Centro, S. de R.L. de C.V., Casas Beta del Norte, S. de R.L. de C.V. and Casas Beta del Noroeste, S. de R.L. de C.V. Desarrolladora de Casas del Noroeste S.A. de C.V. or DECANO builds the developments that PICSA and Beta plans and promotes. We also receive executive and administrative services from Administradora PICSA, S.A. de C.V. and Altos Mandos de Negocios, S.A. de C.V. Homex Atizapan, S.A. de C.V., and Hogares del Noroeste, S.A. de C.V., which we operate and control as a joint venture with strategic partners in the region, owns one of our middle-income developments in the Mexico City area. AeroHomex, S.A. de C.V. provides transportation services to us. Through AAA Homex Trust, a Mexican trust, we establish factoring facilities for the settlement of trade payables to many of our suppliers. See Materials and Suppliers.
We develop customer awareness through our marketing and promotion efforts and referrals from satisfied customers. Through surveys we conduct through our marketing department and with sales agents, we gather demographic and market information to help us gauge the feasibility of new developments. We use these surveys to target groups of customers who share common characteristics or have common needs and offer packages of services, including housing models and financing sources, tailored to these groups.
We conduct advertising and promotional campaigns principally through print media, including billboards, fliers, and brochures designed specifically for the target market, as well as local radio and television. Moreover, we complement these campaigns with additional advertising efforts, including booths at shopping centers and other high traffic areas, to promote
open houses and other events. In some locations, we work with local employers and other groups to offer our homes to their employees or members and rely on positive word-of-mouth from satisfied customers for a large percentage of our sales. We also employ specially-trained salespeople to market our middle-income housing developments.
In general, we make sales either at sales offices or model homes. Using data we gather through our marketing efforts, we open sales offices in areas where we identify demand. As of December 31, 2006, we operated 67 sales offices, one in each of the developments we have established. Similarly, once we have purchased land and planned a development in regions we have identified as underserved, we build and furnish model homes to display to prospective customers. We have sales offices in each of our branches where trained corporate sales representatives are available to provide customers with relevant information about our products, including financing, technical development characteristics, and information about our competitors and their products. We provide the same information through trained corporate sales representatives at model homes. During 2005 we changed our method of compensating our sales agents to an exclusively performance-based commission method, typically 1.7% of the total home price.
We provide our customers with assistance through our sales departments from the moment they contact us, during the process of obtaining financing, and through the steps of establishing title on their new home. We have specialized sales areas in each of our offices that advise customers on financing options, collecting necessary documentation, and applying for a loan. We also help to design down payment plans tailored to each customers economic situation, although we do not provide any financing to our clients either at any point in the sale process. Once houses are sold and delivered, our specialized teams are available to respond to technical questions or problems during the two year warranty period following the delivery.
We assist qualified homebuyers in obtaining mortgage financing by participating in all the stages of applying for and securing mortgage loans from housing funds, commercial banks, and sofoles.
For sales of affordable entry-level homes, the process of obtaining customer financing generally occurs as follows:
· a potential home buyer enters into a purchase agreement and furnishes the necessary documentation to us;
· we review the documentation to determine whether all the requirements of the relevant mortgage provider have been met;
· we create an electronic credit file for each home buyer and submit it to the relevant mortgage provider for approval;
· we supervise and administer each client file via our database through all the phases of its processing and arrange for signing the required documentation once approval has been obtained;
· the home buyer makes any required down payment;
· once the home has been completed, the buyer signs the deed of transfer of title and the mortgage agreement; and
· we deliver the home to the buyer and register the title.
For sales of middle-income housing, the process of obtaining customer financing occurs as above, except that we collect a down payment of between 10% to 25% of a homes total sales price immediately following the execution of the purchase agreement, and the buyer signs the deed of transfer of title and the mortgage agreement when the home is approximately 95% complete.
In all cases, the procedures and requirements for obtaining mortgage financing are determined by the mortgage provider.
In general, the purchase agreement we enter into with a potential buyer binds the buyer to purchase the relevant home at the time that the home is completed. We collect an origination fee at the time that a buyer enters into a purchase agreement, which is returned (less a processing fee) if the sale does not close as a result of a buyers breach or if a lender declines a mortgage financing application. We have not experienced and do not expect to experience losses resulting from breaches of buyer purchase agreements because we generally have been able to locate other buyers immediately in these cases.
The purchase price of the homes we sell is denominated in pesos and is either fixed in the purchase agreement or is subject to an upward adjustment for the effects of inflation. In cases where the price of a home is subject to adjustment and increases due to inflation, any difference is payable by the buyer.
