Table Of ContentTable Of Content

2006 Report on Operations …………………………….. 1 2007 Business Outlook ………………………………… 4 Statement of Management’s Responsibility ………... 6

For Financial Statements

Consolidation Report Independent Auditors’ Report ……………………. 7 Balance Sheets ………………………………………. 9 Statements of Income ………………………………. 10 Statement of Changes in Stockholders’ Equity…. 11 Statements of Cash Flows ………………………….. 12 Notes to Financial Statements …………………….. 14

Parent Company

Independent Auditors’ Report ……………………. 50 Balance Sheets ………………………………………. 52 Statements of Income ………………………………. 53 Statement of Changes in Stockholders’ Equity… 54 Statements of Cash Flows ………………………….. 55 Notes to Financial Statements …………………….. 56

Board of Directors and Officers ………………….…….. 87 CIP Management Support Services Group ……..…… 88 Corporate Directory …………………………………..….. 89

LMG CHEMICALS CORP. 2006 Annual Report on Operations LMG’s Consolidated Results of Operations: The Consolidated Net Income of LMG in 2006 is PhP 27.2 million. This is a significant achievement for LMG as this represents a 254% increase over the 2005’s PhP 7.7 million. The Consolidated Gross Revenues in 2006 is PhP 308.7 million, 15% lower than the gross revenues in 2005 at PhP 362.4 million. LMG’s Stand-alone Operations: In 2006, as a stand-alone company, from its own operation, LMG earned PhP 17.7 million net profit after tax. This represents another major accomplishment, as the increase over last year’s PhP 1.4 million was a stunning 1150%. HIGHLIGHTS of 2006 OPERATIONS PASIG OPERATIONS

Manufacturing The combined production output of the sulfuric acid and detergent sulfur plants for 2006 was 19.8% lower than last year’s production output.

Sulfuric Acid In 2006, sulfuric acid production output dropped by 8% compared to that of 2005. The acid plant operated at production rates which allowed it to generate enough power to meet its internal requirements including the supply of power to its sulfuric flaking plant and plant auxiliaries. Production efficiency of the sulfuric acid plant continued to be high in 2006 resulting into a significant positive variance of PhP3.4 million for the year.

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Detergent Sulfur Flaking The production output of the Detergent Sulfur Flaking Plant (DSP) was 13% lower than the 2006 budget. Export of sulfur flakes was limited to LMG’s customers in Vietnam. The continued efforts to reduce costs were effective as manufacturing overhead was reduced by a significant 16%. Cost reduction activities include streamlining of operational procedures to enhance efficiencies and improvement in the scheduling of shutdowns/startups.

Sales and Marketing

Overall Volume Performance – Sales volume performance for the year is 2% higher than last year. However, this is still 15% lower than sales budget for 2006.

Sulfuric Acid Technical Grade – Sales volume of Sulfuric Acid Technical Grade in 2006 increased by a significant 23.1% over that of 2005, largely due to recovery of market share. Sulfuric Acid Chemically Pure – Similarly, Sulfuric Acid Chemically Pure or CP exhibited better performance in 2006. Sales volume increased by 42% compared to last year. However, CP sales volume was only 86% of budget. Oleum – Oleum sales remained strong in 2006. The expected shift of raw material from oleum to molten sulfur of LMG’s major oleum customer did not materialize in 2006. As a result, sales volume was 192% of the year’s budget. This is, however, 26% lower than sales performance in 2005. Detergent Sulfur – Detergent sulfur sales in 2006 dropped from the previous year’s volume by 38.8%. This was mainly due to lower molten sulfur supply. As a result, export sales of sulfur flakes dropped by 19.9% in 2006 compared to last year. Traded Molten Sulfur – The volume of traded molten sulfur in 2006 compared to 2005 increased by a significant 64.4%

Strategic Material Purchasing

Sulfur Supply – In 2006, Pilipinas Shell continues to be LMG’s major supplier of sulfur.

