interceramic · percent up to 29.3 million square meters, while overall we sold 33.4 million square...

innovative products in the marketplace, such as our coloured body porcelainproducts. In Mexico, we have pursued an aggressive marketing campaigndesigned to bring consumers into our more than 200 showrooms nationwide,where we find that our product presentation in concert with the sophisticatedarray of Kohler bathroom and kitchen fixtures is very important in obtainingconsumer commitment to the Interceramic brand. In the United States, wherethe market is less consumer driven than in Mexico, we work with buildingcontractors, interior decorators and flooring distributors and professionals tolearn about and select Interceramic products for their clients and customers.We also continue to focus on customer service in a number of areas, includingour new comprehensive integrated information systems, extensive training ofour sales staff from top-to-bottom, and the availability of consumer educationseminars and programs designed to increase awareness of the many excitingand bold uses of our tile products.

While we at Interceramic are thankful that the last several years have shownsteady growth and constantly improving financial condition, the year 2005 wasa truly defining achievement for the Company. We believe that in this year, allthe Company has put in place over preceding periods has finally come togetherto allow Interceramic to post the kind of marked annual financial improvementthat we have been working towards for some time. All trends continue to bodewell for us, and with the tremendous boost from the fourth quarter of 2005 wehave the greatest of expectations for 2006. As always, we thank our investors,customers and employees for their continued support.

1

Board of Directors Report

2005 was a year full of achievements and one in which Interceramicaccomplished many of its goals, the Company closed the year with excellentfinancial results with record Sales and EBITDA figures, consistentlygenerating sustainable growth and strengthening the Company's position in themarkets within which it operates At US $406.0 million, consolidated sales for2005 were 19.0 percent higher than sales in 2004 of US $341.2 million, puttingthe threshold of half a billion dollars of sales firmly in our sights. Despitehaving to pay US $4.9 million more for electricity and natural gas during 2005than we did in 2004, the Company was still able to achieve a key 33.0 percentgrowth in operating income during the year compared to 2004. This is evenmore impressive taking into consideration the fact that since 2003Interceramic’s cost of energy has risen by a total of almost US $10.0 million,yet our EBITDA over that same period was up by US $16.1 million.

A number of other developments occurred over the year, including thecompletion of our fourth production facility in Chihuahua, the opening of threenew Company-owned stores in the United States markets of Sacramento andManteca, California, and Denver, Colorado, as well as the opening of 20 newstores in Mexico, of which 11 are owned by the Company and nine are newindependent franchise stores. The new plant in Mexico has boosted ourproduction capacity by about 25 percent, and this state-of-the-art facility isalready operating at full capacity with very high efficiencies and our highest-ever levels of quality production.

For the year, our gross income for 2005 at US $146.6 million was 20.5 percentbetter than that of US $121.6 for 2004. Operating income of US $30.3 millionwas far better than we have ever achieved, and a good 33.0 percent ahead ofoperating income of US $22.8 million generated last year. The Company’soperating margin continued to climb up as well, ending the year at 7.5 percentcompared to 6.7 percent in 2004. While overall 2005 EBITDA would be hardpressed to match the increase posted in the fourth quarter, for the year it stillgrew by 27.4 percent over 2004, reaching US $52.3 million in 2005 comparedto US $41.0 million in 2004. The new production facility in Chihuahuaresulted in an increased volume of manufactured product during 2005 of 11.6percent up to 29.3 million square meters, while overall we sold 33.4 millionsquare meters of products over the course of the year. Our year-end debt toEBITDA ratio reflected the excellent results for the year, ending at 2.3compared to 2.8 at the end of 2004.

Assessed domestically and Internationally, Interceramic showed impressivegains in each market, both for the quarter and the year. In 2005, sales inMexico of US $230.5 million grew by 21.1 percent over sales in Mexico for2004 of US $190.4 million. The amount of product sold in Mexico during 2005as compared to 2004 increased nicely too–up by about 13 percent–and webelieve that we are gaining significant market share in Mexico, growing at afaster pace than our competitors. In the International markets, primarily theUnited States, for all of 2005, Interceramic’s International sales were US$175.5 million, an increase over last year’s sales of US $150.8 million by 16.3percent. The amount of product sold by the Company Internationally increasedas well, up by almost ten percent to about 11.9 million square meters.

Overall growth in sales affirms the Company’s growth strategy, as we madeconsiderable gains through our expanded Company-owned distribution in boththe United States and Mexico, while at the same time making improvementsthrough independent distribution in each market as well. The key feature of ourstrategy continues to be innovation, attracting more consumers and securingbetter pricing through the offering of the most technologically and stylistically

Oscar E. Almeida ChabreChairman of the Board

Víctor D. Almeida GarcíaVicechairman / Chief Executive Officer

The Management of Internacional de Cerámica, S.A. de C.V. is responsible forthe internal controls of all of the internal processes of the company, includingthe preparation and finalization of all of the company’s financial information.Mancera, S.C. (Member of Ernst & Young Global), as the external auditors ofInternacional de Cerámica, S.A. de C.V., is responsible for the examination ofthe annual consolidated financial statements, in accordance with generallyaccepted accounting principles, and further must prepare a report as to saidfinancial statements detailing the financial situation of the company, also incompliance with generally accepted accounting principles in Mexico, and, also,through a reconciliation note, with the generally accepted accounting principlesin the Unites States. The Audit Committee watches over and supervises theseprocesses and also recommends to the Board of Directors, for its approval, theoffice of independent accountants to be used as the external auditors for theCompany.

As part of this vigilance process, the Committee meets with the company’sManagement and with the external independent auditors, for the purpose ofdiscussing the effectiveness of the internal controls which are applied to theoperations and financial processes of the company, as well as to evaluate theaccounting policies and practices and the results derived from the annualaudits.

Apart from meeting with Management and with the external, independentauditors, the Audit Committee undertook the following activities:

• It was in agreement with and ratified the selection of Mancera, S.C., as theexternal auditor for Internacional de Cerámica, S.A. de C.V., so it couldexamine the Company’s consolidated financial statements and subsequentlyprepare and finalize a report, same which shall be presented for approval at theAnnual Shareholders Meeting to take place on March 31, 2006.• The consolidated financial statements for the year ended December 31, 2005were reviewed and discussed with the Board of Directors and with the externalauditors. • Discussions were held with the independent auditors regarding the auditing ofthe consolidated financial statements of Internacional de Cerámica, S.A. deC.V., specifically as to the depth and reach of the audit, any observations to bemade, and the results derived from the auditing process. • The economic independence and related criteria for the independent auditorswas reviewed and evaluated. • All transactions which the company undertook with related parties werereviewed and evaluated, and a determination was made that said transactionswere no more or less favorable to the company as if those transactions wouldhave taken place with any other supplier or party.

Based on the discussions which took place between Management and theindependent auditors, the disclosures made on the financial statements report,the statements made by Management to this Auditors Committee, and thereport of the independent auditors, this Audit Committee recommended to theBoard of Directors that the consolidated financial statements for the year endedDecember 31, 2005 be presented for approval at the Annual ShareholdersMeeting to take place on March 31, 2006.

2

Report of the Audit Committeefor the year ended December 31, 2005

CP Humberto Valles HernándezPresident

3

Net Sales(Million of Nominal US Dollars)

Gross Profit and Margin(Million of Nominal US Dollars)

Mexico International

Operating Income and Margin(Million of Nominal US Dollars)

EBITDA(Million of Nominal US Dollars)

Debt Service(Million of Nominal US Dollars)

Net Debt to EBITDA(Million of Nominal US Dollars)

4

After almost 27 years of operations, today Interceramic has eight plants in fourmanufacturing complexes; three of them located in Chihuahua, México and afourth in Garland, TX in the United States, with a total annual capacity of 33.0million square meters of ceramic floor and wall tile.

In Mexico, Interceramic products are distributed through a unique franchisenetwork with more than 200 stores located nationwide, offering consistency inquality of products and excellence of service. Interceramic showrooms displayproduct in unique life-size vignettes with different design ideas toaccommodate every taste.

In the United States and Canada Interceramic products are distributed throughmore than 100 independent distributors, as well as 23 company-ownedshowrooms (International Tile and Stone Galleries) in the states of Texas,Georgia, Arizona, Nevada, New Mexico, California, Oklahoma and Colorado.

Manufacturing plants and Distribution network

In June of 2005, Interceramic began operating its eighth manufacturing facility.The investment of this new plant was approximately 27.0 million dollars.

This plant, which was designed by our engineers in collaboration with SACMIthe manufacturing leader of machinery for the production of ceramic tile, is themost sophisticated in the world to date.

Plant 8 has the largest mill in America; its one-of-kind spray drier was designedto maximize production efficiency. A closed-circuit system in its pressesprovides great flexibility to make size changes according to market demand.