We internally develop most of the construction designs that we use. Our architects and engineers are trained to design structures to maximize efficiency and minimize production costs. Our standardized modular designs, which focus on quality and size of construction, allow us to build our homes quickly and efficiently. By allowing our clients to upgrade finishing details on a custom basis after homes are delivered, we experience savings that allow us to build larger homes than our competitors.
We use advanced computer-assisted design systems and combine market research data in order to plan potential developments. We believe that our comprehensive design and planning systems, which are intended to reduce costs, maintain competitive prices, and increase sales, constitute a significant competitive advantage in the affordable entry-level housing market. In order to further enhance the residential nature of our communities, we often design our developments as gated communities, install infrastructure for security surveillance, and arrange street layouts to foster road safety. We continue to invest in the development of design and planning construction systems to further reduce costs and continue to meet client needs.
We manage the construction of each development directly, coordinate the activities of our laborers and suppliers, oversee quality and cost controls, and assure compliance with zoning and building codes. We have developed efficient, durable, and low-cost construction techniques, based on standardized tasks, which we are able to replicate at all of our developments. We pay each laborer according to the number of tasks completed. We generally subcontract preliminary site work and infrastructure development such as roads, sewage, and utilities. Currently, we also subcontract the construction of a limited number of multi-unit middle-income apartment buildings in the Mexico City area.
Our designs are based on modular forms with defined parameters at each stage of construction, which are closely controlled by our central information technology systems. Our methods result in low construction costs and high quality products. We use substantially similar materials to build our middle-income homes, with higher quality components for certain finishing details and fixtures.
Materials and Suppliers
We maintain strict control over our building materials through use of a sophisticated electronic barcode identification system that tracks deliveries and monitors all uses of supplies. In general, we reduce costs by negotiating supply arrangements at the corporate level for the basic materials used in the construction of our homes, including concrete, concrete block, steel, bricks, windows, doors, roof tiles, and plumbing fixtures. We take advantage of economies of scale in contracting for materials and services in every situation and seek to establish excellent working relationships with our suppliers. In order to better manage our working capital, we also arrange lines of credit for many of our suppliers through a factoring program sponsored by Nacional Financiera, S.N.C., or NAFIN, a Mexican government-owned development bank, as well as certain additional financial institutions. We guarantee a portion of the financing provided to some of our suppliers for materials we buy from them during construction and repay these lenders directly with funds received when homes are delivered, which allows us to ensure suppliers are paid on time while minimizing our need to secure construction financing.
Our main suppliers include Cemex, S.A de C.V., Aceros Turia, S.A. de C.V., Aceros de Toluca, S.A. de C.V., Electroferretera Orvi, S.A. de C.V., Distribuidora Jama, S.A. de C.V, KS Tuberia, S.A. de C.V., Prefabricados y Sistemas, S.A. de C.V, Industrial Bloquera Mexicana, S.A. de C.V., Sanitarios Azulejos y Recubrimientos, S.A. de C.V., Mexicana de Laminacion, S.A. de C.V., Coacero, S.A. de C.V., Aceros el Arbol, S.A. de C.V., Grupo Forestal el Nayar, S.A. de C.V., Materiales para Construccion los Grandes, S.A. de C.V., Distribuidora de Acero Comercial, S.A. de C.V., Armasel, S.A. de C.V., Distribuidora Tamex S.A. de C.V., Masonite de Mexico S.A. de C.V., Termoplasticos del Centro, S.A. de C.V. and Logistica Distribucion y Servicios, S.A. de C.V.
Substantially all of the materials that we use are manufactured in Mexico and are delivered to our sites from suppliers local facilities on a time-efficient basis devised to keep low levels of inventory on hand. Our principal materials and supplies are readily available from multiple sources and we have not experienced any shortages or supply interruptions.
As of December 31, 2006, we had a total of approximately 11,948 employees . All of these employees were employed in Mexico. Total employees for 2005, 2004 and 2003 were 7,337, 8,559 and 7,911, respectively. Approximately 3,631 of our employees as of December 31, 2006 were administrative and managerial personnel.
We hire local labor forces for specific housing developments in each region that we operate in addition to experienced in-house personnel for supervisory and highly skilled work. We have an efficient information technology system that controls payroll costs. Our systems, using barcoded identification cards, track the number of tasks completed by each employee according to the parameters of our modular construction designs, assign salaries according to tasks and homes completed, and award incentives for each stage of the development based on team performance. We also streamline governmental and social security costs for our workforce using a strict attendance control system that captures information fed via our system through laborers identification cards.
