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Philippine Long Distance Telephone Company 20-F 2007 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549
FORM 20-F
[ ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(B) OF THE SECURITIES EXCHANGE ACT OF 1934 OR
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 – For the fiscal year ended December 31, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 – For the transition period from _________ to _________
OR
[ ] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 – Date of event requiring this shell company report __________
Commission file number 1-03006
Philippine Long Distance Telephone Company (Exact name of Registrant as specified in its charter)
Republic of the Philippines (Jurisdiction of incorporation or organization)
Ramon Cojuangco Building Makati Avenue Makati City, Philippines (Address of principal executive offices)
Securities registered or to be registered pursuant to Section 12(b) of the Act.
* Registered on the New York Stock Exchange not for trading but only in connection with the registration of American Depositary Shares pursuant to the requirements of such stock exchange.
Securities registered or to be registered pursuant to Section 12(g) of the Act.
None
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 issuer’s classes of capital or common stock as at the close of the period covered by the annual report.
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the
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 [ ] No [√]
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 [√] No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filed. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [√] Accelerated Filer [ ] Non-Accelerated Filer [ ]
Indicate by check mark which financial statement item the registrant has elected to follow: Item 17 [ ] Item 18 [√]
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 [ ] No [√] TABLE OF CONTENTS
CERTAIN CONVENTIONS AND TERMS USED IN THIS REPORT
Unless the context indicates or otherwise requires, references to “we,” “us,” “our” or “PLDT Group” mean Philippine Long Distance Telephone Company and its consolidated subsidiaries, and references to “PLDT” mean Philippine Long Distance Telephone Company, not including its consolidated subsidiaries (see Note 2 –Basis of Consolidated Financial Statements Preparation to the accompanying consolidated financial statements in Item 18 for a list of these subsidiaries, including a description of their respective principal business activities).
Any discrepancies in any table between totals and the sums of the amounts listed are due to rounding.
All references to the “Philippines” contained in this report mean the Republic of the Philippines and all references to the “U.S.” or the “United States” are to the United States of America.
In this report, unless otherwise specified or the context otherwise requires, all references to “pesos,” “Philippine pesos” or “Php” are to the lawful currency of the Philippines, all references to “dollars,” “U.S. dollars” or “US$” are to the lawful currency of the United States, all references to “Japanese yen,” “JP¥” or “¥” are to the lawful currency of Japan, and all references to “Euro” or “€” are to the lawful currency of the European Union. Unless otherwise indicated, translations of peso amounts into U.S. dollars in this report were made based on the volume weighted average exchange rate quoted through the Philippine Dealing System, which was Php49.045 to US$1.00 on December 31, 2006. On June 26, 2007, the volume weighted average exchange rate quoted was Php46.222 to US$1.00.
In this report, each reference to:
• ACeS Philippines means ACeS Philippines Cellular Satellite Corporation, our wholly-owned subsidiary;
• AIL means ACeS International Limited, a 36.99%-owned associate of ACeS Philippines;
• Airborne Access means Airborne Access Corporation, a 51%-owned subsidiary of ePLDT;
• ARPU means average monthly revenue per user;
• BCC or Bonifacio Communications Corporation, our 75%-owned subsidiary;
• BSP means Bangko Sentral ng Pilipinas;
• ClarkTel means PLDT Clark Telecom, Inc., our wholly-owned subsidiary;
• CyMed means CyMed, Inc., a wholly-owned subsidiary of SPi;
• Digital Paradise means Digital Paradise, Inc., a 75%-owned subsidiary of ePLDT;
• DoCoMo means NTT DoCoMo, Inc.;
• DSL means digital subscriber line;
• ePLDT means ePLDT, Inc., our wholly-owned subsidiary;
• ePLDT Ventus means the umbrella brand name for ePLDT’s call center business, including Ventus, Vocativ and Parlance;
• First Pacific means First Pacific Company Limited;
• First Pacific Group means First Pacific and its Philippine and other affiliates;
• GAAP means generally accepted accounting principles;
• GSM means global system for mobile communications;
• Infocom means Infocom Technologies, Inc., a 99.6%-owned subsidiary of ePLDT;
• Level Up! means Level Up!, Inc., a 60%-owned subsidiary of ePLDT;
• Mabuhay Satellite means Mabuhay Satellite Corporation, our 67%-owned subsidiary;
• Maratel means PLDT-Maratel, Inc., our 97.5%-owned subsidiary;
• netGames means netGames, Inc., an 80%-owned subsidiary of ePLDT;
• NTC means the National Telecommunications Commission of the Philippines;
• NTT means Nippon Telegraph and Telephone Corporation;
• NTT Communications means NTT Communications Corporation, a wholly-owned subsidiary of Nippon Telegraph and Telephone Corporation of Japan;
• NTTC-UK means NTT Communications Capital (UK) Ltd., a wholly-owned subsidiary of NTT Communications;
• PAPTELCO means Philippine Association of Private Telephone Companies, Inc.;
• Parlance means Parlance Systems, Inc., a wholly-owned subsidiary of ePLDT;
• PFRS means Philippine Financial Reporting Standards;
• Piltel means Pilipino Telephone Corporation, a 92.1%-owned subsidiary of Smart;
• PLDT Beneficial Trust Fund means the beneficial trust fund created by PLDT to pay the benefits under the PLDT Employees’ Benefit Plan;
• PLDT Global means PLDT Global Corporation, our wholly-owned subsidiary;
• SEC means the Securities and Exchange Commission;
• SIM means subscriber identification module;
• SMS means short messaging service;
• Smart means Smart Communications, Inc., our wholly-owned subsidiary;
• Smart Broadband means Smart Broadband, Inc. (formerly Meridian Telekoms, Inc.), our wireless broadband provider and a wholly-owned subsidiary of Smart;
• SPi means SPi Technologies, Inc., a wholly-owned subsidiary of ePLDT;
• SubicTel means Subic Telecommunications Company, Inc., our wholly-owned subsidiary;
• Telesat means Telesat, Inc., our 94.4%-owned subsidiary;
• VAS means value-added service;
• VAT means value-added tax;
• Ventus means ePLDT Ventus, Inc., a wholly-owned subsidiary of ePLDT;
• Vocativ means Vocativ Systems, Inc., a wholly-owned subsidiary of ePLDT;
• VSAT means very small aperture terminal;
• WAP means wireless application protocol;
• W-CDMA means wireless-code division multiple access; and
• Wolfpac means Wolfpac Mobile, Inc., our wireless content operator and a wholly-owned subsidiary of Smart.
Some information in this report may contain forward-looking statements within the meaning of Section 27A of the U.S. Securities Act of 1933, as amended, and Section 21E of the U.S. Securities Exchange Act of 1934, as amended. We have based these forward-looking statements on our current beliefs, expectations and intentions as to facts, actions and events that will or may occur in the future. Such statements generally are identified by forward-looking words such as “believe,” “plan,” “anticipate,” “continue,” “estimate,” “expect,” “may,” “will” or other similar words.
A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. We have chosen these assumptions or bases in good faith. These forward-looking statements are subject to risks, uncertainties and assumptions, some of which are beyond our control. In addition, these forward-looking statements reflect our current views with respect to future events and are not a guarantee of future performance. Actual results may differ materially from information contained in the forward-looking statements as a result of a number of factors, including, without limitation, the risk factors set forth in Item 3. “Key Information –– Risk Factors.” When considering forward-looking statements, you should keep in mind the description of risks and other cautionary statements in this report.
You should also keep in mind that any forward-looking statement made by us in this report or elsewhere speaks only as at the date on which we made it. New risks and uncertainties come up from time to time, and it is impossible for us to predict these events or how they may affect us. We have no duty to, and do not intend to, update or revise the statements in this report after the date hereof. In light of these risks and uncertainties, you should keep in mind that actual results may differ materially from any forward-looking statement made in this report or elsewhere.
Item 1. Identity of Directors, Senior Management and Advisors
Not applicable.
Item 2. Offer Statistics and Expected Timetable
Not applicable.
The selected consolidated financial information below should be read in conjunction with, and is qualified in its entirety by reference to, our consolidated financial statements, including the notes, included elsewhere in this report. The consolidated financial statements have been prepared and presented in conformity with U.S. GAAP.
Prior to the filing of our Annual Report on Form 20-F in respect of the year ended December 31, 2002, the consolidated financial statements included in our Annual Reports on Form 20-F filed with the U.S. Securities and Exchange Commission, or U.S. SEC, were prepared in conformity with PFRS. PFRS varies in certain significant respects from U.S. GAAP. A description of the significant differences between U.S. GAAP and PFRS and a quantitative reconciliation of such differences in the net loss and stockholders’ equity to U.S. GAAP was disclosed in a note to our previously filed consolidated financial statements.
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(1) We maintain our accounts in Philippine peso. For convenience, the peso financial information as at and for the year ended December 31, 2006, has been translated into U.S. dollars at the exchange rate of Php49.045 to US$1.00, the rate quoted through the Philippine Dealing System as at December 31, 2006. This translation should not be construed as a representation that the Philippine peso amounts represent, or have been or could be converted into, U.S. dollars at that rate or any other rate.
(2) In 2006 and 2002, our convertible preferred shares were deemed anti-dilutive based on a calculation of the required dividends on preferred shares for each series of convertible preferred shares divided by the number of equivalent common shares assuming such preferred shares were converted into common shares and compared against the basic earnings per share. Since the amount of dividends on preferred shares over the equivalent number of common shares were greater than the basic earnings per share, the amounts for basic and diluted earnings per share are the same.
(3) Total debt represents current portion of long-term debt, long-term debt — net of current portion and notes payable.
(4) Total liabilities on a consolidated basis represent the difference between total assets and minority interest in consolidated subsidiaries, preferred stock subject to mandatory redemption and stockholders’ equity.
(5) For purposes of this ratio, “Earnings” consist of income before provision for income tax (excluding PLDT’s share in undistributed income of less than 50% owned affiliates) and fixed charges (excluding capitalized interest). “Fixed charges” consist of interest (including capitalized interest, discounts and other financing costs) on all indebtedness, amortization of deferred financing costs and the estimated financing component of rent expense (i.e., one-third of rent expense).
Due to PLDT’s net losses in 2002, the coverage ratio on a consolidated basis was less than 1.0x in that year. In order to achieve a coverage ratio of 1.0x, we would have had to generate additional consolidated earnings of Php2,463 million for the year ended December 31, 2002.
The following table summarizes PLDT’s capital stock outstanding as at December 31, 2006, 2005 and 2004.
(1) Preferred stock subject to mandatory redemption in 2008 (see Note 14 – Preferred Stock Subject to Mandatory Redemption to the accompanying consolidated financial statements in Item 18 for further discussion).
(2) All shares of the Series VII Convertibles Preferred Stock were converted in 2006 (see Note 14 – Preferred Stock Subject to Mandatory Redemption to the accompanying consolidated financial statements in Item 18 for further discussion).
The table sets forth dividend declarations on shares of PLDT’s common stock in 2006:
In addition, on March 6, 2007, PLDT declared cash dividend of Php50 per share to common shareholders of record as at March 20, 2007 which was paid on April 20, 2007.
Our current policy is to declare and pay dividends taking into consideration the interests of our shareholders as well as our working capital, capital expenditures and debt servicing requirements. Also taken into consideration are our ability to meet loan covenant requirements and the required prior written consents of certain creditors and preferred stockholders (for stock dividends), under certain conditions, in the declaration and payment of dividends as discussed in Note 12 – Interest-bearing Financial Liabilities and Note 15 – Stockholders’ Equity to the accompanying consolidated financial statements in Item 18. The retention of earnings is necessary to meet the funding requirements of our business expansion and development programs. Unappropriated retained earnings of PLDT include undistributed earnings representing accumulated equity in the net earnings of our subsidiaries, which are not available for distribution as dividends until received in the form of dividends from such subsidiaries (see Note 15 – Stockholders’ Equity to the accompanying consolidated financial statements in Item 18). Dividends are generally paid in Philippine pesos. In the case of shareholders residing outside the Philippines, PLDT's transfer agent in Manila, which acts as the dividend-disbursing agent, converts the peso dividends into U.S. dollars at the prevailing exchange rates, and remits the dollar proceeds abroad, net of withholding tax.
A summary of dividends paid per share of PLDT's common stock stated in both Philippine peso and U.S. dollars follows:
(Note: Dividends on PLDT's common stock were declared and paid in Philippine peso. For the convenience of the reader, the peso dividends are translated into U.S. dollars based on exchange rates on the respective dates of dividend payments).
The Philippine government does not administratively fix the exchange rate between the Philippine peso and the U.S. dollar. Since August 1, 1992, a market average rate has been determined daily in inter-bank trading using the Philippine Dealing System, known as the “Philippine Dealing System Reference Rate.” The Philippine Dealing System is a specialized off-floor direct dealing service for the trading of Philippine pesos-U.S. dollars by member banks of the Bankers Association of the Philippines and BSP, the central bank of the Philippines. All members of the Bankers Association of the Philippines are required to make their Philippine peso-U.S. dollar trades through this system, which was established by Telerate Financial Information Network of Hong Kong.
The following shows the exchange rates between the Philippine peso and the U.S. dollar, expressed in pesos per U.S. dollar, for the periods indicated, based on the volume-weighted average exchange rate for each business day in each of the periods presented:
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Source: Philippine Dealing System Reference Rate (1) Simple average of exchange rates for the period. (2) Highest exchange rate for the period. (3) Lowest exchange rate for the period.
_________________
Source: Philippine Dealing System Reference Rate (1) Simple average of exchange rates for the month. (2) Highest exchange rate for the month. (3) Lowest exchange rate for the month.
This report contains conversions of Philippine peso amounts into U.S. dollars for your convenience. Unless otherwise specified, these conversions were made at the exchange rate as at December 31, 2006 of Php49.045 to US$1.00. You should not assume that such peso amounts represent such U.S. dollar amounts or could have been or could be converted into U.S. dollars at the rate indicated, or at any particular rate. As at June 26, 2007, the exchange rate quoted through the Philippine Dealing System was Php46.222 to US$1.00.
Risks Relating to Us
We face competition from well-established telecommunications operators and may face competition from new entrants that may adversely affect our business, results of operations, financial condition and prospects
The Philippine government has liberalized the Philippine telecommunications industry and opened up the Philippine telecommunications market to new entrants. Including the PLDT Group, there are nine major local exchange carriers, seven international gateway facility providers and five cellular service providers in the country. Many new entrants into the Philippine telecommunications market have entered into strategic alliances with foreign telecommunications companies, which provide them access to technological and funding support as well as service innovations and marketing strategies. Consequently, we are facing increasing competition in major segments of the telecommunications industry, particularly data and other network services segments. We cannot assure you that the number of providers of telecommunication services will not further increase or that competition for telecommunications customers will not lead our cellular and fixed line subscribers to switch to other operators or lead us to increase our marketing expenditures or reduce our rates, resulting in a reduction in our profitability.
Competition in the cellular telecommunications industry in the Philippines is based primarily on factors such as network coverage, quality of service and price. Recently, competition has increased as operators sought to develop and maintain market share and to attract new subscribers. Our principal cellular competitors, Globe Telecom, Inc., or Globe, and Digital Telecommunications Philippines, Inc., or Digitel, have introduced aggressive marketing campaigns and promotions. In addition, the government may allocate additional frequencies and award additional cellular telecommunications licenses in the future which could lead to increased competition.
As a result of the competitive environment, Smart has not increased its cellular rates since November 1998. Moreover, the level of competition requires Smart to continuously innovate its products and to conduct promotions, which may affect its cellular revenues and revenue growth. For example, in order to test the market demand for fixed rate or “bucket” plans for voice and text services and in response to similar types of promotions launched by its competitors, Smart launched, in March 2005, the Smart 258 Unlimited Call and Text promotions pursuant to which Smart and Talk ‘N Text prepaid subscribers had the option to avail themselves of unlimited on-network (Smart-to-Smart) voice calls or unlimited on-network (Smart-to-Smart) text messages at a fixed rate.
There can be no assurance that incurring additional marketing expenses for these promotions and responding to rate pressures and the potential loss of customers will not have a material adverse effect on our financial performance.
Rapid changes in telecommunications technology may adversely affect the economics of our existing businesses and the value of our assets, increase our required capital expenditures and create new competition
The telecommunications sector has been characterized recently by rapid technological changes. We cannot assure you that these developments will not result in competition from providers of new services or the need to make substantial capital expenditures to upgrade our facilities. Furthermore, the NTC has issued to Smart and our competitors the license covering 3G cellular services, and we have incurred significant expenses in the roll out of these services. We are also continuing to upgrade to a next generation, all-IP network and rolling out a wireless broadband network in order to expand our capability to provide broadband services. These projects will require significant capital expenditures over the next few years.
Our future success will depend, in part, on our ability to anticipate or adapt to such changes and to offer services that meet customer demands on a competitive and timely basis. We may be unable to obtain new technologies on a timely basis or on satisfactory terms or implement them in an appropriate or effective manner. Future development of new technologies, services or standards could require significant changes to our business model which could necessitate new investments. In addition, new products and services may be expensive to develop and may result in increased competition. Such strategic initiatives and technological developments could require us to incur significant additional capital expenditures. There can be no assurance that we would be able to adopt and successfully implement new technologies. In addition, there can be no assurance on how emerging and future technological changes will affect our operations or the competitiveness of our services.
Our results of operations have been, and may continue to be, adversely affected by competition in international long distance service
The international long distance business has historically been one of our major sources of revenue. However, due to competition and the steep decline in international settlement rates that are paid to us by foreign telecommunications carriers for termination of international calls on our network, revenues generated from our international long distance business have overall declined in recent years.
We anticipate that revenues from international long distance and international data services, including our services, will continue to decline in the future, due primarily to:
• increased competition from other domestic and international telecommunications providers;
• advances in technology;
• alternative providers offering Internet telephony, also known as Voice over Internet Protocol, or VoIP, and broadband capacity; and
• unauthorized traffic termination and bypass routings by international simple resale operators.
We cannot assure you that these declines will not materially and adversely affect our financial performance.
Net settlement payments between PLDT and other foreign telecommunications carriers for origination and termination of international call traffic between the Philippines and other countries have been our predominant source of foreign currency revenues. However, in U.S. dollar terms, these payments have been declining in recent years. A continued decline in our foreign currency revenues could increase our exposure to risks from declines in the value of the Philippine peso against the U.S. dollar. We cannot assure you that we will be able to achieve adequate increases in our other revenues to make up for any adverse impact of a further decline in our net settlement payments.
Our debt instruments contain restrictive covenants which require us to maintain certain financial tests and our substantial indebtedness could impair our ability to fulfill our financial obligations, service our other debt and carry out new financings or pay dividends
As at December 31, 2006, we had consolidated total indebtedness of approximately Php86,059 million (US$1,755 million), and a consolidated ratio of debt to equity (total debt on a consolidated basis divided by total equity) of 0.79x. Our existing debt instruments contain covenants which, among other things, require PLDT to maintain certain financial ratios calculated on the basis of PFRS on a consolidated and non-consolidated basis, limit our ability to incur indebtedness, make investments and pay dividends. Financial statements prepared in conformity with PFRS differ in some material respects from financial statements prepared in conformity with U.S. GAAP. For a description of some of these covenants, see Item 5. “Operating and Financial Review and Prospects — Liquidity and Capital Resources — Financing Activities — Debt Financing — Debt Covenants.”