Technology

5

It has the most advanced glazing equipment to accomplish the newest looks indemand in the market. Its highly productive electronic kilns are the largest inAmerica. An electronic selection equipment with English and Italiantechnology guarantees world quality. Finished product is handled byautomation and laser operated robots.

More than 3,900 employees have made the Interceramic name asynonym of Quality, Innovation and Service.

Our unique franchise distribution network has made it possible forour service philosophy to reach the end consumer consistentlythroughout Mexico.

6

Service

Provide our customers with the most innovative, high-quality ceramic tile and relatedproducts, and world class customer service by recruiting a highly qualified team,through the effective use of creative sales strategies and by using and efficienttechnology-driven distribution network.

Be the best manufacturer and distributor of ceramic tile and related products in theworld, providing our customers with total satisfaction through commitment to ourvalues of respect, loyalty, humility, and honesty. We will dedicate ourselves to workingresponsibly, communicating effectively, and working together as a team. We willcreate high value for our shareholders through effective leadership, strategicpartnership, by recruiting the best people, and by using the best technology anddistribution systems available worldwide.

Mission

Vision

Interceramic has its own Research & Development Center and a staff dedicatedto the research for innovation in all fields of ceramic tile manufacturing, fromthe original concept to raw materials, machinery and manufacturing processes.This has enabled the company to offer the market aesthetically sophisticatedproducts that constantly exceed customer’s expectations.

A commitment to constant renewal, quality, innovation and service makeInterceramic a state-of-the-art company competing in the world market withthe finest-quality products.

Innovation

8

At Interceramic, the orderly and sustainable development of its day to dayactivities and operations is a top priority, same which has been strengthenedwith the implementation of the policies and standards set out for SociallyResponsible Companies. This is why at Interceramic we carry out SocialResponsibility not only in areas external to the Company, but also internallywith all of the Company’s collaborators with the firm goal of continuing to bea competitive and socially conscious Company. The main principles for SocialResponsibility at Interceramic are as follows:

1).- Quality of Life, providing a favorable, stimulating, creative and inclusivework environment, attaining professional and human development of all of theCompany’s collaborators and any person in any way related to the Company.

2).- Corporate Ethics, with principles that guide and guarantee the transparentoperation of the Company and its relationships with clients, suppliers,government authorities and the community at large.

3).- Conservation and Care, of the environment through the application ofpractices and procedures which reflect respect towards the world that surroundsus, promoting the optimum use of resources and likewise promoting theminimization and recycling of waste products.

4).- Community Ties, creating synergies for the solution of social problems,including direct participation with the Foundation “Vida Digna, A.C.,” whichseeks to improve the quality of life of children living in the Tarahumara Sierraby providing better education and health resources for those children.

Being a Socially Responsible Company reflects the integration into ourbusiness strategies of a socially responsible vision based on policies andprocedures which allow the Company to go above and beyond the minimumlegal requirements so that in doing so it can contribute to the sustainabledevelopment of Mexico and of our Society.

Social Responsability

9

INTERNACIONAL DE CERAMICA, S.A. DE C.V. AND SUBSIDIARIES

Consolidated Balance Sheets as of December 31, 2004 and 2005(In thousands of Mexican pesos of purchasing power of December 31, 2005)

Consolidated Balance Sheets

11

2005

Ps. 132,890

410,68850,27158,671

( 24,301)495,329

1,289,04438,796

1,956,059

6,339

4,267,756( 2,027,334)

2,240,422

52,986123,996

Ps. 4,379,802

2005Thousands ofU.S. dollars

US$ 12,449

38,472 4,709 5,496

( 2,276)46,401

120,754 3,634

183,238

594

399,790 ( 189,914)

209,876

4,964 11,616

US$ 410,288

2004

Ps. 199,317

375,10243,45022,038

( 18,319)422,271

1,128,97826,451

1,777,017

7,734

4,359,326( 1,842,489)

2,516,837

52,07893,723

Ps. 4,447,389

AssetsCurrent assets:

Cash and cash equivalents

Accounts receivable:TradeDue from related parties Other accounts receivableLess: allowance for doubtful accounts

Inventories, netPrepaid expenses and other current assets

Total current assets

Investment in shares of associated companies

Property, plant and equipmentLess: accumulated depreciation

GoodwillOther assets

Total assets

See accompanying notes to consolidated financial statements

December 31,


Consolidated Balance Sheets as of December 31, 2004 and 2005(In thousands of Mexican pesos of purchasing power of December 31, 2005)


12

LiabilitiesCurrent liabilities:

Notes payable to financial institutionsCurrent portion of long-term debtTrade accounts payableDue to related parties Accrued expenses and taxes other than

income taxesIncome tax payable and employee statutory

profit sharingTotal current liabilities

Long-term debtLabor obligations Deferred income taxTotal liabilities

Stockholders’ equity Common stock Premium on common stockStock repurchase reserveRetained earningsCumulative comprehensive lossMajority stockholders’ equityMinority stockholders’ equity

Total stockholders’ equity

Total liabilities and stockholders’ equity


2005

Ps. 50077,973

317,71323,630

183,640

8,519611,975

1,217,04953,971

403,8172,286,812

799,7291,815,920

182,153756,543

(1,731,289)1,823,056

269,9342,092,990

Ps. 4,379,802


US$ 477,304

29,7622,214

17,203

79857,328

114,0095,057

37,828214,222

74,916170,11017,06470,871

( 162,182)170,77925,287

196,066

US$ 410,288

2004

Ps. 273,704 235,783 263,499 21,978

159,992

6,630 961,586

821,357 48,224

536,438 2,367,605

799,7291,815,920

191,922464,590

( 1,486,401)1,785,760

294,0242,079,784

Ps. 4,447,389

December 31,


Consolidated Statements of Income For the years ended December 31, 2003, 2004 and 2005(In thousands of Mexican pesos of purchasing power of December 31, 2005, except per unit amounts)


13

Net salesCost of salesGross profit

Operating expensesOperating income

Comprehensive financing (cost) income:Interest incomeInterest expenseForeign exchange (loss) gain, netMonetary position gain

Other income (expense), netIncome before income taxes and

employee statutory profit sharing

Income tax expenseEmployee statutory profit sharingConsolidated net income Net income of minority

stockholdersNet income of majority

stockholders

Weighted average number of shares“Ceramic B” and “Ceramic D” outstanding (in thousands)

Net income per unit

2005

Ps. 4,461,986( 2,850,928)

1,611,058

( 1,279,245)331,813

14,258( 113,790)

53,94046,375

783

( 24,433)

308,163

5,624-

313,787

31,603

Ps. 282,184

162,664Ps. 1.73


US$ 417,985( 267,066)

150,919

( 119,836)31,083

1,336( 10,659)

5,0534,344

74

( 2,289)

28,868

527-

29,395

2,960

US$ 26,435

162,664US$ 0.16

2004

Ps. 3,996,175 ( 2,570,960)

1,425,215

( 1,157,468) 267,747

13,749 ( 80,620)

19,884 60,471 13,484

( 405)

280,826

( 56,710)( 1,166)

222,950

39,534

Ps. 183,416

146,746Ps. 1.25

2003

Ps. 3,639,633 ( 2,376,574)

1,263,059

( 1,019,532) 243,527

8,806 ( 84,860) ( 97,264)

54,378( 118,940)

( 8,716)

115,871

( 49,766)-

66,105

31,869

Ps. 34,236

99,111Ps. 0.35

Years ended December 31,


14

INTERNACIONAL DE CERAMICA, S.A. DE C.V.AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders´ Equity

For the years ended December 31, 2003, 2004 and 2005(In thousands of Mexican pesos of purchasing power of December 31, 2005)

Balance at December 31, 2002Repurchase of common stockMinority cash dividendComprehensive income:

Net incomeMinimum pension liabilityResult from holding non monetary assetsResult from translation of

foreign subsidiariesComprehensive incomeBalance at December 31, 2003Increase of stock repurchase reservePaid in capitalUnrealized profits by the

acquisition of subsidiariesMinority cash dividendComprehensive income:


foreign subsidiariesComprehensive incomeBalance at December 31, 2004Decrease of stock repurchase reserve Minority cash dividendComprehensive income:


foreign subsidiariesComprehensive incomeBalance at December 31, 2005Thousands of U.S. dollars

Premium oncommon stock

Ps. 1,338,865

Ps. 1,338,865

477,055

Ps. 1,815,920

Ps. 1,815,920$ 170,110

Common StockPs. 770,248

( 4,910)

Ps. 765,338

34,391

Ps. 799,729

Ps. 799,729$ 74,916

Stock repurchasereserve

Ps. 193,862 ( 51,724)