We have implemented programs throughout Homex to assist our employees in obtaining elementary and middle-school equivalency degrees. We believe that these programs enhance our ability to attract and retain high quality employees. In 2004 and 2005 we were named as one of the top 50 Great Places to Work in Mexico by the Great Place to Work Institute, which is based in the United States. We were most recently honored with the 2007 Great Place to Work recognition.
As of December 31, 2006, approximately 99% of our construction employees were members of a national labor union of construction workers. The economic terms of our collective bargaining agreements are negotiated on an annual basis. All other terms and conditions of these agreements are negotiated every other year. We believe that we have an excellent working relationship with our workforce. We have not experienced a labor strike or any significant labor-related delay to date.
Customer Services and Warranties
We provide a two year warranty to all of our customers, which could apply to damages derived either from our operations or from defects in materials supplied by third parties (electrical installations, plumbing gas, waterproofing, etc.) or other circumstances outside our control. We have not historically incurred significant expenses under the warranty, although no assurance can be given that substantial claims might not be made in future periods. We do not currently have any material litigation or claims pending regarding such warranty with respect to home construction. We do not make provisions for the warranty but we obtain a security bond from our contractors to cover the claims from their customers and we withhold a guarantee deposit, which is reimbursed to our contractors once the warranty periods expire. In addition, we also obtain insurance for any defects, hidden or visible, that the construction may have, which also covers the warranty period
We seek to foster brand loyalty after construction is complete by strengthening community relations in the developments we build. As part of agreements with potential clients and governmental authorities, we donate land and build community infrastructures such as schools, day-care centers, churches, and green areas, often amounting to 10% to 15% of the total land area of the developments we construct. For a period of eighteen months, we also provide for community development specialists to assist in promoting community relations in certain developments by organizing neighborhood events such as competitions for beautiful homes and gardens.
Our operations are subject to Mexican federal, state, and local regulation as any other corporation doing business in Mexico. Some of the most relevant statutes, regulations, and agencies that govern our operations as a Home Development Company include the following:
· The Mexican General Human Settlements Act (Ley General de Asentamientos Humanos) regulates urban development, planning and zoning and delegates to the Mexico City and state governments the authority to promulgate urban development laws and regulations within their jurisdiction, including the Urban Development Act (Ley de Desarrollo Urbano) of each state where we operate, which regulates state urban development.
· The Mexican Federal Housing Act (Ley Federal de Vivienda) coordinates the activities of states, municipalities, and the private sector within the context of the housing industry. As in effect, the Federal Housing Act seeks to encourage and promote the construction of affordable entry-level housing.
· Local Building Regulations (Reglamentos de Construccion) and urban development plans promulgated by the states, Mexico City, and local municipalities control building construction, establish the required licenses and permits, and define local zoning and land-use requirements.
· The Mexican INFONAVIT Act (Ley del Instituto del Fondo Nacional de la Vivienda para los Trabajadores) requires that construction financing provided by INFONAVIT be granted only to registered developers that participate in public INFONAVIT bidding processes.
· The Federal Mortgage Society Organizational Act (Ley Organica de la Sociedad Hipotecaria Federal) encourages the development of the primary and secondary home mortgage markets by authorizing SHF to grant home mortgage loans pursuant to the Federal Mortgage Society General Financing Conditions (Condiciones Generales de Financiamiento de Sociedad Hipotecaria Federal), which regulate the general terms and conditions on which these loans may be granted.
· The Mexican Federal Consumer Protection Act (Ley Federal de Proteccion al Consumidor) promotes and protects consumer rights and seeks to establish equality and legal certainty in relationships between consumers and commercial suppliers.
Our operations are subject to the Mexican General Environmental Protection Act (Ley General del Equilibrio Ecologico y la Proteccion al Ambiente), the Mexican General Waste Prevention and Management Act (Ley General para la Prevencion y Gestion Integral de los Residuos), and the related regulations. The Mexican Ministry of the Environment and Natural Resources (Secretaria del Medio Ambiente y Recursos Naturales) and the Mexican Federal Environmental Protection Agency (Procuraduria Federal de Proteccion al Ambiente) are the federal governing authorities responsible for enforcing environmental regulations in Mexico, including environmental impact studies, which are required for obtaining land-use permits, investigations, and audits, as well as to provide guidelines and procedures regarding the generation, handling, disposal, and treatment of hazardous and non-hazardous waste.
We are committed to conducting our business operations in a manner that minimizes environmental impact. Our business processes include procedures that are intended to ensure compliance with the Mexican General Environmental
Protection Act, the Mexican General Waste Prevention and Management Act, and the related regulations. In accordance with these laws, we build our homes with metal instead of wooden beams and treat waste water. We plant trees on the land of homes we sell and provide plantings on land that we donate to our communities. Our internal teams conduct environmental studies for each project and produce environmental reports that are intended to identify environmental issues and assist in project planning in order to minimize adverse environmental effects, such as limiting the felling of trees during the process of urbanizing rural land for use in our developments. Our costs include the cost of complying with applicable environmental regulations. To date, the cost of complying and monitoring compliance with environmental regulations applicable to us has been immaterial.