Our substantial indebtedness and the requirements and limitations imposed by our debt covenants could have important consequences. For example, they could:
• require us to dedicate a substantial portion of our cash flow to payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate requirements; and
• limit the availability and amount of dividend payments to our common shareholders.
The principal factors that can negatively affect our ability to comply with the financial ratios and other financial tests under our debt instruments are depreciation of the Philippine peso relative to the U.S. dollar, poor operating performance of PLDT and our consolidated subsidiaries, impairment or similar charges in respect of investments or other long-lived assets that may be recognized by PLDT and its consolidated subsidiaries and increases in our interest expenses. Since approximately 96% of our total consolidated debts were denominated in foreign currencies, principally in U.S. dollars, many of these financial ratios and other tests are negatively affected by any weakening of the peso.
The peso has been subject to significant fluctuations in recent years. From 2002 to 2004, the peso has generally been depreciating from a high of Php49.336 on May 20, 2002 to a low of Php56.443 on October 14, 2004. In 2005, the peso fluctuated significantly from a low of Php56.321 on July 8, 2005 to a high of Php53.062 on December 29, 2005. While the peso continued to appreciate in 2006, there can be no assurance that the peso will not depreciate and be subject to significant fluctuations going forward.
We have maintained compliance with all of our financial ratios and covenants, as measured under PFRS, under our loan agreements and other debt instruments. However, if negative factors adversely affect our financial ratios, we may be unable to maintain compliance with these ratios and covenants or be unable to incur new debt. Inability to comply with the financial ratios and covenants or raise new financing could result in a declaration of default and acceleration of some or all of our indebtedness. The terms of some of our debt instruments have no minimum amount for cross-default.
If we are unable to meet our debt service obligations or comply with our debt covenants, we could be forced to restructure or refinance our indebtedness, seek additional equity capital or sell assets. An inability to effect these measures successfully could result in a declaration of default and an acceleration of some or all of our indebtedness.
In addition, we may have difficulty meeting debt payment obligations if we do not continue to receive cash dividends from Smart.
Creditors of our subsidiaries will have superior claims to our subsidiaries’ cash flow and assets
A growing portion of our consolidated operating revenues and cash flow from operations is derived from our subsidiaries, particularly Smart. Smart and some of our other subsidiaries have significant internal cash requirements for debt service, capital expenditures and operating expenses and so may be financially unable to pay any dividends to PLDT. Although Smart made dividend payments to PLDT since December 2002, we cannot assure you that PLDT will continue to receive dividends or other distributions, or otherwise be able to derive liquidity from Smart or any other subsidiary or investee in the future.
Creditors of our subsidiaries will have prior claims to our subsidiaries’ assets and cash flows. We and our creditors will effectively be subordinated to the existing and future indebtedness and other liabilities, including trade payables, of our subsidiaries, except that we may be recognized as a creditor on loans we have made to subsidiaries. If we are recognized as a creditor of a subsidiary, our claim will still be subordinated to any indebtedness secured by assets of the subsidiary and any indebtedness of the subsidiary otherwise deemed senior to the indebtedness we hold.
Our businesses require substantial capital investment, which we may not be able to finance
Our projects under development and the continued maintenance and improvement of our networks and services, including Smart’s projects, networks and services, require substantial ongoing capital investment. Our consolidated capital expenditures in 2006 and 2005 totaled Php20,348 million and Php15,864 million, respectively. Our 2007 budget for consolidated capital expenditures is approximately Php21,400 million, of which approximately Php11,100 million is budgeted to be spent by PLDT and approximately Php8,800 million is budgeted to be spent by Smart; the balance represents the budgeted capital spending of our other subsidiaries. PLDT’s capital spending is intended principally to finance the continued build-out and upgrade of its data and Internet protocol infrastructures and for its fixed line data services and the maintenance of its network. Smart’s capital spending is focused on expanding and upgrading its transmission network facilities to meet increased demand for cellular services.
Future strategic initiatives could require us to incur significant additional capital expenditures. We may be required to finance a portion of our future capital expenditures from external financing sources, which have not yet been fully arranged. We cannot assure you that financing for new projects will be available on terms acceptable to us or at all. If we cannot complete our development programs and other capital projects, our growth, results of operations and financial condition could be materially and adversely affected.
Our financial position could be materially and adversely affected if the peso significantly fluctuates against the U.S. dollar
Substantially all of our indebtedness and related interest expense, a substantial portion of our capital expenditures and a portion of our expenses are denominated in U.S. dollars and other foreign currencies, but a significant portion of our revenues is denominated in pesos. As at December 31, 2006, 96% of our total consolidated indebtedness was denominated in U.S. dollars. As at December 31, 2006, approximately 43% of our consolidated foreign currency-denominated debts were unhedged. A depreciation of the peso against the U.S. dollar increases the amount of our debt obligations and operating and interest expenses in peso terms. In the event that the peso depreciates against the U.S. dollar, we may be unable to generate enough funds through operations (such as by raising our service rates, including through adjustments to rates for local exchange service based on movements in the peso-to-dollar exchange rate) and other means to offset the resulting increase in our obligations in peso terms. Further, these changes could cause us not to be in compliance with the financial covenants imposed by our lenders under certain loan agreements and other indebtedness.
On the other hand, approximately 33% of PLDT Group’s consolidated service revenues are either denominated in U.S. dollars or is linked to the U.S. dollar. In this respect, an appreciation of the peso against the U.S. dollar reduces our revenues in peso terms and reduces our cash flow from operations.
During the last decade, the peso has generally depreciated against most foreign currencies. In addition, during this period, the Philippine economy has also, from time to time, experienced periods of concentrated peso devaluation and limited availability of foreign currency. Since June 30, 1997, when the Bangko Sentral ng Pilipinas, or BSP, announced that it would let market forces determine the value of the peso, the peso has experienced a significant decline against the U.S. dollar. It depreciated from Php26.376 to US$1.00 on June 30, 1997, to Php56.341 to US$1.00 as at December 31, 2004.
The peso has been subject to significant fluctuations in recent years. From 2002 to 2004, the peso has generally been depreciating from a high of Php49.336 on May 20, 2002 to a low of Php56.443 on October 14, 2004. In 2005, the peso fluctuated significantly from a low of Php56.321 on July 8 to a high of Php53.062 on December 29, 2005. While the peso continued to appreciate in 2006, there can be no assurance that the peso will not depreciate and be subject to significant fluctuations going forward.
The peso may again be subject to significant fluctuations and may depreciate due to a range of factors, including: • political and economic developments affecting the Philippines; • the volatility of regional currencies, particularly the Japanese yen; • any interest rate increases by the Federal Reserve Bank of the United States; • higher demand for U.S. dollars by both banks and domestic businesses to service their maturing U.S. dollar obligations; and • foreign exchange traders including banks covering their short U.S. dollar positions.
The cellular telecommunications industry may not continue to grow
The majority of our consolidated revenues is currently derived from cellular services. As a result, we depend on the continued development and growth of the cellular telecommunications industry. The cellular penetration rate in the Philippines is estimated to have reached approximately 48%. As such, our cellular business is expected to grow at a slower rate as penetration rate increases and Smart moves further into the lower-income segments of the market. The growth of the cellular communications market depends on many factors beyond our control, including the continued introduction of new and enhanced cellular devices, the price levels of cellular handsets, consumer preferences and amount of disposable income of existing and potential subscribers. Any economic, technological or other developments resulting in a reduction in demand for cellular services may harm our business.
Our businesses depend on the reliability of our network infrastructure, which is subject to physical, technological and other risks
We depend to a significant degree on an uninterrupted operation of our network to provide our services. We also depend on robust information technology systems to enable us to conduct our operations. The development and operation of telecommunications networks are subject to physical, technological and other risks, which may cause interruptions in service or reduced capacity for customers. These risks include:
• physical damage;
• power loss;
• capacity limitation;
• cable theft;
• software defects; and
• breaches of security by computer viruses, break-ins or otherwise.
The occurrence of any of these risks could have a material and adverse effect on our ability to provide services to customers. While we are undertaking initiatives to prevent and/or mitigate the occurrence of said risks, including the preparation of a disaster recovery plan that aims to allow restoration of service at the soonest possible time from occurrence of an incident. We cannot assure you that these risks will not occur or that our initiatives will be effective should such risks occur.
A significant number of PLDT’s shares are held by three separate shareholders, which may not act in the interests of other shareholders or stakeholders in PLDT
The First Pacific Group has beneficial ownership of approximately 28% in PLDT’s outstanding common stock as at May 31, 2007. This is the largest block of PLDT’s common stock that is directly or indirectly under common ownership.
NTT Communications, which owned 14% of PLDT’s common stock as at December 31, 2005, transferred on March 14, 2006 approximately 12.6 million shares of PLDT’s common stock, representing approximately 7% of the outstanding shares of PLDT’s common stock, to DoCoMo pursuant to a stock sale and purchase agreement dated January 31, 2006. NTT Communications is a wholly-owned subsidiary, and DoCoMo a majority-owned subsidiary of NTT. In connection with this transaction, First Pacific and certain of its affiliates, or the FP Parties, NTT Communications, DoCoMo and PLDT entered into a Cooperation Agreement, dated January 31, 2006, or the Cooperation Agreement, pursuant to which, among other things, certain rights of NTT Communications under the Stock Purchase and Strategic Investment Agreement dated September 28, 1999 and the Shareholders Agreement dated March 24, 2000 were extended to DoCoMo. As a result, NTT Communications and DoCoMo, in coordination with each other, have contractual veto rights over a number of major decisions and transactions that PLDT could make or enter into, including:
• capital expenditures in excess of US$50 million;
• any investments, if the aggregate amount of all investments for the previous 12 months is greater than US$25 million in the case of all investments to any existing investees and US$100 million in the case of all investments to any new or existing investees, determined on a rolling monthly basis;
• any investments in a specific investee, if the cumulative value of all investments made by us in that investee is greater than US$10 million in the case of an existing investee and US$50 million in the case of a new investee;
• issuance of common stock or stock that is convertible into common stock;
• new business activities other than those we currently engage in;
• merger or consolidation; and
• the provision of financial support to Piltel in excess of that remaining available under the PLDT Letter of Support, or LOS.
Moreover, as a result of the Shareholders Agreement, the Cooperation Agreement and their respective stockholdings, the FP Parties, NTT Communications and/or DoCoMo are able to influence our actions and corporate governance, including:
• elections of PLDT’s directors; and
• approval of major corporate actions, which require the vote of common stockholders.
The FP Parties and/or NTT Communications and/or DoCoMo may exercise their respective influence over these decisions and transactions in a manner that could be contrary to your interests.
If a major shareholder sells its interest in PLDT, the transaction may result in an event of default under certain circumstances
If First Pacific Group or NTT Communications sell all or a portion of their equity interest in PLDT, in certain circumstances, such sale may give rise to an obligation for PLDT to make an offer to purchase its outstanding debt under its US$250 million 11.375% notes due 2012, and may result in a default under certain of Smart’s loan agreements. As at December 31, 2006, Php13,208 million in principal amount of PLDT’s indebtedness is directly subject to a change in major shareholding or offer to purchase requirement and Php1,273 million in principal amount of Smart’s indebtedness is subject to an event of default in the event of a change in major shareholding of PLDT. In such event, if PLDT fails to complete an offer to purchase the affected debts, all of its debt could become immediately due and payable as a result of various cross-default provisions.
The franchise of Smart may be revoked due to its failure to conduct a public offering of its shares
Smart has publicly stated that it believes that it had ten years from the commencement of its operations, or until August 2004, to conduct a public offering of its shares required under the Public Telecommunications Policy Act, or R.A. 7925. As Smart has not conducted a public offering of its shares, the Philippine Congress may revoke the franchise of Smart for its failure to comply with the requirement under R.A. 7925 on the public offering of its shares. A quo warranto case may also be filed against Smart by the Office of the Solicitor General of the Philippines for the revocation of the franchise of Smart on the ground of violation of R.A. 7925. In September 2004, Senate Bill No. 1675 was filed seeking to amend Section 21 of R.A. 7925. The bill seeks to declare that a telecommunications entity shall be deemed to have complied with the requirement of making a public offering of its shares if two-third of its outstanding voting stock are owned and controlled directly or indirectly, by a listed company. The bill is currently pending in the Philippine Senate. However, we cannot assure you that such bill will be enacted and that the franchise of Smart will not be revoked due to Smart’s failure to timely conduct a public offering of its shares.
Our business is significantly affected by governmental laws and regulations, including regulations in respect of our franchises, rates and taxes
We operate our business under franchises, each of which is subject to amendment, termination or repeal by the Philippine Congress. Additionally, PLDT operates pursuant to various provisional authorities and certificates of public convenience and necessity, or CPCNs, which are granted by the NTC and expire between now and 2028. Some of PLDT’s CPCNs and provisional authorities have already expired. However, PLDT filed applications for extension of these CPCNs and provisional authorities prior to their respective expiration dates and is therefore entitled to continue to conduct its business under its existing CPCNs and provisional authorities pending the NTC’s decisions on these extensions. Smart also operates its cellular, international long distance, national long distance and global mobile personal communications via satellite services pursuant to CPCNs, which will expire upon the expiration of its franchise. Smart’s franchise is due to expire on March 27, 2017, 25 years after the date on which its current franchise was granted. Smart operates international private leased circuits under a provisional authority, which expired on November 6, 2006. Smart applied for an extension of this provisional authority or for the issuance of a CPCN prior to its expiration. The NTC has not yet acted on the motion. Because PLDT and Smart filed the applications for extension on a timely basis, we expect that these extensions will be granted. However, we cannot assure you that the NTC will grant these extensions. If a CPCN has not been issued, the NTC may permit an operator to provide services pursuant to a provisional authority. Provisional authorities are typically granted for a period of 18 months. The Philippine Revised Administrative Code of 1987 provides that if the grantee of a license or permit, such as a CPCN or provisional authority, has made timely and sufficient application for the extension thereof, the existing CPCN or provisional authority will not expire until the application is finally decided upon by the administrative agency concerned. However, we cannot assure you that our franchises, CPCNs and provisional authorities will be renewed. For a description of our licenses, see Item 4. “Information on the Company –– Licenses and Regulation.”
The NTC also regulates the rates we are permitted to charge for services that have not yet been deregulated, such as local exchange services. We cannot assure you that the NTC will not impose additional obligations on us that could lead to the revocation of our licenses if not adhered to and/or reduction in our revenues and other income or profitability. In addition, the NTC could adopt changes to the regulations governing our interconnection with other telecommunications companies or the rates and terms upon which we provide services to our customers that could have a material and adverse effect on our results of operations.
In the first quarter of 2005, House Bill, or HB, No. 926 was filed and is now pending in the House of Representatives of the Philippines. The proposed bill provides for the cancellation of the currency exchange rate mechanism pursuant to which utility companies, including us, are permitted to adjust their monthly local exchange service rates according to changes in the peso-to-U.S. dollar exchange rate. If this bill is passed into law or if the NTC issues guidelines to change the basis of the currency exchange rate mechanism, our ability to generate U.S. dollar-linked revenues from our local exchange business could be adversely affected. A decline in our foreign currency-linked revenues could increase our exposure to risks from declines in the value of the Philippine peso against the U.S. dollar.
The PLDT Group is also subject to a number of national and local taxes. On May 24, 2005, the president of the Philippines signed into law Republic Act No. 9337, or R.A. 9337, amending certain sections of the National Internal Revenue Code, which took effect on November 1, 2005. R.A. 9337, among others, introduced the following changes:
a. The regular corporate income tax rate for domestic corporations and resident/non-resident foreign corporations increased from 32% to 35% effective November 1, 2005 and will be reduced to 30% effective January 1, 2009.
b. The VAT rate increased from 10% to 12% effective February 1, 2006.
c. The input VAT on capital goods should be spread evenly over the estimated useful life or sixty months, whichever is shorter, if the acquisition cost, excluding the VAT component thereof, exceeds one million pesos.
There can be no assurance that the increase in taxes will not have a material adverse effect on PLDT Group’s revenues, profitability and cash flows. In addition, there can be no assurance that PLDT Group will not be subject to new and/or additional taxes and that PLDT Group will be able to impose additional charges or fees to compensate for the imposition of such taxes.
There are also various bills pending in the Philippine Congress which propose to impose a franchise tax on telecommunication companies and to tax telecommunications services, among them, the imposition of a tax on mobile phone companies on all text entries to text games; the imposition of a Php0.50 specific tax on each SMS to be borne by the cellular phone companies; and the imposition of a 10% ad valorem tax on all cellular phone calls using 3G. We cannot assure you that we would be able to impose additional charges or fees to compensate for the imposition of such taxes.
The NTC may implement proposed changes in existing regulations and introduce new regulations which may result in increased competition and may have negative implications for our revenues and profitability
On June 16, 2000, the NTC issued Memorandum Circular No. 13-6-2000 proposing that cellular operators, including Smart and Piltel, be required, among other things:
• to bill their subscribers for cellular calls on a six-second pulse basis instead of the current per minute basis;
• not to bill calls directed to recorded voice messages; and
• to extend the expiration date of prepaid cards from the current two months to two years.
Along with the other Philippine cellular operators, Smart filed a complaint for the nullification of this memorandum circular before the regional trial court of Quezon City and sought for the issuance of a preliminary injunction while proceedings are ongoing. The regional trial court issued the preliminary injunction, which restrained the implementation of the memorandum circular. The complaint of the Philippine cellular operators is being heard by the regional trial court of Quezon City.
In December 2005, the NTC issued a consultative document on the development of competition policy framework for the information communications sector. The consultative paper contains eleven questions which cover the following key areas:
• a review of market trends deemed to impinge on current and future state of competition in the sector;
• an exploration of major policies that may change the balance of market power, hence the nature and degree of competition;
• an assessment of the quality of current regulation, identifying major handicaps of the NTC; and
• a discussion of the urgent tasks for the NTC to effectively govern a dynamic and complex industry.
The NTC invited public comment from industry stakeholders and other interested parties in relation to the issues raised in the paper. On January 31, 2006, we submitted a comprehensive response to the consultative paper. On August 24, 2006, the NTC issued another consultative document specifically focusing on its proposal to impose asymmetric regulations on carriers with significant market power, or SMP, including a discussion on its proposed roadmap for implementing such SMP obligations. On October 23, 2006, we submitted our response to the second consultative paper to the NTC.
In formulating both our responses, we took into account both industry interests and the broader context of our nation’s economic development, drawing on the experience in other countries. We believe that the basis for the need for regulatory reform is unclear and the envisioned SMP regime is inappropriate for the Philippines, as the market is highly competitive and well-functioning. In addition, the imposition of SMP and its attendant obligations would discourage capital investments in a sector on which the Philippine economy is highly dependent. We have therefore proposed that the NTC explore its full range of options available on a cost-benefit basis, taking into consideration the specific local context of the Philippine marketplace.