Ps. 142,13849,784

Ps. 191,922( 9,769)

Ps. 182,153$ 17,064

Retainedearnings

Ps . 311,612

34,236

Ps. 345,848( 49,784)

( 14,890)

183,416

Ps. 464,5909,769

282,184

Ps. 756,543$ 70,871

Cumulativecomprehensive loss

Ps. ( 1,606,242)

( 1,089)55,479

19,972

Ps. ( 1,531,880)

( 441)43,459

2,461

Ps. ( 1,486,401)

( 4,774)( 206,950)

( 33,164)

Ps. ( 1,731,289)$ ( 162,182)

ComprehensiveIncome

Ps. 34,236( 1,089)

55,479

19,972Ps. 108,598

183,416( 441)

43,459

2,461Ps. 228,895

282,184( 4,774)( 206,950)

( 33,164)Ps. 37,296

Majoritystockholders’ equity

Ps. 1,008,345( 56,634)

34,236( 1,089)

55,479

19,972

Ps. 1,060,309

511,446

( 14,890)

183,416( 441)

43,459

2,461

Ps. 1,785,760

282,184( 4,774)( 206,950)

( 33,164)

Ps. 1,823,056$ 170,779

Minoritystockholders’ equity

Ps. 227,850

( 17,163)

31,869

16,357

Ps. 258,913

( 17,565)

39,534

13,142

Ps. 294,024

( 32,348)

31,603

( 23,345)

Ps. 269,934$ 25,287

Total stockholders’equity

Ps. 1,236,195 ( 56,634)( 17,163)

66,105( 1,089)

71,836

19,972

Ps. 1,319,222

511,446

( 14,890)( 17,565)

222,950( 441)

56,601

2,461

Ps. 2,079,784

( 32,348)

313,787( 4,774)( 230,295)

( 33,164)

Ps. 2,092,990$ 196,066



15


Consolidated Statements of Changes in Financial Position For the years ended December 31, 2003, 2004 and 2005(In thousands of Mexican pesos of purchasing power of December 31, 2005)

Operating activitiesNet income of majority stockholdersItems that did not require

(generate) resources:DepreciationGoodwill amortizationGoodwill impairmentDeferred income taxMinority net income

Changes in operating assets and liabilities:Accounts receivableInventoriesOther assetsTrade accounts payableOther accounts payable

Resources generated by operating activities

Financing activitiesRepurchase of capital stockMinority cash dividendsPaid in capitalProceeds from long-term debt and

financial institutions loansRepayment of long-term debt and

financial institutions loansMonetary gain from financing activitiesExchange (gain) loss generated

by financing activitiesResources provided (used in) financing

activities

Investing activitiesAcquisition of shares on a permanent basis

Increase of property, plant and equipment, net

Resources used in investingactivities

Net (decrease) increase in cash and cash equivalents

Cash and cash equivalents at beginning of year

Cash and cash equivalents at end of year

2005

Ps. 282,184

241,319-

4,520( 44,300)

31,603515,326

( 67,104)( 200,852)( 40,097)

47,34117,665

272,279

-( 32,348)

-

1,359,459( 1,306,847)

( 21,271)

( 66,662)

( 67,669)

( 13,721)

( 257,316)

( 271,037)

( 66,427)

199,317Ps. 132,890


US$ 26,435

22,606

423 ( 4,150)

2,960 48,274

( 6,286)( 18,815)( 3,756)

4,435 1,655

25,507

-( 3,030)

-

127,350

( 122,421)( 1,993)

( 6,245)

( 6,339)

( 1,285)

( 24,105)

( 25,390)

( 6,222)

18,671US$ 12,449

2004

Ps. 183,416

213,202 1,969

-26,807 39,534

464,928

( 38,848) ( 79,055)

70,024 ( 1,097)

17,695 433,647

-( 17,565)

511,446

424,210

( 470,061) ( 64,076)

( 2,773)

381,181

( 193,118)

( 476,642)

( 669,760)

145,068

54,249Ps. 199,317

2003

Ps. 34,236

186,656 --

27,34231,869

280,103

37,492( 114,010) ( 22,469) ( 48,498) ( 22,291)

110,327

( 56,634)( 27,376)

-

544,373

( 498,307) ( 87,601)

112,507

( 13,038)

-

( 142,332)

( 142,332)

( 45,043)

99,292Ps. 54,249

Years ended December 31,



16

Notes to Consolidated Financial Statements

(Thousands of Mexican pesos of purchasing power of December 31, 2005 and thousandsof U.S. dollars, except for number of shares and units, minimum dividend per share,market value per unit and exchange rates, which are stated in pesos (Ps.))

1. Nature of business and significant accounting policies

Nature of business

Internacional de Ceramica, S.A. de C.V. (“Interceramic”) and itssubsidiaries, Recubrimientos Interceramic, S.A. de C.V.(“Recubrimientos”) and Interceramic, Inc., which is located inGarland, Texas, are all engaged in the manufacture and marketing ofceramic floor and wall tiles, the extraction of clay for the manufactureof ceramic tiles and marketing of bathroom furniture. The othersubsidiaries, which are listed below in the “ Basis of consolidation”,are engaged primarily in the marketing of ceramic tiles and in themanufacture and marketing of adhesives in Mexico City, Guadalajara,Monterrey, Veracruz and Chihuahua. Interceramic and its subsidiariesare hereinafter referred to collectively as the “Company.”

Significant accounting policies

The consolidated financial statements of the Company have beenprepared in Mexican pesos (“Ps.”) in conformity with accountingprinciples generally accepted in Mexico (“Mexican GAAP”).

The significant accounting policies and practices followed in thepreparation of the consolidated financial statements are describedbelow:

a) Basis of consolidation

The consolidated financial statements include those of Internacionalde Ceramica, S.A. de C.V. and its subsidiaries. Significantintercompany balances and transactions have been eliminated in theseconsolidated financial statements. The subsidiaries included in theconsolidated financial statements are as follows, along withcorresponding ownership:

In September 2005, Holding de Franquicias Interceramic, S.A. deC.V., acquired 80% of the shares of Mosaicos y Terrazos del Sureste,S.A de C.V. The cost of acquisition of these shares amountedPs.15,075, which includes goodwill for Ps. 4,520 that was recorded inconsolidated statements of income.

In September 2005, Holding de Franquicias Interceramic, S.A. deC.V., acquired 80% of the shares of Mosaicos y Terrazos del Sureste,S.A de C.V. The cost of acquisition of these shares amountedPs.15,075, which includes goodwill for Ps. 4,520 that was recorded inconsolidated statements of income.

Adhesivos y Boquillas Interceramic, S. de R.L. de C.V.

Holding de Franquicias Interceramic, S.A. de C.V.

Holding de Servicios Interceramic, S.A. de C.V.

Interceramic Holding, Inc.

Interceramic de Occidente, S.A. de C.V.

Interceramic Trading Co.

Operadora Interceramic de México, S.A. de C.V.

Recubrimientos Interceramic, S.A. de C.V.

2004

51.00

100.00

100.00

100.00

100.00

100.00

100.00

50.01

2005

51.00

100.00

100.00

100.00

100.00

100.00

100.00

50.01


Ownership percentage as ofDecember 31

Estados Financieros Consolidados

17



1. Nature of business and significant accounting policies(continued)

a) Basis of consolidation (continued)

In March 2004, the Company acquired 100% of the shares of Holdingde Franquicias Interceramic, S.A. de C.V., which currently owns100% of the capital of Interacabados de Occidente, S.A. de C.V.,Distribucion Interceramic, S.A. de C.V., Grupo ComercialInterceramic, S.A. de C. V. and Materiales Arquitectonicos yDecorativos, S.A. de C.V. The cost of acquisition of the shares totaledPs. 185,363, amount that included paid goodwill for Ps. 54,047.

In these transactions, main assets and liabilities are shown as follows:

In Stockholders Extraordinary Meeting held on January 14, 2004, theacquisition of Grupo Comercial Interceramic, S.A. de C.V., andMateriales Arquitectonicos y Decorativos, S.A. de C.V., wasapproved, by acquiring 100% of the shares of Holding de FranquiciasInterceramic, S.A. de C.V.

In March 2004, Interacabados del Centro, S.A. de C.V., changes itsname to Holding de Servicios Interceramic, S.A. de C.V. and itcurrently owns 100% of the capital of Servicios Minas Interceramic,S.A. de C.V., Servicios Administrativos Interceramic, S.A. de C.V.,Servicios Tecnicos Interceramic, S.A. de C.V., Servicios TecnicosRecubrimientos, S.A. de C.V., Servicios Operativos FranquiciasInterceramic, S.A. de C.V., and Servicios Comerciales FranquiciasInterceramic, S.A. de C.V.