The limited supply of molten sulfur prevented the Company from expanding its export market.

The average cost of molten sulfur however, increased by 58.56% in 2006.

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BATANGAS OPERATIONS

San Pascual

The Polymerization Plant equipment and spares were sold through auctions held during the year resulting in sales proceeds amounting to PhP 3.6 million. The remaining minor plant equipment and spares which were not sold during the auctions are scheduled to be disposed off through another bidding process in 2007.

Pinamucan Bulk Chemical Terminal (PBCT)

Utilization of storage tanks in the tank farm in Pinamucan was reduced to 89% from May to December 2006 due to the termination of the lease contract for the tank of Basic Chemical Solutions (BCS). Revenues from tank rental decreased by 8.8% in 2006 compared to 2005. Revenues from throughput charges, however, increased by 10.4% in 2006 versus 2005, despite the decrease of 16.5% in the volume of shipments handled in 2006 compared to 2005.

The two (2) tanks transferred from San Pascual were commissioned in 2006. The tanks received the first shipment on 03 May 2006. This recovered part of the lost revenues in 2006 due to the termination of BCS’ lease contract.

LMG’S SUBSIDIARIES

Kemwater Phil. Corp. (KPC) KPC in 2006 registered a new record in Gross Sales Revenues at PhP153.5 million,

an increase of 17% compared to last year. Net Income for the year at PhP 10.7 million grew by a significant 76% from 2005 level.

Efficiencies in plant operations improved further in 2006 as expenses continued to

decline by 3% versus 2005. Better operating practices are in place and performance standards have been upgraded. As a result, plant downtimes and the production off-spec products declined. Efforts for the improvement and building the skill level of the plant organization continued. Despite a very lean organization, people were responding positively to more responsibilities.

KPC has achieved the internationally accepted quality standard for its product. The

alumina content is now set at the international standard of 17% which is now the Company’s standard for its alum products.

Total sales volume increased by 7% in 2006 over that of 2005. The growth was due mainly to one of KPC’s key clients’ increasing the capacity of its old plant and the starting up of a second plant. KPC also continued to deliver on the liquid alum supply

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contracts won in 2005 with Manila Water and Maynilad Water. Actual sales volume for liquid alum, however, dropped by 5% versus last year, as the actual usage of Manila Water in 2006 was very low due to overall good water turbidity and the maximized use of raw water from the La Mesa. On another solid alum variant, sales volume decreased by 32%. Main factors for the decrease are: a major dealer of KPC decided to put up its own alum plant, the increase in the volume of alum imports, and the entry of specialty chemicals for specific raw water conditions. CHEMPHIL MARKETING CORP. (CMC)

CMC is another company which is 100%-owned company by LMG. It is the trading arm of LMG which trades liquid caustic soda (LCS) in the domestic market. It sources its LCS from Basic Chemical Solutions (BCS) of Singapore.

In April 2006, the Agency Agreement between LMG and BCS expired and this was no longer renewed. Hence, CMC only traded LCS from January-April 2006. Despite the shortened period of only four (4) months to trade in 2006, CMC’s LCS sale volume in 2006 only dropped by only 19.4% compared to the whole year trading period of 2005.

2007 BUSINESS OUTLOOK

The coming year will remain to be difficult and challenging for LMG. While there was a slight recovery in market share in 2006, LMG is challenged to increase its sales volume to achieve, at the very least, breakeven in 2007. Cost reduction and organizational re-structuring projects will be vigorously pursued to bring down manufacturing overhead expenses. A management control system for plant operating and overhead expenses shall be implemented to further ensure the effective control of expenses in the plant operations. LMG will continue its partnership with Pilipinas Shell as its regular supplier of molten sulfur. It will endeavor to secure other sources to complement the supply from Pilipinas Shell. The two (2) remaining storage tanks acquired from Napocor are being offered to prospective lessees. Thus, with the implementation of the strategies and major programs as reflected in the Business Plan for 2007, LMG expects to recover from the losses it incurred in 2006.