There can be no assurance that the NTC will not impose changes to the current regulatory framework which may lead to increased competition. Any such changes may have an adverse effect on our business, results of operations and prospects.
If we are unable to install and maintain telecommunications facilities and equipment in a timely manner, we may not be able to keep up with our principal competitors, which may have negative implications for our revenue and profitability
Our business requires the regular installation of new, and the maintenance of existing, telecommunications transmission and other facilities and equipment, which are being undertaken. The installation and maintenance of these facilities and equipment are subject to risks and uncertainties relating to:
• shortages of equipment, materials and labor;
• work stoppages and labor disputes;
• interruptions resulting from inclement weather and other natural disasters;
• unforeseen engineering, environmental and geological problems; and
• unanticipated cost increases.
Any of these factors could give rise to delays or cost overruns in the installation of new facilities or equipment or could prevent us from properly maintaining the equipment used in our networks, and could have a material and adverse effect on our results of operations and financial condition.
We may not be successful in our acquisitions of and investments in other companies and businesses, and may therefore be unable to implement fully our business strategy
As part of our growth strategy, we may, from time to time, make acquisitions and investments in companies or businesses, which may or may not be significant. The success of our acquisitions and investments depends on a number of factors, including: • our ability to identify suitable opportunities for investment or acquisition; • our ability to reach an acquisition or investment agreement on terms that are satisfactory to us or at all; • the extent to which we are able to exercise control over the acquired company; • the economic, business or other strategic objectives and goals of the acquired company compared to those of the PLDT Group; and • our ability to successfully integrate the acquired company or business with our existing businesses.
Any of our contemplated acquisitions and investments may not be consummated due to reasons or factors beyond its control. Even if any contemplated acquisitions and investments are consummated, we may not be able to realize any or all of the anticipated benefits of such acquisitions and investments. Moreover, if we are unsuccessful in our contemplated acquisitions and investments, we may not be able to implement fully our business strategy to maintain or grow certain of our businesses.
Failure to achieve and maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 could adversely impact investor confidence and the market price of our common shares and ADSs
Effective internal controls over financial reporting are necessary for us to provide reasonable assurance with respect to our financial reports and to effectively prevent fraud. If we are unable to provide reasonable assurance with respect to our financial reports and effectively prevent fraud, our reputation and results of operations could be harmed.
We
are required to comply with various Philippine and U.S. laws and regulations on
internal controls. For example, pursuant to Section 404 of the Sarbanes-Oxley
Act of 2002, beginning with this Annual Report on
Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud. Therefore, even effective internal control over financial reporting can provide reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain the adequacy of our internal control over financial reporting, including through a failure to implement required new or improved controls, or if we experience difficulties in their implementation, our business and operating results could be harmed, we could fail to meet our reporting obligations and there could be a material adverse effect on the market prices of our common shares and ADSs.
Risks Relating to the Philippines
PLDT’s business may be affected by political or social or economic instability in the Philippines
On May 10, 2004, the Philippines held a presidential election which resulted in a victory by the incumbent President Arroyo who successfully retained her post. Shortly after the elections, allegations of irregularities in the presidential elections, such as stolen ballots and vote buying intensified. The Philippine Congress commenced an inquiry into a wire tapped audio tape which contains a conversation allegedly between President Gloria Macapagal-Arroyo and a commissioner of the Commission on Elections discussing the vote count on the presidential election. On June 27, 2005, President Gloria Macapagal-Arroyo publicly stated that she did speak to a commissioner of the Commission on Elections in order to protect her votes, but not to influence the outcome of the election. Impeachment complaints based on allegations of culpable violation of the Constitution, graft and corruption and betrayal of public trust were filed against President Arroyo with the Philippine Congress. On September 6, 2005, the Philippine Congress voted to reject the impeachment complaints against President Arroyo.
Other recent developments include coup d’etat attempts against the administration of President Arroyo. On February 24, 2006, President Arroyo declared a state of emergency allowing for warrantless arrests and a temporary take-over of privately-owned utility companies. On March 3, 2006, President Arroyo lifted the state of emergency.
In June 2006, President Arroyo proposed to amend the Constitution of the Philippines to implement a unicameral federal, parliamentary system patterned after the German constitution. Under said system, the country would be split into “states” with each “state” granted a local legislature. There were also plans to remove or ease the current ban on foreign ownership of property, land and commercial organizations in the Philippines. A group of local leaders have joined together in what was known as the “People’s Initiative” which caused to further the amendment of the Constitution. In addition to nationwide campaigns and rallies, a petition was filed with the Supreme Court, or SC, to reform the Constitution. This petition was rejected by the SC on October 25, 2006. Nevertheless, the People’s Initiative continues to advocate amendments to the Constitution.
Furthermore, the Philippine economy has experienced periods of slow growth, high inflation and significant devaluation of the peso. The Philippine government is also facing a fiscal deficit that the government is aiming to eliminate by 2008 by implementing a number of economic reforms.
The fiscal deficit position of the Philippine government and the ongoing political uncertainty have resulted in increased concerns about the political and economic stability of the country. This, in turn, has resulted in the volatility of the peso against the dollar. There can be no assurance that the political environment in the Philippines will be stable or that the current or any future government will adopt economic policies conducive to sustained economic growth or which do not impact adversely on the current regulatory environment for telecommunications or other companies.
If foreign exchange controls were to be imposed, our ability to meet our foreign currency payment obligations could be adversely affected
Approval from or registration with the BSP for the issuance and guarantee of foreign currency-denominated borrowings is not required in order to make our foreign currency payment obligations legally valid and binding. However, receiving this approval and registration will enable a borrower to access the banking system to obtain foreign currency to service its debt obligations rather than using other sources of foreign currency, for example, foreign currency revenue streams.
The Philippine government has, in the past, instituted restrictions on the conversion of the peso into foreign currency and the use of foreign exchange received by Philippine companies to pay foreign currency-denominated obligations. The Monetary Board of the BSP has statutory authority, with the approval of the President of the Philippines, during a foreign exchange crisis or in times of national emergency, to:
• suspend temporarily or restrict sales of foreign exchange;
• require licensing of foreign exchange transactions; or
• require the delivery of foreign exchange to the BSP or its designee banks.
We cannot assure you that foreign exchange controls will not be imposed in the future. If imposed, these restrictions could materially and adversely affect our ability to obtain foreign currency to service our foreign currency obligations.
The occurrence of natural catastrophes may materially disrupt our operations
The Philippines has experienced a number of major natural catastrophes over the years including typhoons, volcanic eruptions and earthquakes that may materially disrupt and adversely affect our business operations. The recent earthquake that hit Taiwan in December 26, 2006 severed cable systems linking the Philippines to other Asian and American countries, causing major slowdown of voice and non-voice data traffic exchange. There can be no assurance that the insurance coverage PLDT maintains for these risks will adequately compensate it for all damages and economic losses resulting from natural catastrophes.
Item 4. Information on the Company
We are the leading national telecommunications service provider in the Philippines. Through our three principal business groups — wireless, fixed line, and information and communications technology — we offer a wide range of telecommunications services to approximately 26 million subscribers in the Philippines across the nation's most extensive fiber optic backbone and fixed line, cellular and satellite networks.
We are the leading fixed line provider in the Philippines with approximately 63% of the total reported fixed line subscribers nationwide as at December 31, 2006. Smart, our wholly-owned subsidiary, is the leading cellular service provider in the country, with approximately 41% of total reported cellular subscribers as at December 31, 2006. Piltel, Smart’s 92.1%-owned subsidiary, had approximately 17% of total reported cellular subscribers as at December 31, 2006. We have interests in the information and communications technology sectors, including the operation of our VitroTM data center, call center and business process outsourcing, or BPO, businesses.
Our common shares are listed and traded on the Philippine Stock Exchange, or PSE, and our American Depositary Shares, or ADSs, evidenced by American Depositary Receipts, or ADRs, are listed and traded on the New York Stock Exchange in the United States.
We had a market capitalization of approximately Php481,948 million (US$10,437 million) as at May 31, 2007, representing one of the largest market capitalizations among Philippine-listed companies. For the year ended December 31, 2006, we had consolidated operating revenues of Php127,536 million (US$2,600 million).
Our principal executive offices are located at the Ramon Cojuangco Building, Makati Avenue, Makati City, Philippines and our telephone number is (632) 816-8556. Our website address is www.pldt.com.ph. The contents of our website are not a part of this annual report.
Historical Background and Development
PLDT was incorporated under the old Corporation Law of the Philippines (Act 1459, as amended) on November 28, 1928, following the merger of four telephone companies under common U.S. ownership. In 1967, effective control of PLDT was sold by General Telephone and Electronics Corporation (a major shareholder since PLDT's incorporation) to a group of Filipino businessmen. In 1981, in furtherance of the then existing policy of the Philippine government to integrate the Philippine telecommunications industry, PLDT purchased substantially all of the assets and liabilities of the Republic Telephone Company, which at that time was the second largest telephone company in the Philippines. In 1998, the First Pacific Group acquired a significant interest in PLDT. On March 24, 2000, NTT Communications, through its wholly-owned subsidiary NTT Communications Capital (U.K.) Limited, or NTTC-UK, became PLDT’s strategic partner with approximately 15% economic and voting interest in the issued and outstanding common stock of PLDT. Simultaneous with NTT Communications’ investment in PLDT, we acquired 100% of Smart. On March 14, 2006, NTT DoCoMo acquired from NTT Communications approximately 7% of PLDT’s outstanding common shares held by NTT Communications with NTT Communications retaining ownership of approximately 7% of PLDT’s common shares. On February 28, 2007, Metro Pacific Asset Holdings, Inc., a Philippine affiliate of First Pacific, completed the acquisition of an additional interest of approximately 46% in PTIC. This additional investment in PTIC, a shareholder of PLDT, represents an attributable interest of approximately 6.4% of the issued common shares of PLDT and thereby raised the First Pacific Group’s beneficial ownership to approximately 28% of PLDT’s shares of common stock as at that date. See Item 7. “Major Shareholders and Related Party Transactions” for further discussion.
PLDT's original franchise was granted in 1928 and was last amended in 1991, extending its effectiveness until 2028 and broadening PLDT’s franchise to permit PLDT to provide virtually every type of telecommunications service. PLDT’s franchise covers the business of providing basic and enhanced telecommunications services in and between the provinces, cities and municipalities in the Philippines and between the Philippines and other countries and territories including mobile, cellular, wired or wireless telecommunications system, fiber optics, multi-channel transmission distribution systems and their value-added services such as but not limited to transmission of voice, data, facsimile, control signals, audio and video, information services bureau and all other telecommunications systems technologies, as are at present available or can be made available through technical advances or innovations in the future. See Item 8. “Financial Information –– Legal Proceedings — Quo Warranto Action” for information regarding legal proceedings initiated by the Solicitor General with respect to PLDT's franchise.
Since the implementation of its Subscriber Investment Plan, or SIP, in 1973 pursuant to Presidential Decree No. 217, which in the past required telephone subscribers to purchase shares of PLDT's preferred stock, PLDT has developed a broad base of public ownership with 2,189,374 common and preferred stockholders of record as at December 31, 2006. As approved by the NTC, the SIP was made optional beginning in April 2003, from being compulsory in earlier years. Of these stockholders, 2,172,964 are Philippine persons representing approximately 86% of PLDT's outstanding common and preferred shares. For purposes of this paragraph, all the ADSs, each representing one PLDT common share and evidenced by American Depositary Receipts, or ADRs, are considered to be held of record in the United States.
Our consolidated capital expenditures amounted to Php20,348 million, Php15,864 million and Php19,268 million in 2006, 2005 and 2004, respectively. Of these amounts, Php8,573 million, Php6,389 million and Php3,917 million were attributable to PLDT for 2006, 2005 and 2004, respectively, while Php10,506 million, Php8,785 million and Php14,735 million were spent by Smart for 2006, 2005 and 2004, respectively. The remaining balances were spent by our other subsidiaries, principally ePLDT and its subsidiaries.
PLDT Group includes the following significant subsidiaries:
As described below, SPi, CyMed and Level Up! were all acquired in 2006 and included in our 2006 consolidated financial statements. See Note 9 – Goodwill and Other Intangible Assets to the accompanying consolidated financial statements in Item 18 for further discussion.
On September 2, 2004, Smart entered into a sale and purchase agreement to acquire 100% of Smart Broadband, a company primarily engaged in providing wireless broadband and data services to small and medium-scale enterprises in the Philippines, for a total consideration of US$45 million, of which payments of US$11 million and US$7 million for an equity interest of 40% in Smart Broadband were made in 2004 and payment of US$4 million for an additional equity interest of 9% was made in January 2005. The balance of US$23 million in respect of the remaining 51% equity interest in Smart Broadband was paid on March 7, 2006. The acquisition aims to strengthen Smart’s position in the wireless data segment and is in line with Smart’s overall strategy of providing the widest range of innovative wireless services.
With Smart and PLDT owning 85.6% and 6.5% as at the year ended December 31, 2004, respectively, of Piltel's common equity, Piltel was reconsolidated into the PLDT group's wireless financial position and results of operations starting the year ended December 31, 2004. On April 25, 2005, PLDT and Smart entered into a subscription and assignment agreement under which PLDT assigned and transferred to Smart its 767 million Piltel common shares in exchange for 11 million of Smart's preferred shares. As a result, Smart's shareholdings in Piltel now represents 92.1% of Piltel's outstanding common shares and PLDT no longer owns any shares of Piltel's common stock.
Following its acquisition in October 2003 of an 80% equity interest in Wolfpac, a company engaged in the business of consumer mobile applications software development and content development, Smart acquired in July 2006 the remaining 20% equity interest in Wolfpac.
On February 16, 2006, ePLDT acquired a 60% equity interest in Level Up!, a leading publisher of online games in the Philippines. The acquisition of Level Up!, together with netGames, ePLDT’s online gaming subsidiary, is expected to strengthen ePLDT’s online gaming business in the Philippines.
On July 11, 2006, ePLDT acquired 100% of SPi Technologies, Inc., or SPi, and its direct and indirect Philippine and offshore subsidiaries for a cash consideration of US$135 million. SPi is the second largest pure-play BPO and the ninth largest independent BPO service provider worldwide. It has operations in 19 locations in North America, Europe and Asia. On August 11, 2006, SPi acquired 100% of CyMed, a leading medical transcription company based in Richmond, Virginia and on April 16, 2007, SPi acquired 100% of Springfield Service Corporation, one of the ten largest U.S. medical billing and revenue cycle management companies.
Wireless
We provide cellular, and wireless broadband, satellite, VSAT and other services under our wireless business, contributing about 96% and 4% of our wireless service revenues, respectively, in 2006. The rapid growth in the cellular market has resulted in a change in our revenue composition and sources of our revenue growth. Starting with 2003, cellular service was our major revenue source surpassing fixed line revenues. Cellular data services, which include all text messaging and text-related services ranging from ordinary text to value-added services, contributed significantly to our revenue increase. Our wireless operating revenues accounted for 63%, 62% and 61% of our consolidated operating revenues for the years ended December 31, 2006, 2005 and 2004, respectively. For the years ended December 31, 2006, 2005 and 2004, cellular service revenues accounted for 96%, 96% and 97%, respectively, of our wireless business operating revenues.
We provide cellular services (including handset sales), through Smart and its subsidiary, Piltel. Smart is the leading cellular services provider in the Philippines, with 17,201,005 subscribers as at December 31, 2006, representing an estimated market share of approximately 41%. Piltel, a reseller of Smart's GSM network with its own branding, had 6,974,379 subscribers as at December 31, 2006, representing an estimated market share of approximately 17%. In 2006, the combined number of Smart's and Piltel's subscribers increased by 3,766,763, or 18%, to 24,175,384. As at December 31, 2006, cellular penetration in the Philippines reached approximately 48%, which was nearly 14 times the country's fixed line penetration, although the existence of subscribers owning multiple SIMs has likely overstated this penetration rate to a certain extent.
Smart's and Piltel's cellular subscriber gains were predominantly attributable to their respective prepaid services. Approximately 99% of Smart’s and all of Piltel’s cellular subscribers were prepaid as at December 31, 2006. The predominance of prepaid service reflects one of the distinguishing characteristics of the Philippine cellular market. The growth in our prepaid service has enabled us to increase and broaden our subscriber base rapidly while controlling credit risk and reducing billing and administrative costs on a per-subscriber basis.
Our cellular subscriber growth has also been driven by text messaging. Text messaging is extremely popular in the Philippines, particularly on the prepaid platform, as it provides a convenient and inexpensive alternative to voice and e-mail based communications. Text messaging contributed significantly to Smart's cellular data service revenue growth in 2006, generating revenues of Php34,403 million, an increase of Php3,594 million, or 12%, over 2005.
Smart's Nokia-provided cellular network is the most extensive in the Philippines, covering substantially all of Metro Manila and most of the other major population centers in the Philippines. Its dual-band GSM network allows it to efficiently deploy high capacity 1800 MHz base transceiver stations, or BTS, in dense urban areas while its 900 MHz BTS can be much more economically deployed in potentially high growth, but less densely populated provincial areas. With 6,099 GSM base stations as of the end of December 2006, Smart’s cellular network covers approximately 99% of all towns and municipalities in the Philippines, accounting for approximately 99% of the population.
Fixed Line
We are the leading fixed line operator in the Philippines and the largest company providing fixed line telecommunications services throughout the country. Our fixed line business group offers local exchange, international long distance, national long distance, data and other network and miscellaneous services. We had 1,776,647 fixed line subscribers as at December 31, 2006. Operating revenues from our fixed line services accounted for 32%, 36% and 37% of our consolidated operating revenues for the years ended December 31, 2006, 2005 and 2004, respectively.
Our 6,400-kilometer long domestic fiber optic network, or DFON, is supported by an extensive digital microwave backbone. Our fixed line network reaches all of the major cities and municipalities in the Philippines, with a concentration in the Metropolitan Manila area. Our network offers the country's most extensive connections to international networks through three international gateway switching exchanges, satellite systems and various regional submarine cable systems in which we have interests.
Information and Communications Technology
Through our wholly-owned subsidiary, ePLDT, we provide broad-based integrated information and communications technology, or ICT, services focusing on infrastructure and solutions for Internet applications, Internet protocol-based solutions and multimedia content delivery. ePLDT's principal activities are the operation of an Internet data center under the brand name Vitro™, call center business, BPO, and Internet and online gaming business. Operating revenues from our ICT services accounted for 5% of our consolidated operating revenues for the year ended December 31, 2006 and 2% for each of the years ended December 31, 2005 and 2004.
We believe our business is characterized by the following competitive strengths:
• Recognized Brands. PLDT and Smart are strong and widely recognized brand names in the Philippines. We have built the PLDT brand name for over 75 years as the leading telecommunications provider in the Philippines. Smart is recognized in the Philippines as an innovative provider of high-quality cellular services. Piltel's Talk ‘N Text brand, which is provided using Smart’s network, has also gained significant recognition.
• Leading Market Shares. With approximately 26 million fixed line and cellular subscribers as at December 31, 2006, we have the leading market position in both the fixed line and cellular markets in the Philippines.