The caption “Minority interest” refers to the interest of the minoritystockholders in the Company’s subsidiaries.

In conformity with Mexican Accounting Principles Bulletin B-15,“Transactions in Foreign Currency and Translation of FinancialStatements of Foreign Operations,” the Company translated thefinancial statements of its foreign subsidiaries to Mexican pesos asfollows:

- The financial information reported by the foreign subsidiaries wasfirst adjusted to be presented on the basis of accounting principlesgenerally accepted in Mexico.

- The financial statements were restated at December 31, 2004 and2005, based on the Consumer Price Index (“CPI”) of the UnitedStates. The monetary effects for the years ended December 31, 2003,2004 and 2005 were determined based on the annual inflation factorderived from the CPI for the respective year.

Cash and short-term investment

Accounts receivable

Inventory

Other assets

Fixed assets

Trade accounts payable

Other liabilities

Total

2004

Ps. 7,135

23,400

70,983

46,734

63,955

( 37,614)

( 43,277)

Ps. 131,316

2005

Ps. 1,355

5,954

9,312

-

10,330

( 8,525)

( 7,871)

Ps. 10,555



18




a) Basis of consolidation (conclude)

- Assets, liabilities and income statement accounts were translated intoMexican Pesos at the closing exchange rate and income statementaccounts were translated at the weighted average exchange rate for theyear. Translation adjustments are reflected in a separate component ofstockholders’ equity entitled “Translation effect of foreignsubsidiaries”.

Consolidated financial statements as of December 31, 2003 and 2004are presented in constant currency at December 31, 2005, using acommon restatement factor which is determinates based on theweighted average net sales. Such factors were 1.0465 and 1.0155,respectively.

b) Estimates in financial statements

The accounting policies followed by the Company are in conformitywith accounting principles generally accepted in Mexico, whichrequire that management make certain estimates and use certainassumptions that affect the amounts reported of assets and liabilitiesand disclosures of contingent assets and liabilities at the date of theconsolidated financial statements and the amounts of revenues andexpenses during the reporting periods. Actual results may differ fromthese estimates.

c) Concentration of risk

In Mexico, the Company distributes its products through Company-owned and independent franchises. In the United States and Canadathe Company distributes its products mainly through its network ofwholly-owned Interceramic Tile and Stone Galleries (ITS) stores anda network of 79 independent distributors with a combined total of 180locations. On a regular basis, the Company assesses the creditworthiness of its customers and distributors and typically obtainspersonal guarantees or liens to secure amounts due from its customersand distributors. No single customer represented more than 5% of theCompany’s consolidated net sales.

d) Recognition of the effects of inflation

The Company recognizes the effects of inflation on financialinformation as required by Mexican Accounting Principles BulletinB-10, (Accounting Recognition of the Effects of Inflation on FinancialInformation). Consequently, the amounts shown in the accompanyingfinancial statements and in these notes are expressed in thousands ofconstant pesos as of December 31, 2005.

Certain concepts and procedures required by the application ofBulletin B-10 are explained below:

- The Company follows the specific-cost method to restate itsinventories.

- Machinery and equipment of foreign origin, was restated based onthe rate of inflation in the country of origin and is converted intoMexican pesos at the market exchange rate in effect at the balancesheet date. Machinery and equipment of domestic origin was restatedbased on the Mexican National Consumer Price Index (NCPI).



19



1.Nature of business and significant accounting policies(continued)

d) Recognition of the effects of inflation (conclude)

- As of December 31, 2004 and 2005 stockholder’s equity accountswere restated by using a common restatement factor, which wasdetermined based on NCPI.

- The gain or loss on monetary position represents the effects ofinflation, as measured by the NCPI, on the Company’s monetaryassets and liabilities. During inflationary periods, losses are incurredby holding monetary assets, whereas gains are realized by holdingmonetary liabilities. The net monetary effect is included in theconsolidated statements of income as part of the “comprehensivefinancing cost”.

- The insufficiency in restated stockholders’ equity consists principallyof the initial cumulative monetary position result and the cumulativedeficit from holding non-monetary assets. The gain from holding non-monetary assets represents the amount by which the increase in thespecific value of assets was higher than the rate of inflation.

e) Cash and short-term investments

Cash and short-term investments are mainly represented by financialinstitutions deposits on immediately available cash instruments withmaturities not exceeding 90 days, and they are presented valued attheir acquisition cost plus outstanding accrued interest. Their amountis similar to their market value.

f) Allowance for doubtful accounts

The allowance for doubtful accounts is determined based on aseniority assessment and a qualitative review of accounts receivable.Total estimate also contemplates assessment of historic losses for badcredits, as well as the review of the economic environment in whichthe Company operates. In Mexico, a part of Company sales are madethough a network of independent dealers where recovery of accountsreceivable is assured and another part of sales is carried out thoughsubsidiary franchises where most of the sales are in cash and,therefore, not giving way to significant doubtful accounts.

In the U.S.A., the estimate for doubtful accounts is based on a numberof factors that include, among others, the assessment of losses due tounrecoverable credits that occurred in prior years, experience, thereview of specific balances of certain accounts and the economicconditions of the environment in which the Company operates.

g) Inventories and cost of sales

Inventories are recorded initially at acquisition or production cost andthen restated to reflect replacement cost, which is not in excess ofmarket value.

Cost of sales represents the estimated replacement cost at the timesales were realized, expressed in constant pesos at the end of the year.



20




g) Inventories and cost of sales (conclude)

Allowance for obsolete and slow-moving inventories is determinedbased on an evaluation of the Company’s inventories, an historicalloss rate and a number of qualitative factors such as aging,discontinued lines of products and slow moving inventories.

h) Investment in shares of associated companies

Investments in Companies in which the Company has an ownershipinterest of between 10% and 50% and for which the Companyexercises significant influence, are accounted for using the equitymethod. Investments in companies in which the Company has anownership interest of less than 10% are recorded at acquisition costand restated for changes in the NCPI.

i) Property, plant and equipment

Machinery and equipment of foreign origin, was restated based on therate of inflation in the country of origin and is converted into Mexicanpesos at the market exchange rate in effect at the balance sheet date.Machinery and equipment of domestic origin was restated based onthe Mexican National Consumer Price Index (NCPI).

- At December 31, 2004 and 2005, approximately 91% of machineryand equipment were restated based on specific factors and 9% wererestated based on the NCPI.

- Depreciation is calculated on the restated values, using the straight-line method based on the remaining useful lives of the assets, which isdetermined periodically by management based on technical studies.

j) Financial Instruments

On January 1, 2005, the Company adopted the requirements ofMexican accounting Bulletin C-2, Financial Instruments, as amended,issued by the Mexican Institute of Public Accountants. Bulletin C-2.This document requires that changes in the fair value of instrumentsclassified as “available for sale” be disclosed in stockholders’ equityuntil such time as the instruments are sold.

Also, the Company follows the policy of determining at the balancesheet date whether there is objective evidence of impairment in thevalue of a financial asset or of a group of financial assets. Shouldthere be objective and other-than-temporary evidence of impairmentin the value of either its instruments available for sale or held tomaturity, the Company is required to determine the amount of therelated loss and recognize such loss as part of the comprehensive costof financing. At December 31, 2005, the Company has recorded nosuch impairment loss.

The Company adopted, the requirements of Mexican accountingBulletin C-10, Accounting for Derivative Instruments and HedgingActivities. Said Bulletin establishes the features that financialinstruments should include in order to be considered as derived, and italso sets the conditions for derived financial instruments to beconsidered as coverage. It defines the concept of effectiveness,pointing out the rules for assessment of coverage instruments andaccounting treatment of changes in their value.



21




j) Financial Instruments (conclude)

Derivatives designated as and that qualify as hedges are classified asfair value, cash flow or foreign currency hedges, depending on theparticular risk being mitigated.

For fair value hedges, the gain or loss resulting from the valuation ofthe hedging instrument to its fair value is recognized immediately inearnings of the period of change, with the offsetting loss or gainresulting from valuing the hedged item attributable to the risk beinghedged being adjusted to the carrying value of the hedged item. Anyresulting hedge ineffectiveness is recorded in earnings.

Through December 31, 2004, the gain or loss from valuing derivativeswas recognized in results of operations net of costs, expenses andrevenues related to the assets and liabilities being hedged. Thoseinstruments not qualifying as hedges were presented at market valueand gains or losses arising from changes in such market value wascharged or credited to operations.

k) Impairment of long-lived assets

Beginning January 1, 2004, the Company adopted the dispositions ofBulletin C-15 “Impairment of long -lived assets and their disposition,”issued by the Mexican Institute of Public Accountants.