We are a holding company and conduct our operations through subsidiaries. The table below sets forth our principal subsidiaries as of December 31, 2006.
(1) On September 1, 2004, the Company acquired an additional 4.14% ownership interest in Desarrolladora de Casas del Noroeste, S.A. de C.V. (DECANO), from the former owners of Econoblock, which merged into DECANO in 2004 and resulted in DECANO becoming a wholly-owned subsidiary of the Company.
(2) The balance of the shares of Homex Atizapan is held by the individual who owns the land being developed by this subsidiary.
(3) The balance of the shares of Hogares del Noroeste, S.A. de C.V. is held by a Mexican corporation that owns the land being developed by this subsidiary.
DISCUSSION AND ANALYSIS OF FINANCIAL
The following discussion should be read in conjunction with our audited consolidated financial statements and their accompanying notes included elsewhere herein. Our consolidated financial statements and other financial information included in this annual report, unless otherwise specified, are restated in constant pesos as of December 31, 2006. Our consolidated financial statements have been prepared in accordance with Mexican Financial Reporting Standards (MFRS) which differs in certain respects from U.S. GAAP as described in Notes 26, 27 and 28 to our audited consolidated financial statements.
This annual report contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to these differences include, but are not limited to, those discussed below and elsewhere in this annual report, particularly in Cautionary Statement Regarding Forward-Looking Statements and Risk Factors.
Critical Accounting Estimates
Our consolidated financial statements have been prepared in accordance with MFRS, which requires that we make certain estimates and use certain assumptions that affect the amounts reported in our consolidated financial statements and the accompanying notes. Although these estimates are based on our best knowledge of current events, actual results may differ. Our critical accounting estimates are listed below
Goodwill and Intangible Assets
We are required to apply the purchase method of accounting for all business combinations which requires the recognition of certain acquired intangible assets separate from goodwill. Goodwill and other intangibles determined to have an indefinite life are no longer to be amortized but are to be tested for impairment at least annually. In our allocation of the purchase price of the acquisition of Controladora Casas Beta, S.A. de C.V., we identified and allocated a value to intangible assets totaling Ps.470.4 million (Ps. 455.3 million at historic cost) related to the Beta trademark and Ps.135.3 million (Ps. 126.8 million at historic cost) related to the value of the backlog which represents the houses under construction as of the date of the Beta acquisition. As of December 31, 2006, the net book value of the Beta trademark was Ps.318.6 million. The backlog has been completely amortized as of December 31, 2006. The valuation of these intangible assets required us to use our judgment. We also recorded goodwill related to the acquisition of Controladora Casas Beta, S.A. de C.V. of Ps.705.3 million. The annual impairment testing requirements require us to use our judgment and could require us to write down the carrying value of our goodwill and other intangible assets in future periods.
Revenue and Cost Recognition
We use the percentage-of-completion method of accounting for revenues and costs, measuring progress towards completion in terms of actual costs incurred versus budgeted expenditures for each stage of a development. Under the percentage-of-completion method of accounting, revenues for work completed are recognized prior to receipt of actual cash proceeds. We receive cash proceeds from the sale of a home at closing when title to the home is transferred to the buyer. We include revenues in excess of billings as accounts receivable on our balance sheet, and any cash proceeds we receive as advance payments prior to completion of the actual work related to the payments, including customer down payments, are included in current liabilities as advances from customers. Please see Note 3 to the consolidated financial statements.
The percentage-of-completion method of accounting requires us to determine on a monthly basis the percentage of completion of each stage of a development based on actual expenditures incurred to date versus budgeted expenditures. To the extent that the estimated costs of a development stage differ from the actual costs incurred, our recognized revenues could change. In addition, to the extent that estimated revenues derived from home sales per development stage differ from revenues derived from home deliveries per development stage, our recognized revenues could change.
We apply the percentage-of-completion method to recognize revenues from our housing development subject to the following conditions.
· the home buyer has submitted all required documents in order to obtain financing from the mortgage lender;
· we establish that the home buyer will obtain the required financing from the mortgage lender;
· the home buyer has signed a purchase application; and
· the home buyer has made a down payment, where down payments are required.
Beta, which we acquired on July 1, 2005, uses a similar percentage-of-completion method.