• Diversified Revenue Sources. As a result of the continued growth of cellular service in the country, approximately 63% of our consolidated operating revenues in 2006 were derived from our wireless business segment. Fixed line revenues, which represented 32% and 36% of our consolidated operating revenues in 2006 and 2005, respectively, have remained stable over the past three years despite pressures on traditional fixed line voice revenues, resulting from increases in our fixed line data and other network services. We continue to identify and develop new revenue sources from our cellular, fixed line and ICT businesses.
• Advanced Integrated Network. With one of the most advanced and extensive telecommunications networks in the Philippines, we are able to offer a wide array of communications services. We are enhancing the capabilities of our fixed line and wireless networks to allow us to better exploit this competitive strength and achieve higher levels of network efficiency in providing voice and data services. In addition, we have commenced the upgrade to Next Generation Network, or NGN, and the roll out of 3G and wireless broadband in order to increase broadband subscribers, and expand our data/broadband capabilities.
• Innovative Products and Services. We have successfully introduced a number of innovative and award-winning cellular products and services, including Smart Load and Pasa Load. Smart Load is an “over-the-air” electronic loading facility designed to make reloading of air time credits more convenient for, and accessible to consumers. Pasa Load (the term “pasa” means “transfer” in the vernacular), a derivative service of Smart Load that allows load transfers to other Smart Buddy and Talk ‘N Text subscribers.
• Strong Strategic Relationship. We have important strategic relationships with NTT Communications, DoCoMo and First Pacific. The technological support, international experience and management expertise made available to us through these strategic relationships enhance our market leadership and ability to provide and cross-sell a more complete range of products and services.
The key elements of our business strategy are:
• Build on our leading positions in the fixed line and wireless businesses. We plan to build on our position as the leading provider of fixed line service in the Philippines by continuing to launch new products and services to increase subscriber value and utilization of our existing facilities and equipment at reduced cost. We plan to build on our position as the leading wireless service provider in the Philippines by continuing to introduce new products and services to increase our subscribers' use of our network for both voice and data, as well as their reliance on our services. We are currently upgrading our fixed line facilities to NGN, and have rolled out a 3G network based on a W-CDMA technology as well as expanding our DSL and wireless broadband facilities. Our operating target is to continue growth in profitability by increasing our revenues while controlling our costs.
• Capitalize on our strength as an integrated provider of telecommunications services. We offer the broadest range of telecommunications services among all operators in the Philippines. We plan to capitalize on this position to maximize revenue opportunities by bundling and cross-selling our products and services between, and by developing convergent products that feature the combined benefits of voice and data, fixed line, wireless and ICT services utilizing our network and business platforms. We are also lowering our costs by integrating the operations of our different businesses.
• Strengthen our leading position in the data market. Leveraging on the inherent strength of our fixed line business, we are committed to further develop, enhance and lead our fastest growing business segment – data and other network services. Consistent with our strategy of introducing innovative products and services using advanced technology, we have launched various products and services that address different market needs.
• Maintain a strong financial position and improve shareholder returns. Since 2002, we have significantly improved our financial position by utilizing our cash flows principally for debt reduction. As the cash flows generated by our businesses have increased and our leverage ratios have improved, we were able to restore the payment of common dividends to our shareholders beginning 2005. Since then, we have increased our dividend payout to common shareholders from 10% of 2004 earnings to 40% of 2005 earnings and to 60% of 2006 earnings. We expect that a greater proportion of our free cash flows in succeeding years will be utilized for the payment of common dividends and investments in new growth areas while continuing to maintain a healthy balance sheet position.
We provide cellular, wireless broadband, satellite, VSAT and other services through our wireless business segment.
Cellular Service
Overview
Our cellular business, which we provide through Smart and Piltel to over 24 million subscribers, approximately 99% of whom are prepaid subscribers, is focused on providing wireless voice communications, wireless data communications (primarily through text messaging) and a variety of other value-added services, which includes (a) Mobile Banking (banking services delivered over the cellular network); (b) specialized content such as ringtones, logos, caller ringback tunes; (c) Smart Money; (d) international roaming; and (e) games and other VAS developed on Smart’s platform. Smart services approximately seven million subscribers of Piltel on its GSM network through a facilities service agreement with Piltel, under the brand name Talk ‘N Text.
The following table summarizes key measures of Smart’s and Piltel’s cellular business as at and for the years ended December 31, 2006, 2005 and 2004:
_____________
(1) Represents Talk ‘N Text, a prepaid service provided by Piltel using Smart’s network. Piltel’s revenue is net of service fees payable to Smart for using Smart’s network. Piltel does not offer postpaid service.
Service Plans. Smart and its service brands are strong and widely recognized brand names in the Philippines. Smart’s approach has been to methodically segment the market and tailor services and content appropriate to each particular niche. One of the best examples of Smart’s successful market segmentation strategy is Talk ‘N Text, the brand carried by Smart’s subsidiary, Piltel. Talk ‘N Text is aimed at the lower-income markets with the objective of serving as a flanker brand against our competition. Capitalizing on the Filipino’s love for pop culture, Talk ‘N Text extensively uses local celebrities as its endorsers and the vernacular in its advertising and promotional campaigns. With approximately seven million subscribers, Talk ‘N Text has the third-largest GSM subscriber base in the Philippines.
On the postpaid side, we have Smart Gold, which serves the broad postpaid market, and Smart Infinity, a premium postpaid plan targeting affluent individuals 35 years and above who are highly mobile locally and internationally. Smart Infinity offers around-the-clock dedicated personal concierge service, international assistance services, premium handset packages and exclusive lifestyle content.
Voice Services. Cellular voice services comprise local (including Smart-and Piltel-to-fixed lines calls and Smart-and Piltel-to-other mobile operators calls), national long distance and international long distance calls. Voice services remains a major contributor to revenues, generating a total of Php35,221 million, or 45%, and Php35,444 million, or 48%, of cellular service revenues in 2006 and 2005, respectively. Local calls continue to dominate outbound traffic with 67% of all outbound minutes originating from our cellular service. In 2006, traffic volumes from local calls totaled 3,362 million minutes compared to 3,658 million minutes in 2005. National long distance traffic volumes for 2006 stood at 73 million minutes compared to 80 million minutes in 2005. Outbound international long distance decreased to 2% from 4% in 2005 of total outbound traffic with 165 million minutes and 169 million minutes generated in 2006 and 2005, respectively. The ratio of inbound-to-outbound international long distance minutes was 12.5:1 for 2006, compared to 9.2:1 in 2005.
Text Messaging Service and Other Value-added Services. The Philippines cellular market is one of the most text messaging-intensive markets in the world, totaling approximately a billion text messages per day. Text messaging is extremely popular in the Philippines, particularly on the prepaid platform, as it provides a convenient and inexpensive alternative to voice and e-mail based communications. Text messaging also utilizes less network capacity than voice, thereby increasing network efficiency.
Text messaging has been one of the key drivers for our cellular subscriber growth. Strong volume growth in text messaging contributed significantly to Smart's cellular revenue growth in 2006, generating revenues of Php34,403 million, an increase of Php3,594 million, or 12%, over 2005. During 2006, Smart and Piltel's text messaging systems handled over 32,052 million outbound messages on standard SMS services and another 203,669 million messages generated through bucket-priced text services. This compares to 40,781 million outbound messages on standard SMS services in 2005 and 52,373 million outbound messages generated through bucket-priced text services. Unlimited and bucket-priced SMS services were only made available in March 2005.
In 2005, Smart launched a series of promotions to test the market demand for fixed rate or “bucket” plans for voice and text. Bucket pricing promotions have now become a key driver for subscriber activations and usage stimulation.
In addition, in 2006, Smart focused on segmenting its market by offering sector-specific, value-driven packages providing a fixed number of messages with prescribed validity periods.
The success of text messaging is a strong indicator of future data usage potential in this market. In 2006, approximately 51% of Smart’s cellular revenues were derived from data usage, compared to 48% in 2005.
Smart has recognized early the importance of diversified and innovative products and services as a competitive advantage in gaining and retaining market share as well as improving profitability. Smart has diversified its wireless data revenues beyond text messaging and leads the market in terms of enhanced data services. Its catalog of innovations include the award-winning Smart Money (a mobile cash card) and Smart Load (an over-the-air electronic loading facility), both of which were honored by the World GSM Congress in 2001 and 2004, respectively, as “Most Innovative Service for Consumers.” Smart Load has revolutionized the mobile industry with its adaptation of the “sachet” concept in consumer goods to air time reloads. The concept has since been emulated by other Asian operators and is regionally referred to as “micro prepaid reloads”. Smart subsequently introduced Pasa Load, a derivative service of Smart Load, which allows for air time load transfers between subscribers. Smart also offers the following value-added cellular services:
• Mobile Banking, launched in collaboration with various banks, allows subscribers to execute banking transactions such as balance inquiries and transfers over their mobile telephones;
• Smart Money, launched in conjunction with MasterCard, enables subscribers to pay for their purchases by transferring money from their bank accounts to their Smart Money cards as well as reload their prepaid cards electronically; and
• Smart Padala, one of the many innovative initiatives from our Smart Money platform, is the first cash remittance service through text and is faster and cheaper than traditional remittance arrangements. It was launched initially as an international remittance service for overseas Filipino workers but is now available for domestic remittances as well.
We also offer value-added services such as voice mail, information-on-demand, which is a service that allows subscribers to order information from our content providers whenever desired, TextMail, which is a service that allows subscribers to send and receive text messages through their personal computers and location-based services, and Voice Text, which allows subscribers to record a voice message of up to 30 seconds and send it as a text message. In addition, Smart has a number of interactive activities, such as text games and chat services, developed on its own platforms.
Consistent with Smart’s objective to develop new businesses, Smart introduced in 2006 a “fixed wireless” broadband service under the brand SmartBro to complement PLDT’s DSL in areas that are currently not covered by the fixed line network. SmartBro is rapidly increasing network coverage in order to retain “first mover” advantage in areas with limited or no fixed line or broadband coverage. SmartBro is also pioneering a shared access model in order to propagate broadband and address affordability barriers.
Also, Smart rolled out Smart Click, a chain of mobile Internet cafés. Smart Click Internet cafés are housed in air-conditioned 40-foot container vans designed to provide remote communities with high-speed, wireless Internet access nationwide. Smart Click has established 19 mobile Internet cafés as at December 31, 2006.
Due to the high level of text messaging service usage, we believe that the Philippine market is well suited for text-based informational and e-commerce services. Our current approach is to continue maximizing our GSM, or 2G, services while upgrading our network to Enhanced Data for GSM Evolution, or EDGE. EDGE is a technology that would further increase the speed and data capability of our GSM network. In addition, on December 29, 2005, Smart was awarded a 3G license by the NTC after being ranked highest by the NTC in garnering a perfect score on a 30-point grading system designed to gauge the capability of telecommunication operators to effectively provide extensive 3G services. As a result of the perfect ranking, Smart received the largest radio frequency allocation of 15 MHz as well as first choice of frequency spectrum. Smart chose the 1920-1935 MHz and 2110-2125 MHz spectrum, the range that would best enable it to rapidly deploy its 3G network nationwide and at the same time offer the highest quality of 3G service.
Smart further expanded its roster of services with the commercial launch of its 3G services in May 2006. These services include video calling, video streaming, high speed Internet browsing and special 3G content downloads, each offered at rates similar to those of 2G services, and make Smart the first mobile operator in the Philippines to offer 3G services to the public.
Our current policy is to recognize a prepaid subscriber as “active” only when the subscriber activates and uses the SIM card and reloads it at least once during the month of initial activation or in the immediately succeeding month. A prepaid cellular subscriber is disconnected if the subscriber does not reload within four months after the full usage or expiry of the last reload.
Our prepaid cards are sold in denominations of Php300, Php500 and Php1,000, respectively. The stored value of a prepaid card generally remains valid for a period of two months from the time a subscriber activates the card. In 2003, we introduced Smart Load, an “over-the-air” electronic loading facility, which allows consumers to reload prepaid cards with denominations ranging from Php10 to Php 300 and with different expiration periods depending on the denomination of the reload. Moreover, Pasa Load, a derivative service, allows prepaid subscribers to transfer even smaller denominations to other prepaid subscribers. Our prepaid subscribers are charged between Php5.50 per minute and Php6.50 per minute for calls within our wireless network and between Php5.50 per minute and Php6.50 per minute for calls terminating to other cellular or fixed line networks. Voice tariffs on our various prepaid voice packages range from a low of Php5.50 for four 15-second on-net calls to Php20 for three 3-minute on-net calls, valid for one day.
We offer both flat rate, or regular, and consumable postpaid plans with monthly service fees ranging from Php500 to Php8,000. These plans are available with varying amounts of free air time and text messages and different rates beyond the free minutes and text messages, depending on the monthly service fee. Monthly service fees for flat rate, or regular, plans are applicable only to local calls and text messages and for consumable plans to all voice calls, text messages (both local and international) and value-added services.
Smart is permitted to adjust its cellular air time and national direct dial rates according to changes in the peso-to-U.S. dollar exchange rate. Under the authorization granted to Smart by the NTC, Smart is permitted to increase and is required to decrease its air time and national direct dial rates by 1% for every Php0.25 change in the exchange rate relative to a base rate of Php24.726 to US$1.00. However, Smart has not implemented any foreign currency adjustments to its rates since November 4, 1998 because of the concern that increased rates may result in decreased usage or switching to other cellular providers by its subscribers.
All Smart subscribers pay an international direct dialing rate of US$0.40 per minute. This rate applies to 201 destinations, including the United States, Hong Kong, Japan, Singapore, the United Kingdom and the United Arab Emirates. Smart charges US$0.98 per minute for 27 other destinations and US$2.18 per minute for another ten destinations.
We also launch from time to time various promotions to stimulate usage and subscriber growth.
We sell our cellular services primarily through a network of independent dealers and distributors that generally have their own retail networks, direct sales forces and sub-dealers. We currently have nine major dealers, two of which are exclusive. These dealers include major distributors of cellular handsets whose main focus are telecommunications outlets. Account managers from our sales force manage the distribution network and regularly update these business partners on upcoming marketing strategies, promotional campaigns and new products introductions. With the introduction of Smart Load in May 2003, Smart moved into a new realm of distribution. These over-the-air reloads, which were based on the “sachet” marketing concept of consumer goods such as shampoo and ketchup, required a distribution network that approximates those of fast-moving consumer goods companies. Starting with just 50,000 outlets when it was launched, Smart Load’s distribution network now encompasses over 800,000 retail agents, 80% of which are micro businesses (e.g., neighborhood stores, individual entrepreneurs, individual roving agents). These micro-retailers must be affiliated with any of Smart’s authorized dealers, distributors, sub-dealers or agents. With the prepaid reloading distribution network now extended to corner store and individual retailer levels and minimum reloading denominations as low as Php10, Smart’s prepaid service becomes even more affordable and accessible to subscribers.
For prepaid services, we grant discounts to dealers for prepaid phone kits, air time cards and over-the-air reloads sold. Smart and Piltel compensate dealers with Php800 in cash per prepaid phone kit sold. An additional 1% discount based on the suggested retail price is given on cash purchases. Air time cards and over-the-air reloads are sold to distributors at volume discounts determined by the value of the cards purchased by the distributors. Discounts given for air time cards sold range from 8% to 8.4% while discounts on over-the-air reloads range from 2.5% to 5%. Air time cards cannot be returned or refunded and normally expire within six to 12 months after release from the Smart warehouse.
Wireless Broadband, Satellite, VSAT and Other Services
Overview
We currently provide wireless broadband, satellite, VSAT and other services through Mabuhay Satellite and Telesat, ACeS Philippines, our satellite phone service provider, Smart Broadband, our wireless broadband provider, and Wolfpac, our wireless content operator.
Mabuhay Satellite
Mabuhay Satellite is engaged in the control and operation of the Agila II satellite. Commencing commercial operations in January 1998, Agila II is the Philippines' first communication satellite. Mabuhay Satellite leases satellite space segments in both the C and Ku bands on Agila II. Through Agila II, Mabuhay Satellite also offers Internet backbone access, video and data broadcasting, and bandwidth-on-demand, facilitating communication links between telecommunications, broadcast and other public utility companies operating in the Asia-Pacific region. In 2006, Mabuhay Satellite generated revenues of Php1,157 million and posted a net loss of Php1,499 million.
Telesat
Telesat operates a nationwide communications satellite network using VSAT technology. Telesat offers voice, facsimile and data transmission services throughout the Philippines, including areas that are underserved or unserved by local fixed line operators. In 2006, Telesat generated revenues of Php9 million and posted a net loss of Php51 million.
Using VSAT technology, we also provide the following services:
• point-to-multipoint data transmission services, usually for intercompany communication for corporate customers;
• private point-to-point services; and
• connectivity for the cell sites of our wireless network in outlying locations.
We lease transponder capacity on Agila II satellite to provide VSAT services.
ACeS Philippines
ACeS Philippines currently owns approximately 36.99% of AIL. In 2006, ACeS Philippines generated revenues of Php430 million and posted a net income of Php159 million. AIL aims to develop and implement a satellite-based communications system to provide services to users in the Asia-Pacific region through the Garuda I satellite, or ACeS System and ACeS Service. AIL has entered into interconnection agreements and roaming service agreements with PLDT and other major telecommunications operators that will allow ACeS service subscribers to access GSM terrestrial cellular systems in addition to the ACeS system. Further, AIL has an Air Time Purchase Agreement, or ATPA, with National Service Providers in Asia, including PLDT. For further discussion regarding the ATPA, please see Item 5. “Operating and Financial Review and Prospects — Liquidity and Capital Resources — Contractual Obligations and Commercial Commitments — Contractual Obligations — Unconditional Purchase Obligations — Air Time Purchase Agreement with AIL” below and Note 16 – Related Party Transactions to the accompanying consolidated financial statements in Item 18.
As part of the consolidation process of the PLDT Group’s wireless business, ACeS Philippines’ operations has been integrated into Smart. This operational integration effectively gives Smart the widest service coverage in the Philippines through the combination of ACeS Philippines satellite phone service and Smart’s cellular service.
Smart Broadband
Smart Broadband is engaged in providing wireless broadband and data services to residential consumers as well as small and medium-scale enterprises in the Philippines. As of December 31, 2006, Smart Broadband had 121,867 wireless broadband subscribers, of which 120,659 residential subscribers are under the brand name Smart Bro (formerly Smart WiFi). Smart Bro aims to strengthen Smart’s position in the wireless data segment and complements PLDT’s myDSL service in areas where the latter is not available.
Smart Bro offers two packages for its wireless broadband service:
• Smart Bro Plan 999, which is geared towards consumers and provides Internet speeds of up to 384 kbps; and
• Smart Bro Computer Station Plan 2600, which is geared towards entrepreneurs and includes a monthly subscription, hardware, software and merchandising materials.