Said Bulletin establishes that when impairment signs in the value oflong-standing assets exist, recovery value of these assets should bedetermined by obtaining the sales price of said assets and the usevalue. When recovery value is lower than net book value, thedifference is recognized as a loss due to impairment.

l) Intangible assets

Bulletin C-8 “Intangible assets” establishes, among other aspects, thatonly development costs of a project should be capitalized if theycomply with the criteria defined for recognition as assets; pre-operating costs not identified as development should be recorded as anexpense of the year and intangible assets considered with an indefinitelife are not amortized, but rather its fair value is subject to impairmenttests. The effects of applying this Bulletin were not significant for theCompany.

The Company owns intangible assets to be amortized, such as deferredcharges, intangible assets for labor obligations, and collateral deposits,which are listed in Note 5.

Assets to be amortized and deferred charges are represented mostly byexpenses for implementing software, showrooms, and expensesrelated to the acquisition of long-term debt. Amortization periods forthese assets are 3, 2, and 5 years, respectively.

Amortization periods were determined based on surveys carried out bythe company, except for expenses due to acquisition of long-term debt,which were amortized during the effective period of the debt.



22




m) Goodwill

Goodwill represents the excess of cost over recorded value ofsubsidiaries as of the date of acquisition.

Effective January 1, 2005, the Company adopted the requirements ofMexican accounting Bulletin B-7, Business Acquisitions, issued bythe Mexican Institute of Public Accountants. Goodwill originated bythe acquisition of shares at prices higher than their book value of theissuing company is subject to impairment tests at year end, thuseliminating the relevant amortization.

Goodwill is recorded initially at acquisition cost and then restatedbased on the NCPI.

n) Exchange differences

Foreign currency transactions are recorded at the applicable exchangerate in effect at the transaction date. Exchange differences aredetermined from the date of the transactions to the time of settlementor valuation at the balance sheet date and are charged or credited toincome.

o) Labor obligations

Beginning January 2004, the Company implemented a pension plan inaddition to that granted by the Mexican Social Security Institute.Otherwise, the Company decided to anticipate the effects of bulletinD-3 referring to the new subject “Remuneration at the end of the laborrelationship.” The effects of both the new pension plan and the effectof recognizing compensations are shown in Note 9.

The costs of pensions, compensations, and seniority premiums arerecognized periodically based on calculation performed byindependent actuaries by means of the projected unit credit method,using net financial hypothesis net of inflation, in conformity withguidelines established in Bulletin D-3 “Labor Obligations,” issued bythe Mexican Institute of Public Accountants.

Federal Labor Law establishes the obligation to make certainpayments to personnel who no longer works for the Company undercertain circumstances. At December 31, 2003, compensations topersonnel were recorded under income of the year when paymentoccurs.

p) Income taxes and employee statutory profit sharing

Deferred income taxes are recognized for all temporary differencesbetween balance sheet components for financial and tax reportingpurposes, using enacted income tax rates.

Current year income tax is charged to results of operations andrepresents the tax liability due and payable in less than one year.

The Company periodically evaluates the possibility of recoveringdeferred tax assets and if necessary, adjusts the related valuationreserve.



23



1. Nature of business and significant accounting policies(conclude)

p) Income taxes and employee statutory profit sharing (conclude)

Employee statutory profit sharing is a statutory obligation payable toemployees that is determined in accordance with the provisions ofboth Mexican labor and income tax laws.

In conformity with Bulletin D-4, deferred employee statutory profitsharing is recognized only on temporary differences determined in thereconciliation of current year net income for financial and taxreporting purposes, provided there is no indication that the relatedliability or asset will not be realized in the future. Current yearemployee statutory profit sharing is charged to results of operationsand represents a current liability due and payable in a period of lessthan one year.

q) Revenue recognition

The Company recognizes revenue when goods are shipped andinvoiced. Revenue from retail operations is recognized, generally, atthe point of sale. Returns and allowances are estimated and accruedbased on historical results.

r) Net income per unit

Net income per share is determined on the basis of the weightedaverage number of shares “B” and shares “D” issued and outstanding.

s) Comprehensive income

Comprehensive income consists of net income or loss for the year plusthose items that are reflected directly in stockholders’ equity and thatdo not constitute capital contributions, reductions or distributions,such as insufficiency from restatement of stockholders’ equity,translation effect of foreign subsidiaries and deferred taxes allocatedto stockholders’ equity.

t) Convenience translation

Solely for the convenience of the reader, the consolidated financialstatements as of and for the year ended December 31, 2005 have beentranslated into United States dollars (“US$” or “ dollars”) at theexchange rate of Ps. 10.6750 per US $ 1.00, the rate of exchange atDecember 31, 2005. The translation should not be construed as arepresentation that the Peso amounts have been or could be convertedinto dollars at this or any other rate.

u) Reclassifications

Certain amounts in the 2003 and 2004 consolidated financialstatements have been reclassified to conform to the 2005 presentation.



24


(Thousands of Mexican pesos of purchasing power of December 31, 2005 and thousands of U.S. dollars, except for number of shares and units,minimum dividend per share, market value per unit and exchange rates, which are stated in pesos (Ps.))

2. Related parties

In the normal course of business, the Company has transactions with related parties and affiliated companies. Affiliated companies are those in whichthe Company’s principal stockholders have significant equity interests or control of management. The main transactions with these companies consistof ceramic tile purchases for resale in Mexico and in the United States. Such transactions are negotiated on terms and prices that management believesare comparable to similar transactions with non-related customers.

Transactions with related parties, carried out in the ordinary course of business, were as follows:

Sales of ceramic tile:Affiliated companiesGrupo Comercial Interceramic, S.A. de C.V.Materiales Arquitectónicos y

Decorativos, S.A. de C.V.

Joint venture:Dal-Tile International, Inc.

Inventory purchases:Stockholders:

Kohler, Co.

Joint venture:Custom Building Products, Inc.Compañía en Coinversión:

Custom Building Products, Inc.

Fees paid for administrative servicesand other expenses

Affiliated companies:Arquitectura Habitacional e Industrial,

S.A. de C.V. (Construction Industry)Corporación Administrativa y Técnica,

S.A. de C.V.Corporación Aérea Cencor, S.A. de C.V.

2005

Ps. -

-

148,621Ps. 148,621

Ps. 144,462

11,469Ps. 155,931

Ps. 60,578

23,94410,400

Ps. 94,922

2004

Ps. -

-

110,014Ps. 110,014

Ps. 92,971

6,283Ps. 99,254

Ps. 58,376

38,13810,658

Ps. 107,172

2003

Ps. 184,939

88,462

90,135Ps. 363,536

Ps. 102,988

17,634Ps. 120,622

Ps. -

37,16710,354

Ps. 47,521

Sales to join venture partners consist of ceramic tiles sold in the United States. Purchases from stockholders and joint ventures consist of bathroomfixtures and adhesives related products to be resold in Mexico, respectively.

Fees paid are related to management consulting, use of computer systems, maintenance of equipment, air taxi services and construction of a new plant,which started operations on June 2005. All these services were provided by related parties.


3. Inventories

Inventories at December 31, 2004 and 2005 consisted of the following:

The allowance for obsolete and slow-moving inventories is Ps. 91,451 and Ps. 96,388 at December 31, 2004 and 2005, respectively, and has beendeducted from finished goods and raw materials and supplies.


25



2. Related parties (conclude)

Balances receivable and payable with related parties at December 31, 2004 and 2005 are as follows:


Finished goodsProduction in processRaw materials and suppliesMerchandise in transit

2005

Ps. 1,039,83870,98184,16694,059

Ps. 1,289,044

2004

Ps. 912,13642,155

108,36766,320

Ps. 1,128,978

4. Property, plant and equipment

Details of property, plant and equipment at December 31, 2004 and 2005 was as follows:

BuildingsMachinery and equipmentFurniture and fixturesVehicles

LandProjects in progressNet carrying value

Accumulateddepreciation

Ps. 345,0651,218,543

203,02775,854

Ps. 1,842,489

InvestmentPs. 959,080

2,540,747282,315112,492

3,894,634

172,502292,190

Ps. 4,359,326

AccumulatedDepreciationPs. 388,299

1,335,668222,01081,357

Ps. 2,027,334

InvestmentPs. 1,129,562

2,490,307306,490125,883

4,052,242

179,99235,522

Ps. 4,267,756

Trade receivables:Dal-Tile International, Inc.Officers and employeesOther

Accounts payable:Custom Building Products, IncKohler, Co.Other

2005

Ps. 34,74415,014

513Ps. 50,271

Ps. 1,06322,063

504Ps. 23,630

2004

Ps. 28,35814,704

388Ps. 43,450

Ps. 1,44120,335

202Ps. 21,978

2004 2005



26



4. Property, plant and equipment (conclude)

At December 31, 2004, projects in progress correspond to investments on construction and machinery acquisition for a new plant, which startedoperations in June 2005 and is engaged in the production of ceramic tile.