We recognize deferred tax assets and liabilities based on the differences between the financial statements carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and, if necessary, establish a valuation allowance based on historical taxable income, projected future taxable income and the expected timing of the reversals of existing temporary differences. If these estimates and related assumptions change in the future, we may be required to record a valuation allowance against deferred tax assets resulting in additional income tax expense. Please see Notes 3 and 22 to our consolidated financial statements.
The following table sets forth selected data for the periods indicated, restated in constant pesos as of December 31, 2006 and also expressed as a percentage of our total revenues.
(1) Represents interest income, interest expense, monetary position gains and losses, and foreign exchange gains and losses.
Results of Operations for the Year Ended December 31, 2006 Compared to the Year Ended December 31, 2005
Revenues. Total revenues increased 45.8% to Ps.12,952.6 million in 2006 from Ps.8,882.2 million in 2005 primarily due to a 39.7% increase in the number of homes sold and an increase of 4.4% in the average price for all homes. Affordable entry-level homes represented 78.5% of total revenues in 2006 compared to 78.1% in 2005. Middle-income homes represented 21.5% of total revenues in 2006 compared to 21.9% in 2005. We sold 4,192 middle-income homes in 2006 compared to 3,391 middle-income homes in 2005, and sold 39,940 affordable entry-level homes in 2006 as compared with 28,203 affordable entry-level homes in 2005. In 2006, Homex reported other revenues of Ps.215 million compared to Ps.253 million in 2005. This decline was mainly driven by an extraordinary sale of ready mix concrete and concrete block in the third quarter of 2005 to a third party.
Gross Profit. Costs increased 43.2% in 2006 to Ps.8,858.0 million from Ps.6,186.0 million in 2005, due primarily to the incorporation of Beta into the Companys operations as well as the increased volume, as described above. Gross profit increased by 51.9% to Ps.4,094.6 million from Ps. 2,696.1 million in 2005. Our gross profit margin improved to 31.6% in 2006 from 30.4% in 2005.
Selling and Administrative Expenses. Selling and administrative expenses increased 48.8% to Ps. 1,309.9 million in 2006 from Ps.880.1 million in 2005. This increase was due principally to the increased sales, as well as the amortization of a portion of the value of the Casas Beta brand equivalent to 12 months during 2006, resulting in a non-cash impact in the Selling and General Administrative Expenses line of approximately Ps. 91million. As a percentage of sales, selling and administrative expenses increased to 10.1% in 2006 from 9.9% in 2005. The increase in selling and administrative expenses as a percentage of sales was attributable to the 45.8% increase in sales as well as the recognition of the value of the Beta brand.
Net Comprehensive Financing Cost. Net comprehensive financing cost (comprised of interest income, interest expense, monetary position gains and losses, and foreign exchange gains and losses) increased by 60.1% to Ps.762.3 million in 2006 to Ps.476.1 million in 2005. Net comprehensive financing cost as a percentage of sales increased to 5.9% in 2006 from 5.4% in 2005.
Net interest expense increased by 45.2% to Ps.545.3 million in 2006 from Ps.375.4 million in 2005. This increase was primarily due to the payment of the interest of the Senior Guaranteed Notes due 2015. Interest income increased by 72.8% to Ps.104.9 million in 2006 from Ps.60.7million in 2005 due to higher cash balances throughout the year.
We had a foreign exchange loss of Ps.143.0 million in 2006 as a result of a higher debt level exposure in U.S. dollar denominated debt impacted by the peso appreciation of approximately 1.89% against the U.S. dollar during 2006, compared to a foreign exchange loss of Ps.68.1 million in 2005.
Monetary position loss increased from Ps.32.6 million in 2005 to Ps.74.0 million in 2006 as a result of a decrease in our net monetary liability position.
Income Tax Expense and Employee Statutory Profit-Sharing Expense. Income tax expense increased 46.0% from Ps.442.3 million in 2005 to Ps.645.6 million in 2006 due principally to increased revenues and income before taxes. The 31.2% effective income tax rate in 2006 remained relatively stable from the 32.4% in 2005. Employee statutory profit-sharing expense increased from Ps.10.0 million in 2005 to Ps.35.4 million in 2006 as a result of the increase in revenue and income before taxes.
Net Income. Net income increased by 52.1% to Ps.1,387.4 million in 2006 from Ps.912.1 million in 2005 as a result of the factors described above.
Results of Operations for the Year Ended December 31, 2005 Compared to the Year Ended December 31, 2004
Revenues. Total revenues increased 55.4% to Ps.8,882.2 million in 2005 from Ps.5,713.9 million in 2004 primarily due to a 50.9% increase in the number of homes sold, an increase of 2.3% in the average price of our affordable entry-level homes, and additional revenue recognized in connection with increased sales of middle-income homes, for which the revenue per home sold is substantially greater than for affordable entry-level homes. We sold 3,391 middle-income homes in 2005 compared to 1,912 middle-income homes in 2004, and sold 28,203 affordable entry-level homes in 2005 as compared with 19,141 affordable entry-level homes in 2004.