Wolfpac
Wolfpac is primarily engaged in the business of consumer mobile applications software development and consumer mobile content development and other allied services. Wolfpac is one of the leading content providers and the only Philippine content provider to have been nominated twice at the annual GSM Congress for successes in application developments. Wolfpac generated revenues of Php7 million and posted a net loss of Php119 million in 2006. It aims to provide Smart to have a direct link to the content development community, a key differentiator in wireless communication service. The company has various agreements with third parties for musical compositions, original sound recordings, original movies, caller ringtune and other services.
PLDT WeRoam
We also offer PLDT WeRoam, or WeRoam, a wireless broadband service offering running on Smart's nationwide wireless network (using GPRS, EDGE and WiFi technologies) and PLDT's extensive IP infrastructure. WeRoam provides workers and remote offices, of large, medium and small businesses, with continuous wireless data connectivity from wherever the users may be to their corporate headquarters’ Intranet and/or the global Internet. In addition, we expanded the PLDT Innovation Laboratory, or PLDT Innolab, in Manila in partnership with the leading technology companies in the country. With the expanded PLDT Innolab, more clients as well as people from the academe and government can now be accommodated and can experience more on-line industry solutions.
In February 2006, WeRoam introduced a prepaid option with bundled laptops featuring easy payment plans in alliances with PC vendors across the country. In July 2006, WeRoam also made higher speed wireless broadband available to the market with the launch of the WeRoam 3G/HSDPA service.
Revenues
Our wireless broadband, satellite, VSAT and other service revenues consist of:
• lease payments from the rental of Mabuhay Satellite's C-band and Ku-band transponders;
• revenues generated from Telesat's nationwide satellite network;
• revenues generated from ACeS Philippines’ satellite phone service;
• revenues generated from Smart Broadband’s wireless broadband and data services; and
• revenues generated from Wolfpac for wireless data content.
Rates
Mabuhay Satellite leases its transponders to third parties at average annual rates of approximately US$0.9 million and approximately US$0.7 million for its C-band and Ku-band transponders, respectively. Telesat provides its VSAT services on a cost plus mark-up basis. ACeS service mobile subscribers are charged Php13.84 per minute for local and cell-to-cell calls and for national direct dial services, while residential subscribers are charged peak-hour rates of Php13.00 per minute and off-peak hour rates of Php8.00 per minute for domestic calls regardless of destination. For ACeS system public calling offices, callers are charged Php4.50 and Php7.00 per minute for calls terminating to fixed line and cellular networks, respectively. Rates for international long distance calls depend on the country of termination and range from US$0.35 per minute for frequently called countries to US$0.85 per minute for less frequently called countries.
Smart Broadband offers its wireless broadband and data services for residential consumers as well as small and medium-scale enterprises. The wireless broadband service for residential consumers is branded as Smart Bro and offers a maximum speed of 384 kbps for Php999 per month. Monthly service fees for corporate data services range from Php2,200 to Php48,000 depending on the connection speed requirements.
Wolfpac generates revenues from SMS subscriptions, institutional services and downloadable contents. The subscription price for the SMS subscription and institutional services is pegged at Php2.50 per SMS, while downloadable contents range from Php10.00 to Php45.00.
WeRoam postpaid offers several packages for its wireless broadband service that include unlimited Internet access with speeds ranging from 40 kbps to 1.8 Mbps with monthly recurring fees of Php1,000 to Php1,700 depending on the type of plan selected.
WeRoam prepaid offers several packages that include the GPRS/EDGE card and an air time value for three, six and 12 months with monthly subscription fees based on an initial air time value ranging from Php10,860 to Php20,940. Once the initial air time value expires, continued use of the service requires WeLoad or reloading of additional air time value with different denominations and expiration periods.
We provide local exchange, international long distance, national long distance, data and other network and miscellaneous services under our fixed line business segment.
Local Exchange Service
Overview
Our local exchange service, which consists of our basic voice telephony business, is provided primarily through PLDT.
The following table summarizes key measures of our local exchange service segment as at and for the years ended December 31, 2006, 2005 and 2004:
____________ (1) Previously set forth as number of fixed lines in service, this was restated in 2006 to reflect the effect of the change in parameters used to align with the PLDT Group’s policy on subscriber count with the planned use of an integrated billing system for our subscribers.
We also provide local exchange services through our subsidiaries ClarkTel, SubicTel, Maratel and Piltel. Together, these subsidiaries account for approximately 4% of our consolidated fixed line subscribers.
We regularly adjust our rates and introduce new products and services in an effort to increase our number of subscribers, improve our churn management efforts and minimize our credit risk exposure. Since 1999, we have launched a prepaid fixed line service, introduced additional value-added services, introduced initiatives aimed at increasing subscription in areas where we have excess capacity and reduced our installation fees, as described below in the "— Rates" section below.
Initially intended as an alternative affordable telephone service for consumers under difficult economic conditions, our prepaid fixed line services now form an important part of PLDT’s overall churn and credit risk exposure management and subscriber retention strategy.
Rates
As at December 31, 2006, basic monthly charges for our local exchange service in the Metropolitan Manila area were Php594.17 for a single-party residential line and Php1,237.27 for a single business line. Monthly charges vary according to the type of customer (business or residential) and location, with charges for urban customers generally being higher than those for rural/provincial customers. Regular installation charges amount to Php1,999 for residential customers and Php3,500 for business customers. New products launched on promotion or products bundled on existing services usually waive the installation fee or allow for a minimal installation fee of Php500. Other than basic monthly charges, we do not charge our postpaid subscribers for local calls.
Pursuant to a currency exchange rate mechanism authorized by the NTC, we adjust our monthly local exchange service rates according to changes in the peso-to-U.S. dollar exchange rate. Under the authorization granted to us by the NTC, we are permitted to increase and are required to decrease these rates by 1% for every Php0.10 change in the exchange rate relative to a base exchange rate of Php11 to US$1.00. In 2006, we implemented eight downward adjustments and three upward adjustments in our monthly local service rates. During 2005, we implemented three upward and six downward adjustments in our monthly local exchange service rates.
In the first quarter of 2005, House Bill No. 926 was filed and is now pending in the House of Representatives of the Philippines. The proposed bill provides for the cancellation of the currency exchange rate mechanism currently in place. If this bill is passed into law or if the NTC issues guidelines to change the basis of the currency exchange rate mechanism, our ability to generate U.S. dollar linked revenues from our local exchange business could be adversely affected.
Our prepaid fixed line customers generally do not pay a basic monthly charge and are charged based on usage. Prepaid fixed line customers are generally charged based on usage at a rate of Php1.00 per minute for local calls. Subscribers of TelePwede, our upgraded prepaid fixed line service, are charged a monthly fee of Php115 per month to receive incoming calls and are charged per usage for outgoing calls with varying charges depending on the destination and network of termination. The international and national long distance rates we charge to our prepaid fixed line customers are similar to the rates we charge to our postpaid customers. (For a detailed description of these rates, see “— International Long Distance Service — Rates” and “— National Long Distance Service — Rates.”) Prepaid phone kits, each containing Php500 worth of pre-stored call credits, are sold for Php1,900 per unit.
International Long Distance Service
Overview
Our international long distance service consists of voice and packet-based voice and data services that go through our international gateway facilities. We also generate international long distance revenues through access charges paid to us by other Philippine telecommunications carriers for incoming international voice calls that terminate to our local exchange network. Our packet-based voice and data services are transmitted over our existing traditional circuits, VoIP systems and the network of a consortium of dominant Asian carriers in which PLDT is a member.
The following table shows certain information about our international long distance business as at and for the years ended December 31, 2006, 2005 and 2004:
International long distance service historically has been a major source of our revenue. However, due to the steep decline in inbound termination and collection rates and intense competition, revenues derived from our international long distance service have been declining. We adopted a two-pronged initiative in early 2000 with respect to inbound international service to try to address this issue. First, we lowered our inbound termination rates at that time; by reducing our rates, we reduced the incentive for unauthorized traffic termination and bypass routings by toll bypass operators, and therefore were able to recover some lost traffic; and secondly, we intensified our efforts to identify and contain unauthorized traffic termination and bypass through more effective monitoring of our international trunks, leased lines and local network. International simple resale operation occurs when a company rents an international leased line from a Philippine international gateway operator, aggregates traffic outside the Philippines and carries and terminates this traffic at the local public switch telephone network in the Philippines. This termination of other unauthorized and international simple resale can be used to bypass the local access charge system and is illegal in the Philippines.
We are more selective in accepting incoming traffic from new and startup carriers, particularly second and third tier international carriers. In addition, we adopted a policy requiring prepayment from certain second and third tier international carriers as a prerequisite for accepting their incoming traffic.
We are also pursuing a number of other initiatives to further strengthen our inbound business. Through PLDT Global, we aggregate inbound call traffic to the Philippines at our points of presence and, using our capacity in submarine cable systems connected to each point of presence, transmit calls to our network. PLDT Global is also enhancing the presence of PLDT in other international markets by offering new products and services such as international prepaid cards, mobile services, SMS transit and other global bandwidth services. We believe these strategies will help us maximize the use of our existing international facilities, and develop alternative sources of revenue.
To stimulate call volume growth and prevent further erosion in our share of outbound international call traffic, we have introduced a number of marketing initiatives, including substantial cuts in international direct dialing rates, innovative pricing packages for large accounts and loyalty programs for some customers.
The table below sets forth the net settlement amounts for international calls handled by PLDT, by country, for the years ended December 31, 2006, 2005 and 2004:
Rates
Since February 1, 2003, a substantial portion of PLDT’s international inbound traffic terminating on its fixed line network is charged US$0.12 per minute.
Rates for outbound international long distance calls are based on type of service, whether operator-assisted or direct-dialed. Our rates are quoted in U.S. dollars and are billed in pesos. The peso amounts are determined at the time of billing. We charge a flat rate of US$0.40 per minute to retail customers for direct-dialed calls, applicable to all call destinations at any time on any day of the week.
On September 15, 2005, we introduced PLDT ID-DSL, a service that allows overseas calls for registered myDSL plan subscribers using a regular PLDT fixed line or a voice pad dialer for as low as US$0.10 per minute or US$0.08 per minute, respectively, depending on a particular subscriber’s DSL plan.
To address the market’s demand for low-priced international calls, PLDT enhanced the Budget Card, a prepaid call card, offering a reduced IDD rate of Php5 per minute as a promotional offer starting September 24, 2005 for calls to 89 overseas destinations including the United States, Canada, Japan and China. Beginning March 4, 2006, the Budget Card IDD rates have been further adjusted to Php3, Php5 and Php8 per minute, depending on the destination, and now permits calls to 100 overseas destinations. Budget Cards are sold in denominations of Php200 and Php100 and must be consumed within 30 days from first use.
National Long Distance Service
Overview
Our national long distance services are provided primarily through PLDT. This service consists of voice services for calls made by our fixed line customers outside of their local service areas within the Philippines and access charges paid to us by other telecommunications carriers for calls carried through our backbone network and/or terminating to our fixed line customers.
The following table shows our national long distance call volumes and revenues as at and for the years ended December 31, 2006, 2005 and 2004:
A substantial portion of our national long distance calls were direct-dialed calls. Operator-assisted calls are charged based on a minimum of three minutes plus operator charges, while direct-dialed calls are charged on a less costly per minute basis. Cellular substitution and the widespread availability and growing popularity of alternative, more economical non-voice means of communications, particularly e-mailing and cellular text messaging, have negatively affected our national long distance call volumes. The integration of some of our local exchanges into a single local calling area, as approved by the NTC, has also negatively affected our national long distance call volumes and, consequently, our revenues. Because of this integration, calls between two exchanges located within the same province are no longer considered national long distance calls but are treated as local calls.
Rates
Rates for national long distance calls are based on type of service, such as whether the call is operator-assisted or direct-dialed. In line with its move towards rate simplification, PLDT simplified these rates to a flat rate of Php4.50 per minute effective November 2, 2001. At the same time, PLDT simplified its rates for calls terminating to cellular subscribers from a range of Php10.00 per minute to Php16.00 per minute to a uniform rate of Php13.75 per minute. Effective March 1, 2003, PLDT increased the rate for calls terminating to other local exchange carriers from a flat rate of Php4.50 per minute to Php5.00 per minute. In addition, NDD calls originating from and terminating to PLDT was also adjusted to Php5.00 per minute from a flat rate of Php4.50 per minute effective June 8, 2003.
In addition, PLDT launches from time to time promotions, such as flat rate promotions for unlimited calls from PLDT subscribers terminating to PLDT and Smart and Talk ‘N Text subscribers, to stimulate fixed line usage.
On January 7, 2006, the Php10 per call to PLDT, Smart and Talk ‘N Text subscribers promotion was made permanent with an optional Php50 monthly service fee for those who may want to avail themselves of the service. The offer introduced a permanent shift from “per minute” charging and allows PLDT fixed line subscribers access to approximately 26 million PLDT, Smart and Talk ‘N Text subscribers at a lower rate. The Php10 per call offer for calls to Smart and Talk ‘N Text subscribers was capped, limiting enrollees to those who registered on or before February 24, 2006. PLDT fixed line subscribers, however, can still register and avail themselves of the unlimited Php10 per call service for national long distance calls within the PLDT network.
We continue to evaluate the present rate structure of fixed line from per minute toll charges to single rate for unlimited calls. This is envisioned to make fixed line rates competitive with VoIP rates and to revitalize interest in fixed line usage. We continue studying various pricing models in respect of the above new rate plan.
PLDT currently has interconnection arrangement with the majority of other local exchange carriers, pursuant to which the originating carrier pays: (1) a hauling charge of Php0.50 per minute for short-haul traffic or Php1.25 per minute for long-haul traffic to the carrier owning the backbone network; and (2) an access charge of Php1.00 per minute to the terminating carrier. PLDT still maintains revenue-sharing arrangements with a few other local exchange carriers, whereby charges are generally apportioned 30% for the originating entity, 40% for the backbone owner and the remaining 30% for the terminating entity. For more information on these interconnection arrangements, see “–– Interconnection Agreements.”
Data and Other Network Services
Our data and other network service revenues include charges for leased lines, IP-based, packet-based and switched-based services. These services are used for domestic and international communications such as private networking, broadband and narrowband Internet-based data communications, and packet-based communication.
The following table shows our data and other network service revenues for the years ended December 31, 2006, 2005 and 2004:
Recognizing the growth potential of data and other networking services, including IP-based services, and in light of their importance to our business strategy, we have been putting considerable emphasis on this service segment. In 2005, this segment registered the highest percentage growth in revenues among our fixed line services and continued to grow in 2006.
The continuous upgrading of our network using next-generation facilities and the completion of our domestic fiber optic backbone has enabled us to offer a growing range of value-added and broadband services. With this and other technological upgrades, our infrastructure has developed from a traditional voice facility to a new packet-switched and IP-based network allowing faster transmission of voice, video and data.
IP-based products are bannered by PLDT DSL (myDSL and BizDSL), PLDT Vibe and I-Gate. PLDT DSL broadband Internet service is targeted for heavy individual Internet users as well as for small and medium enterprises, while PLDT Vibe, or PLDT’s dial-up/narrowband Internet service, is targeted for light to medium residential individual Internet users. I-Gate, our dedicated leased line Internet access service, on the other hand, is targeted for enterprises and value-added service providers.
In 2006, we continued to broaden our service offerings with the launch of new services and with the expansion or enhancement of some of our existing services.
In June 2006, we introduced Shops.work Unplugged, or SWUP, to address the need of retailers and banks for real-time wireless data communication using Smart’s GPRS/EDGE network and PLDT’s private VPN network. SWUP is a bundled solution that offers wireless VPN connections in response to retailers’ cashiering point-of-sale networking requirements, the need for back-up remote connections to bank automated teller machines, or ATMs, and merchants’ swipe card terminal access needs. Retailers will now be able to reach out to a bigger market in areas where physical connections are unavailable, expand the banking system with wireless ATMs and release swipe card terminals to more merchants.
In support of the growing data requirements of the small and medium enterprise market, the network footprints of BRAINS, IP-VPN, Shops.work and Shops.work Unplugged, or SWUP. PLDT’s private local networking services, have been expanded with the roll-out of NGN facilities in key business areas across the country.
The continued growth in data services revenues can be attributed to several product offerings. The steady demand for dedicated connectivity or private networking from the corporate market using PLDT’s traditional international and domestic data offerings, including, among others, Fibernet, Arcstar, Acacia, I-Gate, Diginet, BRAINS, IP-VPN and Shops.work, continues to provide us with a stable revenue source.
Meanwhile, Digital Network, or Diginet, our domestic private leased line service, has been providing Smart’s increasing fiber optic and leased line data requirements.
Information and Communications Technology
We conduct our information and communications technology, or ICT, businesses through our wholly-owned subsidiary ePLDT. ePLDT is a broad-based integrated information and communications technology company, focusing on infrastructure and solutions for Internet applications, Internet protocol-, or IP-, based solutions and multimedia content delivery. ePLDT's principal businesses are the operation of (a) call centers through Vocativ, Parlance and Ventus, (b) BPO, through SPi, (c) an Internet data center under the brand name Vitro™, and (d) Internet and online gaming through Infocom, netGames, Digital Paradise, Digital Paradise Thailand, Level Up! and Airborne Access. Our ICT segment registered revenues of Php6,890 million, Php3,305 million and Php2,401 million, accounting for 5%, 3% and 2% of our consolidated operating revenues for the three years ended December 31, 2006, 2005 and 2004, respectively. The increase in the revenue contribution from our information and communication technology segment was primarily due to the consolidation of SPi, CyMed and Level Up! since their acquisition by ePLDT on July 11, 2006, August 11, 2006 and April 30, 2006, respectively, and is expected to increase going forward with the full-year consolidation of SPi.
Call Centers
We are focused on developing our call center business which capitalizes on the availability of English-speaking college graduates in the Philippines with a strong customer service orientation. ePLDT has established one umbrella brand name, ePLDT Ventus, for all of its call center businesses, including Vocativ and Parlance. Ventus provides offshore, cost-effective contact center outsourcing solutions specializing in inbound customer care. Vocativ provides customer and technical support to its clients in the Philippines, U.S. and U.K., while Parlance provides the exclusive customer support and billing requirements to one of the largest direct-to-home satellite television providers in the U.S. In aggregate, we own and operate approximately 5,600 seats with 5,130 customer service representatives, or CSRs, as at December 31, 2006 compared to approximately 3,350 seats with 3,625 CSRs as at December 31, 2005. In 2006, ePLDT Ventus launched two new sites bringing our total call center site count to seven as at December 31, 2006.
Business process outsourcing
ePLDT acquired a 100% equity interest in SPi and its direct and indirect Philippine and offshore subsidiaries for a total cash consideration of US$135 million on July 11, 2006. SPi is one of the leading pure-play BPO company and the ninth largest independent BPO service provider worldwide. It has operations in 19 locations in North America, Europe and Asia. On August 11, 2006, SPi acquired 100% of CyMed, a leading medical transcription company based in Richmond, Virginia, and on April 16, 2007, SPi acquired 100% of Springfield Service Corporation, one of the ten largest players in the medical billing and revenue cycle management market.