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LMG’S Subsidiaries

Kemwater Phil. Corp.

The year 2007 presents more challenges as well as opportunities for KPC. In manufacturing operations, there is still room for improvement in terms of increasing production output and further reducing direct costs. A more pressing concern for the Company is the significant increase in the volume of alum imports from China at very competitive prices which could affect KPC’s market. Other concerns include the entry of specialty chemicals for water treatment as well as the recurring uncertainty of sulfuric acid supply. Note however, that KPC has identified an alternative supply of sulfuric acid. The opportunities for growth in sales volumes and incomes still abound. Demand for solid alum is expected to at least maintain last year’s high level. There is huge possibility of getting supply contracts with major utilities, given KPC’s more competitive position. The expected improvements in the prices of the major raw material, aluminum hydroxide, and a sustained peso would allow KPC to price its products more competitively. KPC management has high hopes in the trading of polymers as the steps taken to introduce the new product in the market have been encouraging. Chemphil Marketing Corp. (CMC)

In the light of the expiration of the Agency Agreement with BCS in April 2006, the objective of the Company for 2007 is to secure an agency agreement with other chemical traders. The business plan includes the expansion of product lines in 2007 in order to generate additional revenues for the trading business. The Company is now negotiating with prospective suppliers for the possible trading of Vinyl Chloride Monomer (VCM), acetic acid, linear alkyl benzene (LAB) and glycerine.

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Statement of Management’s Responsibility for Financial Statement

The Management of LMG Chemicals Corp. is responsible for all information and representations contained in the financial statements as of December 31, 2006 and 2005 and for the years ended December 31, 2006 and 2005. The financial statements have been prepared in accordance with Philippine Financial Reporting Standards and reflect amounts that are based on the best estimates and informed judgment of Management with an appropriate consideration to materiality.

In this regard, Management maintains a system of accounting and reporting which provides for the necessary internal controls to ensure that transactions are properly authorized and recorded, assets are safeguarded against unauthorized use or disposition, and liabilities are recognized. The Management likewise discloses to the Company’s Audit Committee and to its external auditor: (1) all significant deficiencies in the design or operation of internal controls that could adversely affect its ability to record, process, and report financial data; (2) material weaknesses in the internal controls; and (3) any fraud that involves Management or other employees who exercise significant roles in internal controls.

The Board of Directors reviews the financial statements before such statements are approved and submitted to the stockholders of the Company.

SyCip, Gorres, Velayo & Co., the independent auditors appointed by the stockholders and Board of Directors has examined the financial statements of the Company in accordance with Philippine Standards on Auditing and has expressed its opinion on the fairness of the presentation upon completion of such examination, in its report to the Board of Directors and Stockholders.

ANA MARIA G. ORDOVEZA JAIME Y. GONZALES President and Chief Executive Officer Treasurer and Chief Financial Officer

ALEXANDRA G. GARCIA Chief Operating Officer

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SGV & CO SyCip Gorres Velayo & Co. 6760 Ayala Avenue 1226 Makati City Philippines

Phone: (632) 891-0307 Fax: (632) 819-0872 www.sgv.com.ph BOA/PRC Reg. No. 0001 SEC Accreditation No. 0012-FR-1

INDEPENDENT AUDITORS’ REPORT The Stockholders and the Board of Directors LMG Chemicals Corp. Chemphil Building, 851 A. Arnaiz Avenue Legaspi Village, Makati City We have audited the accompanying financial statements of LMG Chemicals Corp. and subsidiaries, which comprise the consolidated balance sheets as at December 31, 2006 and 2005, and the consolidated statements of income, consolidated statements of changes in stockholders’ equity and consolidated statements of cash flows for each of the three years in the period ended December 31, 2006, and a summary of significant accounting policies and other explanatory notes.

Management’s Responsibility for the Financial Statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with Philippine Financial Reporting Standards. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances.