Gross Profit. Costs increased 55.5% in 2005 to Ps.6,186.0 million from Ps.3,978.5 million in 2004, due primarily to the incorporation of Beta into the Companys operations as well as the increased volume, as described above. Gross profit increased by 55.4% to Ps.2,696.1 million from Ps. 1,735.3 million in 2004. Our gross profit margin remained stable at 30.4% in 2005 from 30.4% in 2004.
Selling and Administrative Expenses. Selling and administrative expenses increased 88.8% to Ps.880.1 million in 2005 from Ps.466.0 million in 2004. This increase was due principally to the addition of Beta to the Companys results as well as higher aggregate sales commissions resulting from the increase in the number of homes sold and the increase in the number of administrative personnel required to support our expanding operations, as well as the increase in training expense for the sales force and branch managers. As a percentage of sales, selling and administrative expenses increased to 9.9% in 2005 from 8.2% in 2004. The increase in selling and administrative expenses as a percentage of sales was mainly attributable to the addition of Beta to the Companys results.
Net Comprehensive Financing Cost. Net comprehensive financing cost (comprised of interest income, interest expense, monetary position gains and losses, and foreign exchange gains and losses) increased by 177.4% from Ps.171.6 million in 2004 to Ps.476.1 million in 2005. Net comprehensive financing cost as a percentage of sales increased from 3.0% in 2004 to 5.4% in 2005.
Net interest expense increased by 308.7% from Ps.91.9 million in 2004 to Ps.375.4 million in 2005. This increase was primarily due to an increase in the Companys debt level, mainly reflecting borrowings under the credit facility entered into in connection with the acquisition of Beta, the Betas existing debt during the period as well as the Companys commercial paper program. Interest income increased by 20.7% to Ps.60.6 million in 2005 from Ps.50.3 million in 2004 due to higher cash balances throughout the year.
We had a foreign exchange loss of Ps.68.1 million in 2005 as a result of a higher debt level exposure in U.S. dollar terms impacted by the peso appreciation of approximately 5.0% against the U.S. dollar during 2005, compared to a foreign exchange gain of Ps.7.6 million in 2004 as a result of the dollar balance that we held after our initial public offering and a peso depreciation of approximately 7.0% against the U.S. dollar, during the first quarter of 2003.
Monetary position loss decreased from Ps.87.4 million in 2004 to Ps.32.6 million in 2005 as a result of a decrease in our net monetary asset position.
Income Tax Expense and Employee Statutory Profit-Sharing Expense. Income tax expense increased 21.1% from Ps.365.2 million in 2004 to Ps.442.3 million in 2005 due principally to increased revenues and income before taxes. The 32.4% effective income tax rate in 2005 remained relatively stable from the 31.9% in 2004. Employee statutory profit-sharing expense increased from Ps.9.2 million in 2004 to Ps.10.0 million in 2005 as a result of the increase in revenue and income before taxes.
Net Income. Net income increased by 18.5% to Ps.912.1 million in 2005 from Ps.769.6 million in 2004 as a result of the factors described above.
Government Policy and Available Financing
The size of the developer-built market depends to a great extent on the availability of mortgage financing. Due to liquidity and general economic crises occurring in the last twenty years, Mexico has experienced fluctuations in the availability of mortgage financing, particularly from private sector sources. As a result, the supply of affordable entry-level and middle-income; housing has also remained low during this period.
During the 1980s, Mexican government policy focused on encouraging investment by the private sector, reducing development costs, and stimulating construction. Government-sponsored funds provided mortgage loan guarantees and direct payment and savings procedures. In 1994, Mexico experienced an economic crisis that led to the devaluation of the Mexican peso and steep rise in interest rates. Smaller housing development companies went out of business, and the industry experienced a sharp fall in home sales between 1995 and 1996 due to diminished commercial bank lending.
Following the 1994 economic crisis, government policy sought to counterbalance the shortage of available financing and the increases in interest rates that resulted by focusing primarily on providing mortgages and construction financing via government sponsored funds in the affordable entry-level sector. Government funds no longer provided development or sales activities and functioned instead as true savings-and-loan programs. Legislative reforms with regard to community-owned agricultural territories (ejidos), which made it possible to sell these formerly restricted properties, also increased the potential supply of land available for development. During this period, the government authorized sofoles that underwrite mortgages with funds and guarantees provided by government agencies, private investment, national, foreign or development bank loans, or through the Mexican capital markets. Furthermore, the government encouraged industry growth and private sector lending by supporting consolidation in the housing development industry.