Data Center
ePLDT operates Vitro™, one of the Philippines' first Internet data centers. The Philippine Board of Investments granted Vitro™ pioneer status, which entitles it to tax and other governmental incentives. Vitro™ is a CISCO-certified co-location service provider. Vitro™ provides co-location, web and server hosting, hardware and software maintenance services, website development and maintenance services, webcasting and webhosting, shared applications, data disaster recovery and business continuity services, intrusion detection and Internet protocol security services, as well as firewall and managed firewall services.
Internet and Online Gaming
ePLDT’s Internet and online gaming business is conducted through several subsidiaries. ePLDT owns a 99.6% interest in Infocom, one of the country's leading Internet service providers, or ISPs. Infocom offers consumer prepaid Internet access under the name WarpSpeed and Speed Tipid and postpaid Internet access; dedicated dial-up and multi-user dial-up corporate leased lines; broadband Internet access through DSL and cable; and website consulting, development and hosting. ePLDT also owns a 75% interest in Digital Paradise, an Internet café business with over 182 branches which assumed the assets of Netopia Computer Technologies, Inc. and the brand Netopia. ePLDT further holds an 80%-interest in netGames, a publisher of Massively Multi-player Online Games in the Philippines, and is the Philippine licensee of Khan Online, the country’s first full 3D online game; a 51% interest in Airborne Access, the country’s leading operator of WiFi hotspots, which provides wireless Internet access in hotspots equipped with Airborne Access WiFi access points and a 60% equity interest in Level Up!, a leading publisher of online games in the Philippines with about an 80% share of the online gaming market.
Wireless Network Infrastructure
Cellular
Through Smart, we operate a digital GSM network. To meet the growing demand for cellular services, Smart has implemented an extensive deployment program for its GSM network covering substantially all of Metro Manila and most of the other population centers in the Philippines. In 2006, Smart has 42 mobile switching centers, 61 text messaging service centers and 6,099 base stations in operation after having added 117 base stations to its nationwide cellular network in 2006. As at December 31, 2006, Piltel has six active cell sites.
Smart has an operating spectrum of 7.5 MHz in the 900 band supporting both its GSM and previously its ETACS network and 20 MHz in the 1800 band for GSM and 15 MHz in the 3G band for W-CDMA. Its dual-band GSM network allows it to efficiently deploy high capacity 1800 MHz base transceiver stations in dense urban areas while its 900 MHz base transceiver stations can be much more economically deployed in potentially high growth, but less densely populated provincial areas. The 3G network revolutionizes mobile technology by providing more capacity, faster data rates and richer data and video applications. Its initial deployment is seen as feasible in urban areas where there is a demand for mobile broadband applications and where 3G mobile units are more likely to be available. Spectrum constraints will not affect the Smart’s expansion plans for GSM in the foreseeable future. Piltel, on the other hand, has an operating spectrum of 11.5 MHz out of the 12.5 MHz allocated in the 800 MHz band.
Due to its access to PLDT’s network assets, Smart has been able to achieve significant capital expenditure savings, which are understood to be significantly less, on a per net addition basis, than its current competitors. This translates into an improved ability to price competitively and target the mass market subscriber base in the Philippines, while retaining profitability. Based on existing equipment purchase contracts, Smart expects incremental capital expenditure per net additional subscriber to amount to less than US$50.
The coming years will see continued increases in coverage (particularly indoor), as well as new types of BTS for outdoor, street level and commercial office coverage. Smart has introduced the Nokia ConnectSite GSM solution for wider coverage and increased efficiencies in underserved areas of the Philippines. The new base station equipment called ConnectSite can be up to 25% more efficient than traditional outdoor cell sites. Smart is one of the very first operators in the world to adopt this solution.
Smart was awarded a 3G license by the NTC on December 29, 2005. Smart received the largest radio frequency allocation of 15 MHz as well as first choice of frequency spectrum. Smart chose the 1920-1935 MHz and 2110-2125 MHz spectrum, the range that would best enable it to rapidly deploy its 3G network nationwide and at the same time offer the highest quality of 3G service. Smart has commenced its 3G network roll-out and continues to extend the reach of its 3G network in various cities and municipalities nationwide, further improving coverage in major urban centers and selected provincial areas.
Smart
and Piltel have been co-locating their cell sites where their base stations are
installed. As at
Wireless Broadband, Satellite, VSAT and Other Services
Smart Broadband operates a nationwide broadband wireless Internet data services. It is operating in the 2.4, 3.5 and 5.7 Ghz spectrum, supporting its WiFi, Canopy and eventually WiMax services, respectively. It offers fixed wireless broadband Internet connectivity to both residential and corporate clients. It also maintains and operates WiFi hotspots installations that serve mobile Internet users. Almost 2,500 of Smart’s base stations are now wireless broadband-capable, covering most of the key cities and the other populated centers in the country. These are strategically co-located in the Smart’s cellular base stations that allow it to reach as many subscribers as possible, in the fastest possible way. For its backbone, it uses the nationwide PLDT and Smart fiber optic and IP backbone that provide substantial bandwidth capacity to utilize and to grow on demand.
Mabuhay Satellite controls and operates the Agila II satellite, which has 30 C-band transponders and 24 Ku-band transponders covering the Asia-Pacific region, the Indian subcontinent and Hawaii. Of the 54 transponders, six have restricted usage due to satellite interference. Through Agila II, Mabuhay Satellite offers Internet service, video and data broadcasting, and bandwidth-on-demand, facilitating communication links between telecommunications, broadcast and other public utility companies operating in the Asia-Pacific region. In December 2000, Agila II joined the U.S. FCC's "Permitted Space Station" list, which permits U.S.-owned and operated earth stations in Hawaii to access Agila II for transpacific telecommunications, data, video and Internet-over-satellite traffic and vice versa.
Telesat operates a national communications satellite network using VSAT technology to provide voice, facsimile, video and data transmission services to areas in the country that are still underserved or unserved by local telephone operators. Telesat leases transponder capacity from Agila II to provide VSAT services such as multipoint-to-multipoint and point-to-multipoint data transmission services, private point-to-point service, and connectivity for the cell sites of our cellular network in outlying locations.
ACeS Philippines manages, controls and operates its own satellite gateway and other ground infrastructure, including a 13-meter feeder-link C-band earth station, beam congruency antenna and equipment that serve as the primary interface between the ACeS system and other telecommunications networks. It uses the Garuda I satellite to provide digital voice services to ACeS Philippines’ mobile and fixed terminal users within the Asian service area.
Fixed Line Network Infrastructure
Domestic
Our domestic telephone network includes installed telephones and other equipment on customers’ premises, local access lines connecting customers to exchanges, referred to as “outside plant,” inter-office lines connecting exchanges, and long distance transmission equipment.
The following table gives some basic measures of the development of our domestic telephone network as at December 31, 2006, 2005 and 2004:
_____________ (1) Previously set forth as number of fixed lines in service, this was restated in 2006 to reflect the effect of the change in parameters used to align with the PLDT Group’s policy on subscriber count with the planned use of an integrated billing system for our subscribers.
We have our own 6,400-kilometer domestic fiber optic network, or DFON, the country's first telecommunications network using fiber optics in delivering voice, video, data, and other broadband and multimedia services nationwide. Our fiber optic network employs synchronous digital hierarchy technology to improve network performance and reduce operating costs. Our network is composed of in-land and submarine cable installations and is configured in seven self-healing rings allowing route delivery even in the event of single link failure per ring. To date, the PLDT DFON is equipped with N x 10 gigabits per second capacity and is connected directly to four existing international submarine cable systems. We use the CS VEGA (formerly CS PLDT), a cable ship that we lease from NTT World Engineering Marine Corporation pursuant to a two-year renewal, entered into in January 2006, to a five-year Chartered Arrangement Maintenance Contract that expired in August 2005 to maintain the 2,400 kilometers of submarine cable comprising the submerged portion of our DFON.
We are currently upgrading our fixed line facilities to NGN, a broad term for certain emerging computer network technologies that can encompass voice, data and video where all information is efficiently transmitted via digital packets of data. It is a platform that will allow for more services to be made available to our fixed line subscribers.
International
We provide international network services using our three international gateway switching exchanges. As of December 31, 2006, our international long distance facilities allow direct correspondence with 49 countries/territories (representing 89 correspondents) and can reach 420 foreign destinations (via direct and transited routes including breakouts) worldwide. We also own interests in submarine and satellite systems, through which we route most of our international traffic.
The table below shows the submarine cable systems in which we have interests and the countries or territories they link:
Additionally, on May 2, 2007, a consortium of seventeen major international telecommunication operators, including PLDT, signed an agreement to build the first high-bandwidth optical fiber submarine cable system linking Southeast Asia and the U.S. The cable project, known as the Asia-America Gateway, will span 20,000 kilometers and will use the latest Dense Wavelength Division Multiplexing technology to provide upgradeable, future proof transmission facilities that will support bandwidth requirements for new and revolutionary broadband applications. It is expected that the Asia-America Gateway will cost approximately US$500 million (of which US$50 million represents PLDT’s investment) and will be ready for service by the end of 2008.
Since the issuance of Executive Order No. 59 in 1993, which requires non-discriminatory interconnection of Philippine carriers' networks, we have entered into bilateral interconnection arrangements with other Philippine fixed line and cellular carriers.
For local calls originating from PLDT and terminating to the cellular networks of Smart and Globe, Smart and Globe charged PLDT a rate of Php4.50 per minute effective January 1, 2002. Effective January 1, 2004, calls terminating to cellular subscribers originating from fixed line subscribers are charged a termination rate of Php4.00 per minute, a decrease from the previous Php4.50 per minute.
Effective January 1, 2003, local access for cellular operators, including Smart, that terminate calls to PLDT’s fixed line network increased from Php2.00 per minute to Php2.50 per minute, which further increased to Php3.00 per minute effective January 1, 2004.
Under a separate agreement between PLDT and PAPTELCO, PLDT is the transit facility provider between Smart, Globe, other local exchange carriers, or LEC, operators and PAPTELCO. PAPTELCO is comprised of 48 LEC and operating in 144 major telephone exchanges nationwide. Transit traffic is a service by PLDT to Smart, Globe, other LEC operators and PAPTELCO members where PAPTELCO members have no direct interconnection with either Smart, Globe and other LEC operators.
Effective February 1, 2003, international calls terminating to PLDT’s fixed line network were charged a termination rate of US$0.12 per minute, an increase from the previous rate of US$0.08 per minute. Also, international calls terminating to Smart’s cellular network were charged a termination rate of US$0.16 per minute, an increase from the previous termination rate of US$0.12 per minute.
Effective January 1, 2002, Smart charged a termination rate of Php4.00 per minute for calls originating from/terminating to another cellular operator’s network. For SMS originating from Smart and terminating on other operators’ cellular network and for SMS originating from other operators and terminating on Smart’s cellular network, the charge is Php0.35 per message.
PLDT, Smart and Piltel provide telecommunications services pursuant to legislative franchises that currently expire, in the case of PLDT, on November 28, 2028, in the case of Smart, on March 27, 2017 and, in the case of Piltel, on May 14, 2019. A franchise holder is required to obtain operating authority from the NTC to provide specific telecommunications services. These approvals may take the form of a Certificate of Public Convenience and Necessity, or CPCN, or, while an application for a CPCN is pending, a provisional authority to operate. Provisional authorities are typically granted for a period of 18 months. The Philippine Revised Administrative Code of 1987 provides that if the grantee of a license or permit, such as a CPCN or provisional authority, has made timely and sufficient application for the extension thereof, the existing CPCN or provisional authority will not expire until the application is finally decided upon by the administrative agency concerned.
PLDT operates its business pursuant to a number of provisional authorities and CPCNs, the terms of which will expire at various times between now and 2028. PLDT's CPCNs to provide services to most of the Metropolitan Manila area, Davao and other Philippine cities expired in 2003. Although some of PLDT's CPCNs and provisional authorities have already expired, PLDT filed timely applications for extension of these CPCNs and provisional authorities prior to their respective expiration dates and is therefore entitled to continue to conduct its business under its existing CPCNs and provisional authorities pending the NTC’s decision on these extensions. PLDT expects that the NTC will grant these extensions; however, there can be no assurance that this will occur. The period of validity of some of PLDT’s CPCNs which expired on November 28, 2003, coterminous with the term of its previous franchise under Republic Act No. 6146, has been extended further by the NTC to November 28, 2028, coterminous with PLDT’s current franchise under Republic Act No. 7082. Motions to extend the period of validity of the other CPCNs to November 28, 2028 are now pending with the NTC. See Item 3. “Key Information –– Risks Factors — Risks Relating to Us — Our business is significantly affected by governmental laws and regulations, including regulations in respect of our franchises, rates and taxes.”
Smart operates its cellular, international long distance and national long distance services pursuant to CPCNs, the terms of which will expire upon the expiration of its franchise. On August 26, 2002, Smart was granted a CPCN to install, operate and maintain nationwide global mobile personal communications via satellite which shall also expire upon expiration of its franchise. Smart’s provisional authority to establish, install, maintain, lease and operate an international private leased circuit was effective until November 6, 2006. Prior to its expiration, Smart filed for an extension of this provisional authority on the issuance of the CPCN, which remains pending. On July 22, 2002, Smart was granted separate CPCNs to operate a cellular mobile telephone system and an international gateway facility.
On December 29, 2005, Smart was awarded a 3G license by the NTC after being ranked highest in garnering a perfect score on a 30-point grading system designed to gauge the capability of telecommunication operators to effectively provide extensive 3G services. As a result, Smart received the largest radio frequency allocation of 15 MHz as well as first choice of frequency spectrum. Smart chose the 1920-1935 MHz and 2110-2125 MHz spectrum.
Under the terms of the 3G license, Smart is required to:
• begin installation and rollout of its 3G network no later than 18 months from the date of the award; • start commercial operations no later than 30 months from the date of the award; and • cover at least 80% of provincial capitals and 80% of chartered cities within five years.
Smart is also required to pay annual license fees of Php115 million based on the 15 MHz awarded to the Company.
Piltel is authorized to provide virtually every type of telecommunications service, including the transmission of voice, data facsimile, audio and video and information services, in and between provinces, cities and municipalities throughout the Philippines. The franchise, which was last amended on May 14, 1992, will expire on May 14, 2019 and may be extended by a legislative act of the Philippine Congress.
The following table sets forth the spectrum system, licensed frequency and bandwidth used by Smart, Piltel and Smart Broadband:
__________ * Smart Broadband frequency assignments on these bands are non-contiguous and on a per station and location basis.
Operators of international gateway facilities and cellular telephone operators, pursuant to Executive Order No. 109, are required to install a minimum number of local exchange lines. Of these new lines, operators are required to install one rural exchange line for every ten urban exchange lines installed. Smart and Piltel were required to install 700,000 and 400,000 lines, respectively, and each has received a certificate of compliance from the NTC.
PLDT, Smart and Piltel are required to pay various permit, regulation and supervision fees to the NTC. PLDT is currently engaged in disputes with the NTC over some of the assessed fees. For more information on the disputes involving PLDT, see Item 8. “Financial Information –– Legal Proceedings –– NTC supervision and regulatory fees, or SRF.”
On May 27, 1998, Smart filed an Urgent Ex Parte Motion and Manifestation regarding the permit fee in the amount of approximately Php113 million assessed by the NTC for the CPCN pertaining to Smart’s Integrated Local Exchange Telephone Service, Domestic Toll Service and Private Line Service (NTC Case No. 93-482). Smart contended that the fee should have been calculated on the basis of the actual local exchange carrier project cost, and that therefore the fee should be Php70 million. Although the NTC has not yet resolved this issue, Smart has already paid Php50 million in respect of this assessment as of the date of filing this annual report.
In a letter dated April 12, 2005, the NTC requested that Smart pay the following permit fees in respect of its CPCNs and provisional authorities:
In its letter dated May 13, 2005, Smart reiterated its petition that the basis for computation of the permit fees should be amended and cited the pendency of its Urgent Ex Parte Motion and Manifestation in NTC Case No. 93-482.
In order to diversify the ownership base of public
utilities, the Public Telecommunications Policy Act
• the fifth anniversary of the date the law became effective; and
• the fifth anniversary of the date of the entity’s commencement of commercial operations.
PLDT and Piltel have complied with this requirement. As Smart has not conducted a public offering of its shares by August 2004, the Philippine Congress may revoke the franchise of Smart for failure to comply with the requirement under R.A. 7925 to conduct a public offering of its shares by August 2004. A quo warranto case may also be filed against Smart by the Office of the Solicitor General of the Philippines on the ground of violation of R.A. 7925 for the failure of Smart to conduct a public offering of its shares by August 2004. However, Smart believes that it did not violate the terms of its franchise by not conducting an initial public offering by August 2004. Smart believes that the period stated in R.A. 7925 and in the other legislative franchises within which to conduct a public offering and listing of shares of stock of telecommunications companies should be deemed as merely directory and not mandatory. The DOJ has rendered an opinion that the three-year period fixed under the Downstream Oil Industry Deregulation Act of 1998 (R.A. 8479) for the conduct of the initial public offering of shares in entities engaged in the oil refinery business should be regarded as merely directory. Smart believes that this DOJ opinion should also apply to the period for the conduct of initial public offering of telecommunications companies. Moreover, Smart believes that it should be deemed to have complied with the requirement of making a public offering of its shares since PLDT owns 100% of the outstanding shares of Smart. The purpose of R.A. 7925 in requiring telecommunications companies to make a public offering of their shares, which is to broaden public ownership in telecommunications entities, is already realized as PLDT, a publicly listed company, owns 100% of Smart. In September 2004, Senate Bill No. 1675 was filed seeking to amend Section 21 of R.A. 7925. The bill seeks to declare that a telecommunications entity shall be deemed to have complied with the requirement of making a public offering of its shares if two-third of its outstanding voting stock are owned and controlled directly or indirectly, by a listed company. The bill is currently pending in the Philippine Senate. PLDT regularly evaluates various strategic options with respect to its capital structure.
The Philippine Congress is considering two bills that relate to the imposition of franchise tax on telecoms companies. HB No. 1469 proposes to re-impose a 5% franchise tax on gross receipts on telephone and telegraph services in lieu of the VAT. HB No. 1560 proposes a franchise tax at the rate of 3.5% on the first year and 7% thereafter on the gross receipts of telecoms and broadcast companies, in lieu of the VAT. There are also various bills in Congress which propose to tax telecommunications services, among them, the imposition of a tax on mobile phone companies on all text entries to text games; the imposition of a Php0.50 specific tax on each SMS to be borne by the cellular phone companies; and the imposition of a 10% ad valorem tax on all cellular phone calls using 3G.
The enactment of the Public Telecommunications Policy Act of the Philippines in March 1995 consolidated the government's various policy issuances governing the telecommunications industry and reaffirmed, among other things, the policy of liberalizing the industry and opening up the telecommunications market to new entrants. Including us, there are nine major local exchange carriers, seven international gateway facility providers and five cellular service providers in the country. Many new entrants into the Philippine telecommunications market have entered into strategic alliances with foreign telecommunications companies, which provide them access to technological and funding support as well as service innovations and marketing strategies. Consequently, we are facing increasing competition in major segments of the telecommunications industry, particularly data and other network services segments.