Auditors’ Responsibility

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Philippine Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

SGV & Co is a member practice of Ernst & Young Global

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Opinion

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of LMG Chemicals Corp. and subsidiaries as of December 31, 2006 and 2005, and their financial performance and their cash flows for each of the three years in the period ended December 31, 2006 in accordance with Philippine Financial Reporting Standards. SYCIP GORRES VELAYO & CO.

Josephine H. Estomo Partner CPA Certificate No. 46349 SEC Accreditation No. 0078-AR-1 Tax Identification No. 102-086-208 PTR No. 0266550, January 2, 2007, Makati City April 4, 2007

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LMG CHEMICALS CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31 2006 2005 ASSETS Current Assets Cash and cash equivalents (Note 4) P=15,044,272 P=8,463,419 Receivables - net (Note 5) 44,940,577 42,222,932 Inventories (Note 6) 42,115,558 55,619,870 Due from related parties (Note 13) 22,632,909 33,046,720 Other current assets (Note 7) 49,303,609 48,853,862 Total Current Assets 174,036,925 188,206,803

Noncurrent Assets Property, plant and equipment (Notes 8, 10 and 12): At cost - net 142,645,732 173,489,553 At revalued amounts 701,802,905 746,182,494 Other noncurrent assets (Note 9) 17,876,161 23,696,110 Total Noncurrent Assets 862,324,798 943,368,157 TOTAL ASSETS P=1,036,361,723 P=1,131,574,960

LIABILITIES AND STOCKHOLDERS’ EQUITY Current Liabilities Notes payable (Notes 8 and 10) P=6,000,000 P=22,550,000 Accounts payable and accrued expenses (Note 11) 59,572,421 89,312,573 Liabilities under letters of credit and trust receipts (Note 6) 4,907,040 8,295,470 Income tax payable 2,658,859 683,432 Due to related parties (Note 13) 13,992,148 26,094,915 Current portion of long-term debt (Notes 8 and 12) – 5,681,544 Total Current Liabilities 87,130,468 152,617,934

Noncurrent Liabilities Accrued retirement benefits payable (Note 18) 36,180,188 44,843,513 Long-term debt - net of current portion (Notes 8 and 12) – 10,900,000 Deferred tax liabilities - net (Note 20) 187,857,119 207,187,335 Total Noncurrent Liabilities 224,037,307 262,930,848 Total Liabilities 311,167,775 415,548,782

Stockholders’ Equity Equity attributable to the Parent Company stockholders: Capital stock - P=1 par value Authorized - 200,000,000 shares Issued - 193,644,204 shares (held by 32 equity 193,644,204 193,644,204 holders in 2006 and 2005) Additional paid-in capital 51,480,533 51,480,533 Revaluation increment in land, net of related deferred tax (Notes 8 and 14) 310,798,043 339,084,348 Retained earnings (Note 14): Appropriated 289,000 289,000 Unappropriated 123,170,863 89,980,594 679,382,643 674,478,679 Less cost of 100,028 shares held in treasury 289,000 289,000 679,093,643 674,189,679 Minority interest 46,100,305 41,836,499 Total Stockholders’ Equity 725,193,948 716,026,178 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY P=1,036,361,723 P=1,131,574,960 See accompanying Notes to Consolidated Financial Statements.

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LMG CHEMICALS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME

Years Ended December 31 2006 2005 2004

REVENUE Sales (Note 13) P=308,678,296 P=362,385,271 P=425,525,396Rental income – – 8,369,246 308,678,296 362,385,271 433,894,642COST OF SALES AND SERVICES (Note 15) 257,164,614 301,148,620 300,007,234

GROSS PROFIT 51,513,682 61,236,651 133,887,408

Operating expenses (Note 16) (59,002,380) (73,554,889) (68,528,817)Interest expense (Notes 10, 12, 13 and 17) (3,635,737) (5,711,026) (10,771,477)Other income - net (Note 17) 41,150,834 21,713,730 8,697,497 (21,487,283) (57,552,185) (70,602,797)