Depreciation expense for the years ended December 31, 2003, 2004 and 2005 was Ps. 186,656, Ps. 213,202 and Ps. 241,319, respectively.

Average depreciation rates used during the year ended December 31, 2005 are shown below:

Buildings 5%Machinery and equipment 8%Furniture and fixtures 23%Automotive equipment 30%

5. Other assets

At December 31, 2004 and 2005, other assets are comprised as follows:

6. Bank loans and notes payable

Notes payable to banks and outstanding long-term debt at December 31, 2004 and 2005 were as follows:

Assets to be amortizedIntangible assets due to labor obligationsDeferred chargesCollateral deposits

2005

Ps. 59,96033,58125,8854,570

Ps. 123,996

2004

Ps. 28,71734,75726,3143,935

Ps. 93,723

Type of loanSecuredSyndicated loanTotal bank loans

Currentportion

Ps. 1,612234,171

Ps. 235,783

TotalPs. 281,266

775,874Ps. 1,057,140

Interest rates4.24%-7.15%

4.52%

Long – termPs. 279,654

541,703Ps. 821,357

December 31, 2004M a t u r i t i e s

Type of loanSecuredSyndicated loanTotal bank loans

Current portionPs. 131

77,842Ps. 77,973

TotalPs. 230

1,294,729Ps. 1,295,022

Interest rates7.10%6.47%

Long – termPs. 99

1,216,950Ps. 1,217,049

December 31, 2005M a t u r i t i e s


27


(Thousands of Mexican pesos of purchasing power of December 31,2005 and thousands of U.S. dollars, except for number of shares andunits, minimum dividend per share, market value per unit andexchange rates, which are stated in pesos (Ps.))

6. Bank loans and notes payable (conclude)

At December 31, 2004 and 2005, all bank loans were denominated inU.S. dollars. All secured and syndicated bank loans are pledged byproperty, plant and equipment, accounts receivable and inventoryamounting to Ps.2,231,291 and Ps. 1,797,308 at December 31, 2004and 2005, respectively.

The Company entered into a line of credit with Wells Fargo for US $25,000 (Ps. 266,875) available through May 2008. At December 31,2005, the Company has not used any amount from the above-mentioned credit line.

The Company has contracted an unsecured credit line with SantanderSerfin for the amount of Ps.3,000, available through June 2006. Theannual interest rate set for this credit line is TIIE plus 3 points,equivalent to 11.49% per year. At December 31, 2005, the Companyhas used the amount of Ps. 500. This amount was paid off duringJanuary 2006, and on that same date cancellation of said credit linewas requested to the Bank.

On January 20, 2005, the Company obtained a new syndicated loan,whose administrative agent is BBVA Bancomer for the amount of US$120,000. The principal will be payable until January 20, 2010, on aquarterly basis beginning on July 31, 2006. Said loan was used mainlyto prepay the previous syndicated loan. This loan is pledged by land,buildings and equipment, accounts receivable, inventory and sharesowned by the Company in a joint venture. The Company’ssubsidiaries Distribución Interceramic, S.A. de C.V., Interacabados deOccidente, S.A. de C.V., Interceramic, Inc., Grupo ComercialInterceramic, S.A. de C.V., Materiales Arquitectónicos y Decorativos,S.A. de C.V., Interceramic Holding Co., Holding de FranquiciasInterceramic, S.A. de C.V. and Holding de Servicios Interceramic,S.A. de C.V., also provided certain guarantees.

During 2004, the Company contracted four revolving credit lines withBancomer, Banorte, Banamex and Scotiabank Inverlat for the amountof US $ 7,000, US $ 8,000, US $ 6,000 and US $ 5,000, respectively.At December 31, 2004 the Company had used US $24,000. Thisamount was paid off during January 2005. The unused portion of theline of credit is US$ 24,000 ($256,200) at December 31, 2005.

As of December 31, 2005, long term debt, excluding labor obligations,matures as follows:

The Syndicated loan and outstanding bank loan agreements establishcertain obligations and restrictive covenants with respect to certaintransactions including, the payment of cash dividends, mergers andcombinations, the disposal of fixed assets, information reportingrequirements and others. In addition, the Company is required tomaintain certain financial ratios. At December 31, 2005, the Companywas in compliance with all of its obligations and restrictionsestablished by these agreements.


Maturities

2007

2008

2009

2010

Amount

Ps. 192,249

320,250

512,400

192,150

Ps. 1,217,049


28




7. Hedge Instruments

On April 20, 2005, the Company enters into interest rate swap agreement with BBVA Bancomer, to manage its interest rate risk on its syndicated loanof US $120,000. The effective term of said agreement is three years, setting a LIBOR interest rate of 4.13%, stating that amounts computed based onset interest rates are to be paid and amounts computed based on variable interest rates are to be received. During 2005, the Company had a loss of Ps.4,929, which was recorded in the comprehensive financing cost due to fluctuation of the LIBOR rate.

The swap is recorded at its market value. At December 31, 2005, the swap reflected a valuation in favor of the Company for the amount of US $ 1,506.At December 31, 2004, the Company had not entered into this type of agreements.

8. Foreign currency position

At December 31, the foreign currency monetary position denominated in U.S. dollars is as follows:

Assets and liabilities denominated in U.S. dollars were translated to Mexican pesos using the interbank exchange rates at December 31, 2004 and 2005of Ps. 11.230 and Ps. 10.6750 per U.S. dollar, respectively. The exchange rate in effect at February 7, 2006, date of issuance of the consolidatedfinancial statements was Ps. 10.5350 per U.S.dollar.

Foreign currency denominated sales during the years ended December 31, 2003, 2004 and 2005 were Ps. 1,598,710 (US $134,647), Ps. 1,767,801 (US$ 150,844) and Ps. 1,929,606 (US $ 175,465), respectively (calculated using the Interbank exchange rate at the end of each month), and represented43.93%, 44.24% and 43.25 % of total net sales, respectively.

Most of the Company’s machinery and equipment is imported, primarily from Italy and Spain.

During the years ended December 31, 2003, 2004 and 2005, the Company imported inventory and machinery and equipment into Mexico totaling US$47,788, US$ 52,429, and US $85,307 respectively.

Current assets

Current liabilities Long-term liabilitiesTotal liabilitiesNet short position

2005

US 2,920

20,265114,009

US 134,274US ( 131,354)

2004

US 41,158

65,75872,022

US 137,780US ( 96,622)


29




9. Labor obligations

The Company records liabilities for seniority premium, pension plan and compensations as it is earned according to computation performed byindependent actuaries by means of the projected unit credit method.

Beginning January 1, 2004, the Company established a pension plan with defined benefits covering all employees upon their 65th. anniversary, providedthey are still working at the plant and whose working shift is full time. Benefits of said plan consist in granting them a compensation equivalent to aone-time only payment of three months’ salary plus twenty days of their last monthly base salary for each one of the years of service, counted from thedate the worker joined the Company to the date he/she stopped working for the Company.

This plan also includes compensations covering employees who are considered as full time workers and whose work shift is considered as full time. Itapplies whenever an employee is laid off without justified cause or when the cause is not clearly proved in accordance with the effective Mexican laborlaw. Benefits of said plan consist in granting them a compensation equivalent to a one-time only payment of three months’ salary, plus twenty days oftheir last monthly base salary for each year of service.

Following is a summary including consolidated data showing actuarial studies at December 31, 2004 and 2005:

Accumulated benefit obligation (ABO)Projected benefit obligation (PBO)Unrecognized transition obligationsUnrecognized net gain ( loss )Net projected liability Additional liabilityAccrued liabilityIntangible assetMinimum pension liability

2005Ps. 53,971Ps. 59,156

( 36,297)( 8,773)

14,08639,885

Ps. 53,971Ps. 33,581Ps. 6,304

2004Ps. 47,830Ps. 52,433

( 39,013)( 1,483)

11,93736,287

Ps. 48,224Ps. 34,757Ps. 1,530


30




9. Labor obligations (conclude)

The components of the net periodic pension cost during the years ended December 31, 2003, 2004 and 2005 were as follows:

The transition liability is being amortized over a period of 21 years.

The significant assumptions considered in determining the net periodic pension cost during the years ended December 2003, 2004 and 2005 were asfollows:

The Company’s subsidiary located in the United States has a defined contribution savings plan covering substantially all its employees. Totalcontributions for the years ended December 31, 2003, 2004 and 2005 were approximately Ps. 2,927 (US $249), Ps. 3,099 (US $276) and Ps. 3,544 (US$ 332), respectively.