Cellular Service
There are presently six operating service providers, namely Smart, Piltel, Globe, Islacom, Digitel and Express Telecom. Globe acquired Islacom (now known as Innove) to form into one operating group, while Smart and Piltel, both being part of the PLDT Group, formed another operating group. These two operating groups have approximately 95% of the Philippine cellular market. The third active operator, Digitel, commenced its cellular service, Sun Cellular, on March 29, 2003 and is estimated to have approximately 5% of the cellular market as at December 31, 2006. In December 2005, the NTC awarded 3G licenses to existing cellular operators Smart, Globe, Digitel and to a new entrant, Connectivity Unlimited Resources Enterprises, or CURE. The NTC has yet to award a fifth license to another operator.
Competition in the cellular industry has intensified with the availability of affordably priced handsets offering a range of new functions and the introduction by competitors of new and improved plans for postpaid subscribers, reduced rates per minute and aggressive marketing and promotional strategies. The principal bases of competition are price, including handset cost, quality of service, geographic coverage and attractiveness of packaged services. Smart's network leads the industry in terms of coverage with 6,099 base stations as at December 31, 2006.
As a result of competitive pressures, several service providers, including Smart and Piltel, have recently introduced “bucket” plans providing unlimited voice and text services, and other promotions. While most of the “bucket” priced plans currently available in the market are being offered on promotional bases, Smart, Globe and Sun Cellular continue to launch other services that are designed to encourage incremental usage from existing subscribers and also to attract new subscribers.
Cellular operators are also competing actively against each other in launching innovative products and value-added services. The growing range of cellular products and services now include text messaging, multi-media messaging, voice mail, text mail, international roaming, information-on-demand, mobile banking, e-commerce, mobile data, cellular Internet access and Internet messaging.
On February 14, 2006, Smart opened its 3G network in selected key cities nationwide, making video calling, video streaming, high speed Internet browsing and special 3G content downloads on its 3G network available to subscribers with 3G handsets. Likewise, Globe is currently rolling out its 3G network.
Consistent with industry practice and Smart’s churn management efforts, Smart "locks" the handsets it sells to its subscribers, rendering them incompatible with SIM cards issued by competitors and thereby hindering them from swapping the existing SIM for a SIM of a competing operator. However, subscribers can have their handsets “unlocked” by unauthorized parties for a nominal fee and purchase new SIM cards from competing operators. “Unlocking” does not involve significant cost. Switching to another cellular operator would, however, result in a change of the subscriber’s cellular telephone number.
From October 2003 to May 2005, “SIM-swapping” became a prevalent promotional activity in the cellular industry. In “SIM-swapping” promotions, prepaid cellular subscribers had the ability to switch from one cellular operator to another by simply exchanging their current prepaid SIM card for another operator’s SIM card with a certain amount of preloaded air time credits at no cost. These “SIM-swapping” activities gave rise to a situation where certain subscribers regularly swapped their SIM card between cellular operators upon full use of the pre-stored air time. As a result, our cellular subscriber base contained a certain number of transient subscribers at any one point in time. In May 2005, we terminated our “SIM-swapping” promotions; as a result, our churn rates increased in the third and fourth quarters of 2005, but leveled off beginning in the first quarter of 2006.
Local Exchange Service
The concerted nationwide local exchange line build-out by various players, as mandated by the Philippine government, significantly increased the number of fixed line subscribers in the country and resulted in wider access to basic telephone service. The growth of the fixed line market, however, remained weak due to the surge in demand for cellular services and, in the past, the general sluggishness of the national economy. Nevertheless, we have sustained our leading position in the fixed line market on account of PLDT's extensive network in key cities nationwide. In most areas, we face one or two competitors. Our principal competitors in the local exchange market are Digitel, Bayan Telecommunications and Globe.
Over the past couple of years, however, competition among local exchange operators has reduced as certain operators have faced financial difficulties or have shifted strategic focus away from the fixed line business to cellular services. On the other hand, we are facing increasing competition from cellular operators mainly due to substitution of cellular services for fixed line services.
International Long Distance Service
Including us, there are 11 licensed international gateway facility operators in the country. While we have so far been able to maintain a leadership position in this highly competitive segment of the industry, in recent years, our market share has reduced largely as a result of (1) competition from other international gateway facility operators and illegal international simple resale operators; (2) an increase in inbound and outbound international long distance calls terminating to and originating from the growing number of cellular subscribers; and (3) the popularity of alternative and cheaper modes of communication such as text messaging, e-mail, Internet telephony and the establishment of virtual private networks for several corporate entities, further heightening the competition.
With respect to inbound calls into the Philippines, we adopted the U.S. FCC benchmark accounting rate of US$0.38 per minute for inbound international calls which represented a settlement rate of US$0.19 per minute, one year ahead of the target date of January 1, 2001. This provided us with increased flexibility to terminate more U.S. traffic into the Philippines, minimize unauthorized traffic termination through international simple resale operations and recover traffic lost due to bypass routings. We have also established, through our wholly-owned subsidiary PLDT Global, presence in key cities overseas to identify and capture Philippine terminating traffic at its source, maximize the use of our international facilities and develop alternative sources of revenue. Effective February 1, 2003, after lengthy negotiations with approximately 100 telecommunications operators around the world, we increased the termination rate with carriers accounting for a substantial portion of our international inbound traffic terminating on its fixed line network to US$0.12 per minute. Prior to the increase in termination rates, a substantial portion of PLDT’s international inbound traffic terminating on its fixed line network was charged an average termination rate of approximately US$0.08 per minute. See Item 5. “Operating and Financial Review and Prospects ––Results of Operations –– 2006 Compared to 2005 –– On Business Segment Basis –– Fixed Line –– Operating Revenues –– Service Revenues –– International Long Distance Service” and Item 3. “Key Information –– Risks Factors –– Risks Relating to Us –– Our results of operations have been, and may continue to be, adversely affected by competition in international long distance service” for further discussion.
With respect to outbound calls from the Philippines, we compete for market share through our local exchange and cellular businesses, which are the origination points of outbound international calls. We have also introduced a number of marketing initiatives to stimulate growth of outbound call volumes, including tariff reductions and volume discounts for large corporate subscribers. Digitel and Globe have also launched new pricing schemes to grow their outbound call volumes.
National Long Distance Service
Our national long distance service business has been negatively affected by the growing number of cellular subscribers in the Philippines and the widespread availability and growing popularity of alternative economical non-voice methods of communication, particularly text messaging and e-mail. In addition, various ISPs have launched voice services via the net to their subscribers nationwide.
While national long distance call volumes have been declining, we have remained a leading provider of national long distance service in the Philippines due to our significant subscriber base and ownership of the Philippines’ most extensive transmission network.
Data and Other Network Services
Another rapidly growing segment of the industry is the market for data and other network services. The growth is spurred by the significant growth in consumer/retail narrowband and broadband Internet access, enterprise resource planning applications, call centers, BPO, on-line gaming and other e-services that drive the need for broadband and Internet-protocol based solutions both here and abroad. Our major competitors in this area are Globe/Innove, Bayan Telecommunications, Eastern Telecoms and Digitel. The principal bases of competition in data services market are coverage, price, customer service and quality of service.
We have not been subject to any material fines or legal or regulatory action involving non-compliance with environmental regulations of the Philippines. We are not aware that we are not in compliance in any material respect with relevant environmental protection regulations.
We do not own any material intellectual property rights apart from our brand names and logos. We are not dependent on patents, licenses or other intellectual property which are material to our business or results of operations, other than licenses to use the software that accompany most of our equipment purchases.
We own four office buildings located in Makati City and own and operate 184 exchanges nationwide, of which 61 are located in the Metropolitan Manila area. The remaining 123 exchanges are located in cities and small municipalities outside the Metropolitan Manila area. We also own radio transmitting and receiving equipment used for international and domestic communications. As at December 31, 2006, we had 4,377 cellular cell sites and 6,099 base stations.
As at December 31, 2006, our principal properties, excluding property under construction, consisted of the following, based on book values:
• 67% consisted of cable, wire and cellular facilities, including our domestic fiber optic network, subscriber cable facilities, inter-office trunking and toll cable facilities and cellular facilities;
• 18% consisted of central office equipment, including three international gateway facilities, six pure national toll exchanges and 15 combined local and toll exchanges, and our communications satellite;
• 11% consisted of land and improvements and buildings, which we acquired to house our telecommunications equipment, personnel, inventory and/or fleet;
• 1% consisted of information origination and termination equipment, including pay telephones and radio equipment installed for customers use, and cables and wires installed within customers' premises; and
• 3% consisted of other work equipment.
For more information on these properties, see Note 7 – Property, Plant and Equipment to the accompanying consolidated financial statements in Item 18.
These properties are located in areas where our subscribers are being served. In our opinion, these properties are in good condition, except for ordinary wear and tear, and are adequately insured.
The majority of our connecting lines are above or under public streets and properties owned by others.
PLDT's and Smart’s properties are free from any mortgage, charge, pledge, lien or encumbrance; however, substantial properties of Mabuhay Satellite and Piltel are subject to liens while a portion of ePLDT’s property is subject to liens.
PLDT has various long-term lease contracts, the bulk of which have lease terms ranging from two to ten years covering certain offices, warehouses, telecommunications equipment locations and various office equipment.
For more information on the obligations relating to these properties and long-term obligations, see Note 21 – Contracual Obligations and Commercial Commitments to the accompanying consolidated financial statements in Item 18.
Item 4A. Unresolved Staff Comments
None.
Item 5. Operating and Financial Review and Prospects
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our audited consolidated financial statements (and the related notes) as at December 31, 2006 and 2005 and for the years ended December 31, 2006, 2005 and 2004 included elsewhere in this report. This discussion contains forward-looking statements that reflect our current views with respect to future events and our future financial performance. These statements involve risks and uncertainties, and our actual results may differ materially from those anticipated in these forward-looking statements as a result of particular factors such as those set forth under "Forward-Looking Statements" and Item 3. "Key Information — Risk Factors" and elsewhere in this report. Our audited consolidated financial statements, and the financial information discussed below, have been prepared in accordance with U.S. GAAP. For convenience, certain peso financial information in the following discussions has been translated to U.S. dollars at the exchange rate at December 31, 2006 of Php49.045 to US$1.00, as quoted through the Philippine Dealing System.
We are the largest and most diversified telecommunications company in the Philippines. We have organized our business into three main segments which serve as the basis for management’s decision to allocate resources and evaluate operating performance:
• Wireless — wireless telecommunications services provided by Smart and Piltel, our cellular service providers; Smart Broadband, our wireless broadband provider; Wolfpac, our wireless content operator; and Mabuhay Satellite, ACeS Philippines and Telesat, our wireless broadband, satellite, VSAT and other services operators;
• Fixed Line — fixed line telecommunications services are primarily provided through PLDT. We also provide fixed line services through PLDT’s subsidiaries ClarkTel, SubicTel, Maratel, Piltel and BCC, which together account for approximately 4% of our consolidated fixed line subscribers, and PLDT Global; and
• Information and Communications Technology — information and communications infrastructure and services for Internet applications, Internet protocol-based solutions and multimedia content delivery provided by PLDT’s subsidiary ePLDT; call center services provided under ePLDT Ventus, including Ventus, Parlance and Vocativ; BPO services provided by SPi (consolidated since July 11, 2006); Internet access and gaming services provided by ePLDT’s subsidiaries, Infocom, Digital Paradise, Digital Paradise Thailand, netGames, Airborne Access and Level Up!; and e-commerce, and IT-related services provided by other investees of ePLDT, as discussed in Note 8 – Investments to the accompanying consolidated financial statements in Item 18.
Key performance indicators and drivers that our management uses for the management of our business include, among others, the general economic conditions in the Philippines, our subscriber base, traffic volumes, and interconnection arrangements.
Wireless
We provide cellular and wireless broadband, satellite, VSAT and other services under our wireless business, with cellular contributing about 96% and the remaining wireless services contributing approximately 4% of our wireless service revenues, respectively, in 2006. Rapid growth in the cellular market has resulted in a change in our revenue composition and sources of our revenue growth. Starting in 2003, cellular service has been our major revenue source surpassing fixed line revenues. As of December 31, 2006, Smart and Piltel, which offer services using Smart’s network, had the largest and third largest cellular subscriber bases, respectively, in the Philippines. In addition, Smart’s and Piltel’s subscribers increased by 18% in 2006, resulting in our aggregate system-wide cellular subscribers outnumbering our fixed line in service by more than 14 to 1 at the end of 2006, which was higher than the increases of Smart’s and Piltel’s subscriber base of 6% in 2005 but lower than the increase of Smart’s and Piltel’s subscriber base of 48% in 2004. Cellular data services, which include all text messaging and text-related services ranging from ordinary text to value-added services, contributed significantly to our cellular revenue increase. Our wireless operating revenues remained stable and accounted for 63%, 62% and 61% of our consolidated operating revenues for each of the years ended December 31, 2006, 2005 and 2004, respectively.
Fixed Line
Our fixed line business provides local exchange service, international and national long distance services, data and other network services and miscellaneous services. Our fixed line operating revenues accounted for 32%, 36% and 37% of our consolidated operating revenues for the years ended December 31, 2006, 2005 and 2004, respectively. Local exchange revenues have declined owing to shift in subscriber preference from postpaid to prepaid service with lower average revenue per user, or ARPUs. National and international long distance revenues have also been declining largely due to a drop in call volumes as a result of alternative means of communications such as texting, e-mailing and Internet telephony. Mitigating these declines was the steady growth of our data and other network services over the recent years. Recognizing the growth potential of the data and other network services segment, we have put considerable emphasis on the development of new packet-switched, data-capable and IP-based networks.
Information and Communications Technology
We conduct our ICT businesses through ePLDT. ePLDT’s principal businesses are the operation of an Internet data center under the brand name VitroTM; one umbrella brand name, ePLDT Ventus, for all of its call center businesses, including Ventus, Vocativ and Parlance; BPO provided by SPi Technologies, Inc., or SPi; Internet and online gaming through Infocom, Digital Paradise and Digital Paradise Thailand, netGames, Level Up! and Airborne Access. The revenue contribution of our information and communications technology segment accounted for 5% of our consolidated operating revenues for the year ended December 31, 2006, and 2% of our consolidated operating revenues for each of the years ended December 31, 2005 and 2004. The increase in the revenue contribution from our information and communication technology segment was primarily due to the consolidation of SPi since its acquisition by ePLDT on July 11, 2006, and is expected to increase going forward with the full-year consolidation of SPi.
Our consolidated financial statements are prepared in accordance with U.S. GAAP, which requires management to make estimates and assumptions that affect amounts reported in our consolidated financial statements and related notes. In preparing these consolidated financial statements, we have made our best estimates and judgments of certain amounts, giving due consideration to materiality.
We believe the following represent our critical accounting policies under U.S. GAAP. The impact and any associated risks relating to these policies in our business operations are discussed elsewhere in this section.
Revenue Recognition
Our revenue recognition policies require us to make use of estimates and assumptions that may affect the reported amounts of our revenues and receivables.
Our agreements with domestic and foreign carriers for inbound and outbound traffic subject to settlements require traffic reconciliations before actual settlement is done, which may not be the actual volume of traffic as measured by us. Initial recognition of revenues is based on our observed traffic adjusted by our normal experience adjustments, which historically have not been material to our consolidated financial statements. Differences between the amounts initially recognized and actual settlements are taken up in the accounts upon reconciliation. However, there is no assurance that such use of estimates may not result to material adjustments in future periods.
Revenues under a multiple element arrangement specifically applicable to our wireless business are split into separately identifiable components and recognized when the related components are delivered in order to reflect the substance of the transaction. The fair value of components is determined using verifiable objective evidence. Revenue for handset sales is quantified and identified separately using the residual value method from our cellular service revenue.
Estimating Useful Lives of Property, Plant and Equipment
We estimate the useful lives of our property, plant and equipment based on the periods over which our assets are expected to be available for use. Our estimation of the useful lives of our property, plant and equipment is based on our collective assessment of industry practice, internal technical evaluation and experience with similar assets. The estimated useful lives of our property, plant and equipment are reviewed at least annually and are updated if expectations differ from previous estimates due to physical wear and tear, technical and commercial obsolescence and legal and other limitations on the use of our assets. It is possible, however, that future results of operations could be materially affected by changes in our estimates brought about by changes in factors mentioned above. The amounts and timing of recorded expenses for any period would be affected by changes in these factors and circumstances. A reduction in the estimated useful lives of our property, plant and equipment would increase our recorded operating expenses and decrease our noncurrent assets. Total carrying values of property, plant and equipment amounted to Php164,081 million and Php173,007 million as at December 31, 2006 and 2005, respectively.
Asset Impairment
U.S. GAAP requires that an impairment review be performed when certain impairment indicators are present. The impairment review first compares the future undiscounted cash flows expected to be generated from the continued use and ultimate disposition of the assets with the book value of the assets. If these cash flows are not sufficient to recover the book value of the assets, an impairment charge is recognized based on the comparison between the discounted value of these cash flows and the book value of the assets. In addition, our projections for future cash flows are generally less during periods of reduced cash flow. As a result, an impairment charge is more likely to occur during a period when our operating results are already otherwise depressed.
Purchase accounting requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair market values of the assets and liabilities purchased. Our business acquisitions typically result in goodwill, which is also subject to a periodic impairment test. Determining the fair value of property, plant and equipment, investments and intangible assets requires us to make estimates and assumptions, such as the determination of future cash flows expected to be generated from the continued use and ultimate disposition of such assets, that can materially affect our consolidated financial statements. Future events could cause us to conclude that property, plant and equipment, investments and intangible assets associated with an acquired business are impaired. Any resulting impairment loss could have a material adverse impact on our financial condition and results of operations.
The preparation of estimated future cash flows involves significant judgments and estimations. While we believe that our assumptions are appropriate and reasonable, significant changes in our assumptions may materially affect our assessment of recoverable values and may lead to future additional impairment charges under U.S. GAAP.
Total carrying values of goodwill and other intangible assets as at December 31, 2006 and 2005 amounted to Php27,241 million and Php16,875 million, respectively.
Financial Assets and Liabilities
U.S. GAAP requires that we carry certain of our financial assets and liabilities at fair value, which requires extensive use of accounting estimates and judgment. While significant components of fair value measurement were determined using verifiable objective evidence (e.g., foreign exchange rates, interest rates, volatility rates), the fair value would differ if we utilized different valuation methodology. Any changes in fair value of these financial assets and liabilities would directly affect our consolidated statements of income and equity.
Total fair value of financial assets and liabilities as at December 31, 2006 amounted to Php35,952 million and Php104,862 million, respectively, while the total fair value of financial assets and liabilities as at December 31, 2005 amounted to Php43,459 million and Php150,077 million, respectively.