Between 1997 and 1998, home sales stabilized, growing slightly in 1997 due to improving economic conditions. During 1999 and 2000, mortgage financing increased due to stabilizing economic conditions. The level of available financing has continued to grow as a result of Mexican government policies implemented. Following the crisis President Foxs administrations goal was to provide 750,000 new mortgages per year by 2006 pursuant to its national housing, plan. The administration set forth four objectives to achieve this growth:
· make more adequate land available, including infrastructure such as sewage and utilities;
· increase deregulation of the home building industry;
· encourage consolidation within the industry; and
· increase financing opportunities available to qualified home buyers.
In conjunction with these efforts, the Mexican legislature amended existing tax regulations in order to allow individuals to deduct a portion of their mortgage loan interest payments from their personal income taxes beginning in 2003, which the administration expects will lead to increased mortgage financing activity.
The actions taken by during President Foxs administration to accelerate housing and mortgage supply in Mexico, resulted in the emergence of a very active housing industry supported by solid private and public institutions. The developer-built market has continued to expand due to higher levels of available mortgage financing, especially through government-sponsored funds such as INFONAVIT, SHF and FOVISSSTE. According to SOFTEC from 2000 to 2006 mortgage providers in Mexico granted 3,253,026 million of mortgages, a 108.4% growth from 326,419 in 2000 to 680,268 in 2006. Between 2003 and 2006, CONAPO estimates that the housing stock increased by another 2.0 million homes.
Current president Felipe Calderon intends to continue to support and promote the housing industry under three main lines: urban development, very affordable housing and home improvement. This administration goal is to provide 1,000,0000 mortages by year 2010.
Changes in the availability of mortgage financing from government agencies could adversely affect us. See Risk FactorsRisk Factors Related to our BusinessDecreases in the Amount of Mortgage Financing Provided by Mexican Government-Sponsored Agencies on which We Depend, or Disbursement Delays, Could Result in a Decrease in Our Sales and Revenues.
LIQUIDITY AND CAPITAL RESOURCES
We have experienced, and expect to continue to experience, substantial liquidity and capital resource requirements, principally to finance development and construction of homes and for land inventory purchases.
As of December 31, 2006, we had Ps.2,331.6 million of cash and cash equivalents and Ps.3,496.1 million of outstanding indebtedness for money borrowed (none of which was construction financing provided by sofoles for developments under construction), as compared to Ps.1,372.2 million of cash and cash equivalents and 3,489.4 million of outstanding indebtedness as of December 31, 2005.
Although we do not commence construction of any development until the availability of mortgage financing for qualified homebuyers is assured, we do acquire land and perform licensing, permitting, and certain infrastructure development activities prior to receiving confirmation of the availability of mortgage financing. Historically, we have financed our development and construction activities through internally generated funds, commercial paper programs, and bridge loans.
Our primary sources of liquidity are:
· cash flow from operations;
· financing from sellers of land and, to a lesser extent, suppliers of materials;
· commercial banks, and other financial institutions; and
· down payments from home buyers.
We believe that our working capital will be sufficient during the next 12 months to meet our liquidity requirements.
The table below sets forth information regarding our outstanding debt as of December 31, 2006.
Debt Outstanding as of December 31, 2006
(1) Issued in an aggregate principal amount of US$250 million with a coupon rate of 7.50%. We entered into a foreign exchange swap to hedge the foreign exchange risk associated with the principal amount of this debt at a rate of Ps.10.83 per U.S. dollar and at an average weighted cost of 2.92%.
(2) TIIE refers to the 28-day Mexican interbank rate (Tasa de Interes Interbancaria de Equilibrio), which was 7.37% as of December 31, 2006. Source: www.banxico.org.mx
Our total indebtedness increased to Ps. 3,496.1 million as of December 31, 2006 from Ps. 3,489.5 million as of December 31, 2005 mainly as a result of the net effect of financial lease maturities and exchange rate adjustments in our U.S. dollar denominated debt.
As of December 31, 2006, our short-term debt was Ps.13.3 million mainly as a result of equipment lease obligations. Our long-term debt was Ps.3,482.8 million, including an equipment lease obligation in the amount of Ps.13.8 million, the remaining balance of the Beta acquisition facility of Ps.540.5 million and our Senior Guaranteed Notes in the aggregate principal amount of Ps.2,928.5 million, which includes the current outstanding mark to market principal only swap (the principal only swap). In connection with the Beta acquisition, we entered into an unsecured credit facility with HSBC in the amount of Ps.1,081.0 million. We repaid approximately 50% of the outstanding amount under the HSBC unsecured credit facility on September 29, 2005 reducing the remaining outstanding balance to Ps.540.5 million as of December 31,2006.