Change in benefit obligation:Net liabilities projected to January 1st.Liabilitites at January 1st.

subsidiary franchises acquired:

Cost of pension:Service costInterest costExpected fund returnAmortization of transition liabilityAmortization of actuarial lossesInflation effectsNet periodic pension cost

Adjustment for actual amount expensed Net liabilities projected to December 31st.Adjustment for actual amount expensed

2005

Total laborobligations

Ps. 11,937-

3,8762,695

( 3)1,887

208774

9,437

( 7,103)( 185)

Ps. 14,086

2004

Total laborobligations

Ps. 3,350558

4,6592,064

( 6)1,610

5481

8,813

( 611)( 173)

Ps. 11,937

2003

Seniority premiumobligations

Ps. 3,668

-

741298

-99

( 9)( 135)

994

( 1,344)32

Ps. 3,350

Discount rateRate of pay increasesEffect of inflation

20035.50%2.50%5.00%

20045.50%1.50%5.00%

20055.50%1.00%4.00%



10. Stockholders´ equity

a) The Company’s capital stock is variable with a fixed minimum of Ps. 231,488 (Ps. 8,000 nominal).

The Company’s capital stock consists of two series of shares (Serie “B” and Serie “D”). Series “B” shares are common, registered shares, with no parvalue and full voting rights (traded as “Ceramic B”).

Series “D” shares are nominative, preferred, registered shares, with limited voting rights, without par value and have no owner ship limitations. TheSeries “D” shares are entitled to a minimum annual preferred dividend of Ps. 0.025 per share. In any given period in which no minimum preferreddividend is declared or it is paid only partially, such dividend or the unpaid amount shall accumulate for future periods. The accumulated minimumpreferred dividends at December 31, 2004 and 2005 is Ps. 5,070 and Ps. 5,892, respectively. (Traded as “Ceramic D”).

Up to December 2004, “ULD” Series units were units with limited vote, nominative, without par value, and have no ownership limitations, convertibleinto regular Series “B” and “D” series over a ten-year term (December 2004); they were represented by linked titles, each of them representing a Series“D” share and a Series “L” share. (traded as “Ceramic ULD”).

In December 2004, the Series “L” shares were converted to Series “B” shares, and thereafter, the Series “L” shares ceased to exist as a class ofCompany’s capital stock, and all voting and other rights previously applicable to holders of Series “L” shares no longer exist as a serie of capital stockand ceasing voting rights and other rights linked to this serie of shares.

An analysis of the authorized and outstanding capital stock as of December 31, 2004 and 2005 is as follows:

b) Until before December 2004, the Company had established a Stock Option Plan, according to which some employees and executives of theCompany could receive options from time to time during their term, to buy a number of Limited Vote Units for the eligible employee as established bythe Board Committee.

All shares distributed under this plan were issued and acquired by a trust expressly established for that purpose. Acquisitions made by the Trust werefunded by contributions made by the Company.


31


Series"B""D"Number of outstanding sharesNumber of authorized shares

2004Number of

shares129,785,37832,878,746

162,664,124162,800,072

2005Number of

shares129,785,37832,878,746

162,664,124162,800,072



10. Stockholders´ equity (conclude)

During 2004, all employees and executives decided to buy from the Trust all the units to which they were entitled, according to the plan. At the timeof the acquisition, all employees had earned said right. At December 31, 2004, therefore, the Trust was cancelled, the total amount of acquisitions madefrom the Trust totaled 1,154,700 Series “B” shares and 1,154,700 Series “D” shares, limited vote units, for the amount of Ps.14,697.

c) Pursuant to a resolution of the general ordinary stockholders’ meeting on April 26, 2005, it was agreed that the amount of Ps.182,153 was to be usedas a top amount in the fund to acquire Company shares, carrying forward the difference against retained earnings.

d) The General Corporate Law requires that at least 5% of net income of the year be transferred to the legal reserve until the reserve equals 20% ofcapital stock. At December 31, 2004 and 2005, the legal reserve was Ps. 38,267 and Ps. 49,339 respectively, which is included in retained earnings.

11. Income taxes, tax on assets and employee statutory profit sharing

a) Internacional de Cerámica, S.A. de C.V., and each of its subsidiaries in Mexico are individually subject to payment of income tax (ISR) and tax onassets (IMPAC). IMPAC is payable only to the extent that it exceeds ISR payable for the same period. The Company files ISR and IMPAC tax returnson an individual entity basis and the related tax results are combined in the consolidated financial statements.


32

Cumulative effect of deferredincome taxes

Insufficiency in labor obligationsInsufficiency in restated

stockholders’ equityCumulative translation effects of

foreign subsidiariesCumulative comprehensive loss

2005

Ps.( 340,046)( 6,304)

( 1,456,611)

71,672Ps.( 1,731,289)

2004

Ps. ( 340,046)( 1,530)

( 1,249,661)

104,836Ps.( 1,486,401)

2003

Ps. ( 340,046)( 1,089)

( 1,293,120)

102,375Ps.( 1,531,880)





11. Income taxes, tax on assets and employee statutory profit sharing (continued)

ISR expense for the years ended December 31, 2003, 2004 and 2005 consist of the following:

b) The main items comprising the liability balance of deferred ISR are:

A valuation allowance has been recorded due to the uncertainly of recovering a portion of tax on assets paid and tax loss carryforwards, primarily fromits operations in the United States. In accordance with tax regulations in effect as of 2005, the Company’s management elected to amortize the taxinventory, giving way to an accelerated amortization of tax loss carryfowards and a release of the applicable reserve.

c) The portion of deferred income taxes attributable to the excess of indexed costs over replacement cost and the translation effect of foreignsubsidiaries, have an effect on deferred income taxes charged to income for the years ended December 31, 2003, 2004 and 2005 as follows:

33

Current income tax and tax on assetsDeferred income tax expense (benefit)

2005

Ps. 38,676( 44,300)

Ps.( 5,624)

2004

Ps. 29,90326,807

Ps. 56,710

2003

Ps. 22,42427,342

Ps. 49,766

Deferred ISR liabilityInventoriesFixed assetsForeign subsidiaries deferred tax liabilities

andtranslation effect

Other – net

Deferred ISR assetAllowance for doubtful accountsAccrued liabilitiesAdvances from customersEffect of tax loss carryforwardsRecoverable tax on assets paid

Less: valuation allowanceNet deferred income tax liability

2005

Ps. 25,371392,482

13,4524,579

435,884

1,25619,6621,866

174,15339,275

( 236,212)204,145

Ps. 403,817

2004

Ps. 190,281388,675

22,0892,551

603,596

1,09721,990

-297,84542,248

( 363,180)296,022

Ps. 536,438



34




(1) Since current tax legislation recognizes partially the effects of inflation on certain items that give rise to deferred taxes, the current year net monetaryeffect on such items has been reclassified in the statement of income from result from the monetary position result to deferred income tax expense ofthe year.

d) A review of main items that in 2003, 2004, and 2005 originated a difference between income tax computed at the current tax rate of 34%, 33%, and30%, respectively, and the provision recorded by the Company for income tax and tax on assets is as follows:

Change in deferred income tax liabilityAdd:Effects of inflationLess:Opening balance of deferred tax by

acquired franchisesDeferred income tax

recorded in insufficiency from restatement of stockholders’ equity

Deferred income tax of translationeffect foreign subsidiaries

Deferred income tax expense (benefit) included in statements of income

2005

Ps.( 132,621)

( 1,836)

-

79,971

10,186

Ps.( 44,300)

2004

Ps. 66,068

30,387

( 30,443)

( 16,912)

( 22,293)

Ps. 26,807

2003

Ps. 102,495

19,135

-

( 70,963)

( 23,325)

Ps. 27,342

Income before provision for income tax andemployee statutory profit sharing Tax computed over income before incometax and employees profit sharing (34%, 33%and 30%, respectively)

Effects of inflationNon-deductible expensesOtherCost of income tax at current rateChange in valuation allowanceEffect of reduction in statutory rate ondeferred ISRNet income tax expenseEffective rate

2005

Ps. 308,163

Ps. 92,449

6,11812,165

725111,457

( 116,809)( 272)

Ps. ( 5,624)36%

2004

Ps. 280,826

Ps. 92,672

( 3,270)8,797

15,216113,415

5,101

( 61,806)Ps. 56,710

42%

2003

Ps. 115,871

Ps. 39,397

( 604)3,8761,737

44,4065,967

( 607)Ps. 49,766

43%



35




In December 2004, the ISR rate was reduced to 30% in 2005 and will be further reduced to 29% in 2006 and 28% in 2007 and thereafter. The effectsof this change represented a benefit in income of the year 2004 and 2005 for Ps. 272 and Ps. 61,806, respectively.

e) The Company has tax loss carryforwards that according to the income effective in Mexican Tax Law, may be amortized against fiscal incomegenerated over the first ten years. Tax loss carryforwards may be restated following certain procedures established by law.