Estimating Allowance for Doubtful Accounts
We estimate the allowance for doubtful accounts related to our trade receivables based on two methods. The amounts calculated using each of these methods are combined to determine the total amount we reserve. First, we evaluate specific accounts where we have information that certain customers are unable to meet their financial obligations. In these cases, we use judgment, based on the best available facts and circumstances, including but not limited to, the length of our relationship with the customer and the customer’s current credit status based on third party credit reports and known market factors, to record specific reserves for customers against amounts due to reduce our receivables to amounts that we expect to collect. These specific reserves are re-evaluated and adjusted as additional information received affects the amounts estimated. Second, a provision is established as a certain percentage of operating revenues based on the aging profile of receivables. This percentage is based on a collective assessment of historical collection, write-off experience, current economic trends, changes in our customer payment terms and other factors that may affect our ability to collect payments. Full allowance is provided for receivables from permanently disconnected subscribers and carriers. Such permanent disconnections generally occur within 105 days from the date payment was due. Partial allowance is provided for active subscribers and carriers based on the age status of receivables.
The amounts and timing of recorded expenses for any period would differ if we made different judgments or utilized different estimates. An increase in our allowance for doubtful accounts would increase our recorded expenses and decrease our current assets. Provision for doubtful accounts amounted to Php736 million, Php2,251 million and Php3,955 million for the years ended December 31, 2006, 2005 and 2004, respectively. Trade and other receivables, net of allowance for doubtful accounts, amounted to Php10,158 million and Php7,856 million as at December 31, 2006 and 2005, respectively.
Investments
The various interests that we hold in companies are accounted for under three methods: consolidation, equity method and cost method. The method of accounting applied to investments involves an evaluation of the significant terms of the investments that explicitly grant or suggest evidence of control or significant influence over the operations of the investees. Consolidated investments include our controlled subsidiaries. Investments in businesses which we do not control but have the ability to exercise significant influence over their operating and financial policies are accounted for using the equity method. Investments in businesses which we do not have the ability to exercise significant influence over operating and financial policies are accounted for using the cost method.
Pension Cost and Other Retirement Benefits
The determination of our obligation and cost for pension and other retirement benefits is dependent on our selection of certain assumptions used by actuaries in calculating such amounts. Those assumptions are described in Note 17 – Employee Benefits to the accompanying consolidated financial statements in Item 18, and include, among other things, discount rates, expected returns on plan assets and rates of compensation increases. In accordance with U.S. GAAP, actual results that differ from our assumptions are recognized as income or expense when the net cumulative unrecognized actuarial gains and losses at the end of the previous reporting period exceeded 10% of the higher of the defined benefit obligation and the fair value of plan assets at that date. While we believe that our assumptions are reasonable and appropriate, significant differences in our actual experience or significant changes in our assumptions may materially affect our pension and other retirement obligations. The accrued benefit cost as at December 31, 2006 and 2005 amounted to Php7,627 million and Php2,421 million, respectively. SFAS No. 158 “Employees’ Accounting for Defined Benefit Pension and Other Post retirement Plans” which was adopted in 2006 requires the recognition of the unfunded status of a benefit plan, and therefore no unrecognized net actuarial loss was recognized as at December 31, 2006. Unrecognized net actuarial gain as at December 31, 2005 amounted to Php116 million.
Deferred Tax Assets
We review the carrying amounts of our deferred tax assets at each balance sheet date and reduce these to the extent that it is no longer probable that sufficient taxable income will be available to allow all or part of the deferred tax assets to be utilized. Our assessment on the recognition of deferred tax assets on deductible temporary differences is based on the forecasted taxable income of the subsequent reporting periods. This forecast is based on our past results and future expectations on revenues and expenses. Management believes that we will not have sufficient future taxable income to utilize the benefits of deductible temporary differences and there is no assurance that we will generate sufficient taxable income to allow all or part of our deferred tax assets to be utilized.
As at December 31, 2006 and 2005, our net deferred tax assets amounted to Php25,366 million and Php23,406 million, respectively, net of valuation allowance amounting to Php299 million and Php5,732 million, respectively.
Legal Contingencies
We are currently involved in various legal proceedings. Our estimate of the probable costs for the resolution of these claims has been developed in consultation with outside counsel handling our defense in these matters and is based upon an analysis of potential results. We currently do not believe these proceedings will have a material adverse effect on our consolidated financial statements. It is possible, however, that future results of operations could be materially affected by changes in our estimates or in the effectiveness of our strategies relating to these proceedings. See Item 8. “Financial Information — Legal Proceedings — Taxation.”
Recently Adopted Accounting Pronouncements
Effective January 1, 2006, we adopted SFAS No. 123 (R), “Share-Based Payment”, which revises SFAS No. 123. This statement requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the period that an employee is required to provide service in exchange for the award. Any awards of liability instruments to employees would be measured at fair value at each reporting date through settlement. We adopted SFAS No. 123 (R) using the modified prospective transition method, and accordingly, the results of prior periods have not been restated. This method requires that the provisions of SFAS No. 123 (R) are applied only to unvested share-based awards as of January 1, 2006. The cumulative effect of adoption of SFAS No. 123 (R) on prior years resulted in a change in our reported net income of Php189 million (net of income taxes of Php93 million and Php1.02 per share) in 2006, which represents the difference between the intrinsic value and the fair value of the liability award on January 1, 2006.
In September 2006, the Financial Accounting Standards Board, or FASB, issued SFAS 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – An amendment of FASB Statements Nos. 87, 88, 106 and 132(R).” We adopted SFAS 158 as effective on December 31, 2006. See Note 17 –– Employee Benefits. Additionally, in September 2006, the U.S. Securities and Exchange Commission issued Staff Accounting Bulletin, or SAB, No. 108,” Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB 108 was effective for us upon adoption on December 31, 2006. SAB 108 did not have a material effect on our financial position or results of operations. Effective January 1, 2006, we adopted FASB Interpretation, or FIN, No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of SFAS 143.” The adoption of SFAS 143 did not had material effect on our financial position or results of operations in 2006.
In May 2005, the FASB, as part of an effort to conform to international accounting standards, issued SFAS 154, “Accounting Changes and Error Corrections”, which was effective for us beginning on January 1, 2006. SFAS 154 requires that all voluntary changes in accounting principles be retrospectively applied to prior financial statements as if that principle had always been used, unless it is impracticable to do so. When it is impracticable to calculate the effects on all prior periods, SFAS 154 requires that the new principle be applied to the earliest period practicable. The adoption of SFAS 154 did not have a material effect on our consolidated financial statements in 2006.
New Accounting Pronouncements Effective Subsequent to 2006
In February 2006, FASB issued SFAS 155, “Accounting for Certain Hybrid Financial Instruments,” an amendment to SFAS 133 and FAS 140. SFAS 155 permits an entity to elect fair value remeasurement for any hybrid financial instrument (with changes in fair value recognized in earnings) if the hybrid instrument contains an embedded derivative that would otherwise be required to be bifurcated and accounted for separately under SFAS 133. The election to measure the hybrid instrument at fair value is made on an instrument-by-instrument basis and is irreversible. The statement will be effective for all financial instruments acquired, issued, or subject to a remeasurement event occurring after the beginning of an entity’s fiscal years beginning after September 15, 2006, with earlier adoption permitted as of the beginning of fiscal year, provided that financial statements for any interim period of that fiscal year have not been issued. We are currently in the process of evaluating any effect of the adoption of FAS 155 will have on our consolidated financial statements.
In June 2006, the EITF reached a consensus on Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross Versus Net Presentation)”. EITF Issue No. 06-3 requires that companies disclose their accounting policy regarding the gross or net presentation of certain taxes. Taxes within the scope of EITF Issue No. 06-3 are any tax assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer and may include, but is not limited to, sales, use, value added and some excise taxes. EITF Issue No. 06-3 is effective for our reporting period beginning January 1, 2007. We are currently in the process of determining the impact of this issue on our consolidated financial statements.
In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, or FIN 48, an interpretation of SFAS No. 109, “Accounting for Income Taxes”. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. FIN 48 is effective for our reporting period beginning January 1, 2007. We are currently in the process of determining the impact of the adoption of this Interpretation on our consolidated financial statements.
In September 2006, FASB issued SFAS 157, “Fair Value Measurements”. This statement applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. Under this statement, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. This statement clarifies the principle that fair value should be based on the assumptions market participants would use when pricing the asset or liability. In support of this principle, the standard establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. The fair value hierarchy gives the highest priority to quoted prices in active markets and the lowest priority to unobservable data, for example, the reporting entity’s own data. Under this statement, fair value measurements would be separately disclosed by level within the fair value hierarchy. This statement will become effective for financial statements issued for fiscal years beginning after November 15, 2007, and with interim periods within those fiscal years. Early adoption is permitted. We are currently in the process of evaluating the impact of this statement on our consolidated financial statements.
In September 2006, the Emerging Issues Task Force, or EITF, reached a consensus on Issue No. 06-1, “Accounting for Consideration Given by a Service Provider to Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive Service from the Service Provider”. EITF Issue No. 06-1 provides guidance regarding whether the consideration given by a service provider to a manufacturer or reseller of specialized equipment should be characterized as a reduction of revenue or an expense. This issue is effective for our reporting period beginning January 1, 2008. Entities are required to recognize the effects of applying this issue as a change in accounting principle through retrospective application to all prior periods unless it is impracticable to do so. We are currently in the process of evaluating the impact of this issue on our consolidated financial statements.
We have reclassified certain accounts in 2005 and 2004 to conform with our 2006 financial statement presentation.
The following table shows the contribution by each of our business segments to our consolidated operating revenues, expenses and net income for each of the years ended December 31, 2006, 2005 and 2004. Most of our revenues are derived from our operations within the Philippines. Our revenues derived from outside the Philippines consist primarily of revenues from incoming international calls to the Philippines.
2006 Compared to 2005
On a Consolidated Basis
Consolidated Operating Revenues
Our consolidated operating revenues for 2006 increased by Php4,201 million, or 3%, to Php127,536 million in 2006 from Php123,335 million in 2005. This increase was higher than the increase in our consolidated operating revenues in 2005, primarily due to an increase in our ICT revenues largely due to the consolidation of SPi, CyMed and Level Up!, continued increase in our call center revenues and the continued growth of our wireless business. The revenue contribution of our wireless business accounted for 63% and 62% of our consolidated operating revenues for 2006 and 2005, respectively.
The following table shows the breakdown of our consolidated operating revenues for the years ended December 31, 2006 and 2005 by business segment:
Consolidated Operating Expenses
Our consolidated operating expenses in 2006 increased by Php4,536 million, or 6%, to Php79,357 million from Php74,821 million in 2005. The increase was primarly due to higher operating expenses associated with our three business segments primarily due to an increase in compensation and employee benefits, primarily resulting from the effect of collective bargaining agreement-related increases in salaries and benefits, an increase in incentive plan-related accruals, the consolidation of SPi, CyMed and Level Up!, and higher accrued bonuses, pension benefits, long-term incentive plan costs and other employee benefits. We currently expect these expenses to be significantly higher going forward as a result of the full year consolidation of SPi, CyMed and Level Up!. As a percentage of our consolidated operating revenues, consolidated operating expenses increased to 62% in 2006 from 61% in 2005.
The following table shows the breakdown of our consolidated operating expenses for the years ended December 31, 2006 and 2005 by business segment:
Consolidated Operating Income
Our consolidated operating income in 2006 was Php48,179 million, a decrease of Php335 million, or 1%, compared to Php48,514 million in 2005 as a result of a 6% increase in our consolidated operating expenses which more than offset the 3% increase in our consolidated operating revenues.
Consolidated Financing Costs
Financing costs on a consolidated basis decreased by Php964 million, or 28%, to Php2,459 million primarily due to lower interest expense and related items owing to lower debt balances in 2006 compared with 2005 and lower accretion on financial liabilities due to lower levels of debt issuance costs, partially offset by lower foreign exchange gains as a result of lower foreign currency debt levels.
Consolidated Interest Income
Interest income on a consolidated basis decreased by Php35 million, or 2%, to Php1,422 million in 2006 from Php1,457 million in 2005 mainly attributable to higher levels of short-term investments which resulted in lower interest income.
Consolidated Loss (Gain) on Derivative Transactions
Loss on derivative transactions on a consolidated basis amounted to Php6,857 million in 2006, an increase of Php5,056 million, or 281%, compared to Php1,801 million in 2005 primarily due to mark-to-market loss from principal only swaps as a result of the peso appreciation in 2006 and lower interest differential between peso and U.S. dollar interest rates.
Consolidated Other Income - Net
Other income on a consolidated basis totaled Php3,595 million in 2006, an increase of Php2,579 million, or 254%, compared to Php1,016 million in 2005. The increase was primarily due to the recognition of a gain of Php1,698 million on early settlement by Piltel of its restructured debt, a gain on disposal of property and equipment of Php355 million, a gain relating to a refund from Manila Electric Company, or Meralco, of Php194 million recorded at fair value in 2006 (payable by Meralco over four years) and a gain on disposal of materials.
Consolidated Income Before Income Tax, Cumulative Effect of Change in Accounting Policy and Minority Interest in Net Loss (Income) of Consolidated Subsidiaries
Our income before income tax, cumulative effect of change in accounting policy and minority interest in net loss (income) of consolidated subsidiaries in 2006 was Php43,828 million, a decrease of Php1,942 million, or 4%, from Php45,770 million in 2005, primarily due to the increase of Php5,056 million in loss on derivative transactions in 2006 and a slightly lower operating income, partially offset by an increase in our other income due to the recognition of a gain of Php1,698 million on early settlement by Piltel of its restructured debt and a significant decline in our financing costs owing to lower interest expense and related items in 2006.
Provision for Income Tax
Provision for income tax increased by Php4,197 million, or 87%, to Php9,046 million in 2006 compared to Php4,849 million in 2005 mainly due to lower non-tax deductible charges, partially offset by the reversal of a valuation allowance of deferred tax assets in relation with the likelihood that Piltel would be able to realize the future tax benefits on these assets. We currently expect that our effective corporate tax rate will be higher going forward than in previous years due to the expiration of Smart’s income tax holiday.
Consolidated Net Income
As a result, our consolidated net income in 2006 was Php33,598 million, a decrease of Php7,005 million, or 17%, compared to Php40,603 million in 2005. The following table shows the breakdown of our consolidated net income for the years ended December 31, 2006 and 2005 by business segment:
On Business Segment Basis
Wireless
Operating Revenues
Our wireless business segment offers cellular services as well as wireless broadband, satellite, VSAT and other services.
The following table summarizes our total operating service and non-service revenues from our wireless business for the years ended December 31, 2006 and 2005 by service segment:
Service Revenues
Our wireless service revenues increased by Php4,188 million, or 6%, to Php78,383 million in 2006 compared to Php74,195 million in 2005 mainly as a result of the continued growth of Smart’s and Piltel’s subscriber base, an increase in international inbound revenues and a reduction in domestic interconnection costs due to a shift from off-network to on-network voice and data usage. As a percentage of our total wireless operating revenues, wireless service revenues increased to 97% in 2006 from 96% in 2005.
Cellular Service
Unless otherwise indicated, the financial data and operating metrics cited in the cellular service section reflect the consolidated results of our cellular subsidiary, Smart and its subsidiary, Piltel.
Our cellular service revenues consist of:
• revenues derived from actual usage of the network by prepaid subscribers and any unused peso value of expired prepaid cards or electronic air time loads, net of discounts given to dealers;
• monthly service fees from postpaid subscribers, including: (1) charges for calls in excess of allocated free local calls; (2) toll charges for national and international long distance calls; (3) charges for text messages of our service customers in excess of allotted free text messages; and (4) charges for value-added services, net of related content provider costs;
• revenues generated from incoming calls and messages to our subscribers, net of interconnection expenses; fees from reciprocal traffic from international correspondents; and revenues from inbound international roaming calls for the service; and
• other charges, including those for reconnection and migration.
Our cellular service revenues in 2006 amounted to Php75,605 million, an increase of Php4,087 million, or 6%, from Php71,518 million in 2005. Cellular service revenues accounted for 94% and 93% of our total wireless operating revenues in 2006 and 2005, respectively. The increase in cellular service revenues was primarily due to the continued growth of Smart’s and Piltel’s subscriber base. As at December 31, 2006, Smart and Piltel cellular subscribers totaled 24,175,384, an increase of 3,766,763, or 18%, over their combined cellular subscriber base of 20,408,621 as at December 31, 2005.
The table below shows our cellular subscribers base as at December 31, 2006 and 2005:
Of our 24,175,384 subscribers as at December 31, 2006, prepaid subscribers accounted for approximately 99% while postpaid subscribers accounted for the remaining 1%. Our cellular prepaid subscriber base grew by 19% to 23,856,821 as at December 31, 2006 from 20,128,543 as at December 31, 2005, whereas our postpaid subscriber base increased by 14% to 318,563 as at December 31, 2006 from 280,078 as at December 31, 2005. Smart’s prepaid and postpaid net subscriber activations totaled 1,738,324 and 38,485, respectively, in 2006, or a quarterly average addition of 434,581 prepaid and 9,621 postpaid subscribers. On the other hand, Piltel’s prepaid subscribers increased by 40% to 6,974,379 as at December 31, 2006 from 4,984,425 as at December 31, 2005, or a quarterly average addition of 497,489 subscribers. Postpaid subscribers as at December 31, 2006 were higher than as at December 31, 2005 primarily due to increased net activations in the last two quarters of 2006.
Our quarterly net subscriber activations (reductions) over the eight quarters in 2006 and 2005 are as follows:
Wireless Broadband, Satellite, VSAT and Other Services
Our revenues from wireless broadband, satellite, VSAT and other services consist mainly of rentals received for the lease of Mabuhay Satellite’s transponders and Telesat’s VSAT facilities to other companies and wireless broadband service revenues from Smart Broadband, charges for ACeS Philippines’ satellite phone service and service revenues from PLDT Global subsidiary’s mobile virtual network operations. Smart Broadband offers a number of wireless broadband services and had 121,867 subscribers as at December 31, 2006.
Gross service revenues from these services for 2006 amounted to Php2,778 million, an increase of Php101 million, or 4%, from Php2,677 million in 2005. The increase was primarily due to the growth in our wireless broadband business.
Non-service Revenues
Our wireless non-service revenues consist of:
• proceeds from sale of cellular handsets; and
• proceeds from sale of cellular SIM-packs.
Our wireless non-service revenues decreased by Php689 million, or 25%, to Php2,022 million in 2006 as compared to Php2,711 million in 2005 mainly attributable to lower handset sales due to the fact that activations in 2006 were primarily driven by more SIM-pack sales.
Operating Expenses
Operating expenses associated with our wireless business in 2006 amounted to Php42,271 million, an increase of Php2,835 million, or 7%, from Php39,436 million in 2005. This increase was mainly due to increases in rent, compensation and benefits, and the recognition of an asset impairment charge, partially offset by decreases in costs of cellular handsets and SIM-packs sold, cost of satellite air time, taxes and licenses, and selling and promotion. As a percentage of our total wireless operating revenues, operating expenses associated with our wireless business decreased to 53% in 2006 from 51% in 2005.
Cellular business expenses accounted for 96% while wireless broadband, satellite, VSAT and other business expenses accounted for 4% of our wireless business expenses in 2006, compared to 94% and 6%, respectively, in 2005.
The following table summarizes our wireless-related expenses for the years ended December 31, 2006 and 2005 and the percentage of each expense item to the total:
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