INCOME BEFORE INCOME TAX 30,026,399 3,684,466 63,284,611

PROVISION FOR (BENEFIT FROM) INCOME TAX (Note 20) Current 10,468,755 4,037,319 5,966,440Deferred (7,671,888) (8,042,051) 9,138,078 2,796,867 (4,004,732) 15,104,518

NET INCOME P=27,229,532 P=7,689,198 P=48,180,093

Attributable to: Equity holders of the parent P=22,965,726 P=5,261,308 P=39,025,997 Minority interests 4,263,806 2,427,890 9,154,096

P=27,229,532 P=7,689,198 P=48,180,093

BASIC/DILUTED EARNINGS PER SHARE (Note 19) P=0.119 P=0.027 P=0.202 See accompanying Notes to Consolidated Financial Statements.

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LMG CHEMICALS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004

Equity Attributable to Parent Company Stockholders Additional Revaluation Total Capital Paid-in Increment in Retained Earnings (Note 14) Treasury Minority Stockholders’ Stock Capital Land Appropriated Unappropriated Stock Total Interest Equity

BALANCES AT DEC. 31, 2003 P=193,644,204 P=51,480,533 P=359,120,490 P=289,000 P=45,693,289 (P=289,000) P=649,938,516 P=30,301,884 P=680,240,400Net income for the year – – – – 39,025,997 – 39,025,997 9,154,096 48,180,093

BALANCES AT DEC. 31, 2004 193,644,204 51,480,533 359,120,490 289,000 84,719,286 (289,000) 688,964,513 39,455,980 728,420,493 Effect of change in income tax Rates (Note 20) – – (20,036,142) – – – (20,036,142) (47,371) (20,083,513)Net income for the year – – – – 5,261,308 – 5,261,308 2,427,890 7,689,198 Total income and expense for the year – (20,036,142) – 5,261,308 – (14,774,834) 2,380,519 (12,394,315)

BALANCES AT DEC. 31, 2005 193,644,204 51,480,533 339,084,348 289,000 89,980,594 (289,000) 674,189,679 41,836,499 716,026,178 Effect of change in income tax rates – – 11,756,296 – – – 11,756,296 – 11,756,296 Transfer of portion of revaluation increment realized through sale (Note 8) – – (40,224,543) – 40,224,543 – – – – Appraisal increase – – 181,942 – – – 181,942 – 181,942 Total income and expense recognized directly in equity – – (28,286,305) – 40,224,543 – 11,938,238 – 11,938,238 Net income for the year – – – – 22,965,726 – 22,965,726 4,263,806 27,229,532 Total income and expense for the year (28,286,305) 63,190,269 – 34,903,964 4,263,806 39,167,770 Cash dividends declared – P=0.1550 per share (Note 14) – – – – (30,000,000) – (30,000,000) – (30,000,000)

BALANCES AT DEC. 31, 2006 P=193,644,204 P=51,480,533 P=310,798,043 P=289,000 P=123,170,863 (P=289,000) P=679,093,643 P=46,100,305 P=725,193,948

See accompanying Notes to Consolidated Financial Statements.

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LMG CHEMICALS CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS

Years Ended December 31 2006 2005 2004

CASH FLOWS FROM OPERATING ACTIVITIES Income before income tax P=30,026,399 P=3,684,466 P=63,284,611Adjustments for: Depreciation and amortization (Note 8) 37,006,590 36,471,450 36,310,333 Loss (gain) on disposals of: Land (14,886,500) – – Other property and equipment and investment (199,626) (2,700,020) 1,487,171 Amortization of deferred license fee (Note 12) 2,549,475 2,549,475 2,549,475 Recovery from Petrocorp investment (Note 9) (9,528,261) – – Interest expense (Notes 9, 10 and 12) 3,635,737 5,711,026 10,771,477 Interest income (2,284,632) (1,637,830) (1,060,185) Dividend income (2,650) – – Reversal of various accrued expenses – (4,070,882) (8,037,425) Unrealized foreign exchange gain - net – (146,974) (16,585)Operating income before working capital changes 46,316,532 39,860,711 105,288,872Decrease (increase) in: Receivables (2,516,862) 27,818,281 (3,767,646) Inventories 13,504,311 (20,209,038) (2,231,719) Due from related parties 952,767 (24,402,048) – Other current assets 1,557,595 (5,993,246) (2,371,389)Increase (decrease) in: Accounts payable and accrued expenses (28,002,343) 29,613,007 (35,411,196) Liabilities under letters of credit and trust receipts (3,388,430) (5,063,344) (8,987,256) Due to related parties (4,441,281) (8,280,411) (162,596) Accrued retirement benefits payable (8,663,325) (550,937) 5,397,944Cash generated from operations 15,318,964 32,792,975 57,755,014Interest paid (3,669,692) (6,452,420) (11,150,074)Interest received 2,373,677 1,488,243 841,033Income taxes paid, including creditable withholding taxes and final taxes (10,694,792) (4,037,319) (6,033,397)Net cash flows from operating activities 3,328,157 23,791,479 41,412,576

CASH FLOWS FROM INVESTING ACTIVITIES Additions to property, plant and equipment (Note 8) (6,214,040) (12,627,599) (17,110,674)Proceeds from sale of: Land 59,546,000 – – Other property and equipment (Note 8) 232,142 5,962,701 5,281,996 Investments in shares of stock 44,491 – 1,300,000 Nonmoving inventories – – 1,220,344Recovery received from Petrocorp investment (Note 9) 9,528,261 – –Disposals of (additions to) other noncurrent assets 3,244,736 (464,850) 1,236,314Dividend income received 2,650 – –Net cash flows from (used in) investing activities 66,384,240 (7,129,748) (8,072,020)

(Forward)

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Years Ended December 31 2006 2005 2004

CASH FLOWS FROM FINANCING ACTIVITIES Payments of: Notes payable (P=16,550,000) (P=821,667) (P=8,978,333) Long-term debt (16,581,544) (18,382,848) (30,904,688)Dividends declared and paid (30,000,000) – –Availment of notes payable – 3,750,000 –Addition to other long-term liabilities – – 6,891,082Net cash flows used in financing activities (63,131,544) (15,454,515) (32,991,939)

EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS – 146,974 16,585

NET INCREASE IN CASH AND CASH EQUIVALENTS 6,580,853 1,354,190 365,202CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 8,463,419

7,109,229 6,744,027

CASH AND CASH EQUIVALENTS AT END OF YEAR (Note 4) P=15,044,272 P=8,463,419 P=7,109,229 See accompanying Notes to Consolidated Financial Statements.

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LMG CHEMICALS CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. Corporate Information LMG Chemicals Corp. (the Parent Company) and its subsidiaries (collectively referred to as the Group)

are incorporated in the Philippines and are primarily engaged in the manufacture and distribution of industrial chemicals. The Group’s registered office address is Chemphil Building, 851 A. Arnaiz Avenue, Legaspi Village, Makati City.

The Parent Company is currently a 73.93%-owned subsidiary of Chemical Industries of the Philippines

(CIP), the ultimate parent and has three domestic subsidiaries, Chemphil Marketing Corp. (CMC), Kemwater Phil. Corp. (KPC) and LMG Land Development Corporation (Landco), a newly formed company which was incorporated in the Philippines on December 15, 2006.

CMC is engaged, as an exclusive agent, in the sale and distribution of liquid caustic soda and other

industrial chemicals (see Note 25). KPC is engaged in the manufacture and trade of chemicals such as water and sewage treatment

chemicals, inorganic coagulants for the paper industry and ground alum for the detergent industry. Landco is engaged to own, use, improve, develop, subdivide, sell, exchange, lease and hold for

investment or otherwise, real estate of all kinds, including buildings, houses, apartments and other structures.