On September 28, 2005, we issued US$250 million of Senior Guaranteed Notes due 2015 with a coupon rate of 7.50%.
We have not paid dividends since the inception of the Company in 1998 and we do not foresee to paying dividends in the near future.
Other than as disclosed elsewhere in this Annual Report including in Item 3. Key Information Risk Factors and Item 4. Information on the CompanyBusiness OverviewThe Mexican Housing Market, we are not aware of any trends, uncertainties, demands, commitments or events which are reasonably likely to have a material effect upon our net sales or revenues, income from continuing operations, profitability, liquidity or capital resources, or that would cause reported financial information to not necessarily be indicative of future operating results or financial condition.
OFF-BALANCE SHEET ARRANGEMENTS
We have no off-balance sheet arrangements as of December 31, 2006.
The following table sets forth information regarding our contractual obligations as of December 31,2006:
Contractual obligations increased by 17.35% from Ps.8,176,084 as of December 31, 2005 to Ps.9,594,752 as of December 31, 2006. This change was mainly due to the purchase of land reserves at the end of 2006.
New Accounting Pronouncements
Mexican Financial Reporting Standards (MFRS)
On December 22, 2006 the Mexican Financial Information Standards Research and Development Board (Consejo Mexicano para la Investigación y Desarrollo de Normas de Información Financiera, A.C. or CINIF) issued the MFRS B-3 Statement of Income, MFRS C-13 Related parties and MFRS D-6 Capitalization of the Comprehensive Financing Cost, these standards will take place in the fiscal years beginning January 1, 2007. The Company believes that the effect of these new accounting principals will not have an effect in its operations and financial position.
MFRS B-3, Statements of Income:
MFRS B-3 establishes a new approach for identifying revenues, costs and expenses as either ordinary or nonordinary.
With this new approach, the classification of special and extraordinary items, as established by the previous Bulletin B-3 and certain specific MFRSs, has been eliminated and the primary sections of the statements of income have been redefined, to provide a new classification of either ordinary or earning levels. As well, the caption Initial accumulated effect of accounting changes has been eliminated from the income statement, as the above-mentioned MFRS B-1, requires that any effect derived from an accounting change affecting the financial information from prior years must be recognized in the financial statements of such years and should not affect the current-year results of operations.
MFRS C-13, Related Parties:
MFRS C-13 broadens the concept of related parties to include joint ventures in which the reporting entity participates, immediate family members of key management personnel or directors, as well as funds derived from labor obligation plans. This standard obligates entities to disclose the relationship between the controlling company and its subsidiary, irrespective of whether transactions were carried out between them in the period or not. MFRS C-13 also establishes that the reporting entity may disclose that the considerations for transactions carried out with its related parties are at arms length, provided that it can be demonstrated. Finally, MFRS C-13 also requires entities to disclose information on the compensation paid to the entitys key managerial personnel or relevant Company directors.
MFRS D-6, Capitalization of the Comprehensive Financing Cost:
MFRS D-6 establishes that entities must capitalize comprehensive financing cost (CFC), which was previously optional. CFC is defined as the net amount of interest expense, foreign exchange rate differences, net monetary position result, changes in the fair value of hedging instruments and other related costs (such as amortization of premiums, discounts on issuance of debt instruments and taxes paid on interests on behalf of third parties). MFRS D-6 establishes the conditions necessary for the capitalization of CFC, as well as guidelines for determining when such capitalization must cease.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS No. 157). SFAS No. 157 provides guidance for using fair value to measure assets and liabilities, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years. We are currently evaluating the potential impact of adopting SFAS No. 157 on our consolidated financial position and results of operations.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 Employers Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87,88, 106 and 132(R) (SFAS N. 158). SFAS No. 158 requires companies to (a) recognize the funded status of a benefit plan (measured as the difference between the fair value of plan assets and the benefit obligations) in its statement of financial position, (b) recognize as a component of other comprehensive income, net of tax, the actuarial gains and losses and the prior service costs and credits that arise during the period, (c ) measure defined benefit plan assets as of the date of a companys statement of financial position, and (d) disclose in the notes to the financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gain or losses, prior service cost or credits, and transition assets or obligation. SFAS No. 158 is effective for companies with publicly traded securities as of the end of the fiscal year ending December 15, 2006. Our adoption of SFAS No. 158 in 2006 is disclosed in Note 26 to our financial statements.
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115, which provides a fair value option to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis. SFAS No. 159 is effective