The Company has tax on assets paid, which according to the applicable law, may be creditable against the excess of ISR over IMPAC of the followingten years. Receivable tax on assets can be recovered subject to certain conditions established in Mexican Tax Law. In 2003, 2004, and 2005,Interceramic did not make any payment for tax on assets because of immediate deduction option of investments on fixed assets. For years ended 2003,2004 and 2005 some subsidiaries paid tax on assets for $ 5,325, $ 1,582 and $ 1,117, respectively.

Restated amounts of tax loss carryforwards and tax on assets as of December 31, 2005, are as follows:

Interceramic, Inc., the Company’s US subsidiary, has net operating loss carryforwards for federal income tax purposes, which if are not utilized to offsetfuture taxable income, will expire at various dates as summarized below:


Year ofexpiration

200720082009201020112012201320142015

Year of tax loss carryforwards or

payment of tax on assets

199719981999200020012002200320042005

Recoverabletax on assets

1,8124,2526,1796,0696,6995,9045,4161,8261,118

Ps. 39,275

Tax loss carryforwards

--

290242218

-972

231,29148,094

Ps. 281,107

Year of tax loss

199619971998199920002001

Year ofexpiration

201120172018201920202021

Tax losscarryforwards

2,365127,69624,00016,58764,53929,468

Ps. 264,655


36



11. Income taxes, tax on assets and employee statutory profit sharing (conclude)

As of December 31, 2003, 2004 and 2005, the balances of the stockholders’ equity tax accounts are:

Beginning in 1999 and through 2001, the Income Tax law allowed the option of deferring payments of a part of income taxes due during those years.Deferred of said tax and related income is controlled through the Net reinvested tax income account (“CUFINRE”). Earnings distributed in excess offiscal balances from CUFINRE and CUFIN, will be subject to enacted corporative income tax rate. Effective January 1, 2002, the above-mentionedoption of deferring a portion of income tax, was eliminated.

12. Information by industry segment and geographical area

Financial information by geographical area is as follows:


Contributed capitalaccount

(“CUCA”)

Ps. 1,878,010

Ps. 1,974,896

Ps. 2,532,888

2003

2004

2005

Net reinvested taxincome account(“CUFINRE”)

Ps. 1,852

Ps. 2,135

Ps. 8,115

Net tax incomeaccount

(“CUFIN”)

Ps. 122,287

Ps. 232,786

Ps. 284,991

Net sales:General customersInter-area transfers

Interest expense, net of monetary effectNet income DepreciationCapital expendituresTotal assets Long-lived assets:Property, plant and

equipmentOther assets and investment

in associated companies

United States

Ps. 1,507,70648,108

Ps. 1,555,814Ps.( 3,033)

7,73850,78418,228

901,193

307,980

11,798Ps. 319,778

Mexico

Ps. 2,131,927863,955

Ps. 2,995,882Ps. ( 27,449)

24,265135,872124,104

4,315,351

1,781,452

780,255Ps. 2,561,707

Consolidated

Ps. 3,639,633-

Ps. 3,639,633Ps.( 30,482)

34,236186,656142,332

3,664,865

2,089,432

101,087Ps. 2,190,519

Eliminations andother adjustments

Ps. -( 912,063)

Ps.( 912,063)Ps. -

2,233--

( 1,551,679)

-

( 690,966)Ps.( 690,966)

For the year ended December 31, 2003


37



12. Information by industry segment and geographical area (continued)






United States

Ps. 1,666,529-

Ps. 1,666,529

Ps.( 266)21,12852,08723,091

918,898

285,154

5,098Ps. 290,252

Mexico

Ps. 2,329,6461,603,375

Ps. 3,933,021

Ps.( 19,883)180,565161,115453,551

5,076,823

2,231,683

960,262Ps. 3,191,945

Consolidated

Ps. 3,996,175-

Ps. 3,996,175

Ps.( 20,149)183,416213,202476,642

4,447,389

2,516,837

101,457Ps. 2,618,294


Ps. -( 1,603,375)

Ps.( 1,603,375)

Ps. -( 18,277)

--

( 1,548,332)

-

( 863,903)Ps.( 863,903)






United States

Ps. 1,929,606-

Ps. 1,929,606

Ps. 4,06675,69871,57225,552

1,003,264

249,846

4,959Ps. 254,805

Mexico

Ps. 2,532,3802,006,349

Ps. 4,538,729

Ps.( 71,481)199,376169,747231,764

5,213,235

1,990,576

1,232,794Ps. 3,223,370

Consolidated

Ps. 4,461,986-

Ps. 4,461,986

Ps.( 67,415)282,184241,319257,316

4,379,802

2,240,222

130,335Ps. 2,370,757


Ps. -( 2,006,349)

Ps.( 2,006,349)

Ps. -7,110

--

( 1,836,697)

-

( 1,107,418)Ps.( 1,107,418)



38



12. Information by industry segment and geographical area (conclude)

Geographical sales by customer location are as follows:

(*) A small part of these sales did not occur in the United States.

13. Commitments and contingencies

The Company has entered into rental agreements for office space, manufacturing facilities, and equipment used in its operations under non-cancelableoperating leases. Future minimum lease commitments under these agreements as of December 31, 2005 are as follows:

Rental expense incurred under operating leases for the years ended December 31, 2003, 2004 and 2005 was Ps.99,504, Ps. 112,066 and Ps. 123,714,respectively.

Under certain lease agreements the respective monthly lease payments will increase annually in accordance with the NCPI.

The Company is party to various claims, legal actions, and complaints arising in the ordinary course of business. In the opinion of management andthe Company’s independent lawyers, all such matters are without merit or are of such nature, or involve such amounts, that an unfavorable dispositionwould not have a material effect on the financial position or results of operations of the Company.


Net sales 2003

Net sales 2004

Net sales 2005

Wholly owneddistributors

Ps. 1,096,968

Ps. 1,224,047

Ps. 1,386,275

Totaldomestic sales

Ps. 2,040,923

Ps. 2,228,374

Ps. 2,532,379

Others (*)

Ps. 91,005

Ps. 110,843

Ps. 141,292

TotalU.S. sales

Ps. 1,598,710

Ps. 1,767,800

Ps. 1,929,606

Totalsales

Ps. 3,639,633

Ps. 3,996,175

Ps. 4,461,986

Independentdistributors

Ps. 410,738

Ps. 432,910

Ps. 402,039

Ventas en Estados UnidosMéxico

20062007200820092010

ThereafterTotal future minimum leasecommitments

Amount

Ps. 126,881116,711100,38779,86769,195

294,993

Ps. 788,034


39



14. Subsequent events

On January 1, 2006, the requirements of the Mexican Board for Research and Development of Financial Reporting Standards (Consejo Mexicano parala Investigación y Desarrollo de Normas de Información Financiera, A.C. or CINIF) went into effect and replaces the standards previously issued bythe Mexican Institute of Public Accountants. The adoption of these new rules will give rise to no changes in the Company’s financial structure or inthe significant disclosures in its financial statements.


Chairman of the BoardOscar E. Almeida Chabre

Vicechairman / Chief Executive OfficerVíctor D. Almeida García

SecretaryNorma Almeida de Champion

DirectorsAlfredo Harp Calderoni

Vicepresident of Foundation Alfredo Harp Helú, A.C.David Kohler

Group President, Kitchen and Bath Group. Kohler Co.Federico Terrazas Torres

Chairman, Grupo Cementos de Chihuahua, S.A. de C.V.Silvia Almeida

President, Corporación Administrativa y Técnica, S.A. de C.V.Diana E. Almeida

DirectorPatricia Almeida

DirectorMark Blaugrund

President, RECON Real Estate Consultants, Inc.Humberto Valles Hernández

Retired Member of Mancera S.C., Member of Ernst & Young GlobalCarlos Elías Terrazas

Chairman, Comercial Corporativa del Norte, S.A. de C.V.

Directors Elected by Series “D” ShareholdersAugusto O. Champion

Chairman, Arquitectura Habitacional e Industrial, S.A. de C.V.Sergio Mares Delgado

President, Grupo Futurama

Statutory AuditorAmerico de la Paz de la Garza

Partner of Mancera, S.C., Member of Ernst & Young Global

This document contains forward-looking statements which reflect the Company's views about future events and financial performance. Actual events and results could differmaterially from those stated herein and, accordingly, undue reliance should not be placed upon them. The forward-looking statements speak only of their dates and the Company

undertakes no obligation to update or revise any of them.

Board of Directors

interceramic · percent up to 29.3 million square meters, while overall we sold 33.4 million square...

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