The accompanying consolidated financial statements of the Group were authorized for issue by the

Board of Directors (BOD) on April 4, 2007. 2. Summary of Significant Accounting and Financial Reporting Policies

Basis of Preparation The consolidated financial statements are prepared under the historical cost basis, except for available-for-sale investments that have been measured at fair value and parcels of land, classified as property, plant and equipment, which are carried at revalued amounts. The consolidated financial statements are prepared in Philippine peso, which is the Group’s functional and presentation currency.

Statement of ComplianceThe accompanying consolidated financial statements have been prepared in compliance with Philippine Financial Reporting Standards (PFRS).

Changes in Accounting Policies The accounting policies adopted are consistent with those of the previous year, except that the Group has made changes in accounting policies resulting from the adoption of the following new and revised standards and Philippine Interpretation International Financial Reporting

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Interpretations Committee (IFRIC) effective January 1, 2006:

• Amendments to PAS 19, Employee Benefits - Actuarial Gains and Losses, Group Plans and Disclosures, provides an additional option to recognize all actuarial gains and losses immediately outside of profit or loss (i.e., in equity). The Group chose not to apply the new option to recognize all actuarial gains and losses immediately outside of the consolidated statement of income.

• Amendments to PAS 39, Financial Instruments: Recognition and Measurement

Amendment for financial guarantee contracts requires financial guarantee contracts that are not considered to be insurance contracts to be recognized initially at fair value and to be remeasured at the higher of the amount determined in accordance with PAS 37, Provisions, Contingent Liabilities and Contingent Assets, and the amount initially recognized less, when appropriate, cumulative amortization recognized in accordance with PAS 18, Revenue. Amendment for hedges of forecast intragroup transactions permits the foreign currency risk of a highly probable intragroup forecast transaction to qualify as the hedged item in a cash flow hedge, provided that the transaction is denominated in a currency other than the functional currency of the entity entering into that transaction and that the foreign currency risk will affect the consolidated statement of income. Amendment for the fair value option restricts the use of the option to designate any financial asset or any financial liability to be measured at fair value through the consolidated statement of income.

• Philippine Interpretation IFRIC 4, Determining Whether an Arrangement Contains a Lease, provides

guidance in determining whether arrangements contain a lease to which lease accounting must be applied.

Adoption of the amendments to the accounting standards and interpretation has no effect on the consolidated financial statements. Additional disclosures required by the revised standards and interpretations were included in the consolidated financial statements, where applicable. Future Changes in Accounting Policies The Group has not applied the following PFRS and Philippine Interpretations which are effective subsequent to December 31, 2006:

• PFRS 7, Financial Instruments: Disclosures, and the complementary amendment to

PAS 1, Presentation of Financial Statements: Capital Disclosures (effective for annual periods beginning on or after January 1, 2007), introduces new disclosures to improve the information about financial instruments. It requires the disclosure of qualitative and quantitative information about exposure to risks arising from financial instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk, as well as sensitivity analysis to market risk. It replaces PAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, and the disclosure requirements of PAS 32, Financial Instruments: Disclosure and Presentation. The amendment to PAS 1 introduces disclosures about the level of an entity’s capital.

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• PFRS 8, Operating Segments (effective for annual periods beginning on or after January 1, 2009), requires a management approach to reporting segment information. PFRS 8 will replace PAS 14, Segment Reporting, and is required to be adopted only by entities whose debt or equity instruments are publicly traded, or are in the process of filing with the Philippine Securities and Exchange Commission for purposes of issuing any class of instruments in a public market.

• Philippine Interpretation IFRIC 7, Applying the Restatement Approach under PAS 29, Financial

Reporting in Hyperinflationary Economies (effective for annual periods beginning on or after March 1, 2006), provides guidance on how to apply PAS 29 when an economy first becomes hyperinflationary, in particular the accounting for deferred income tax.

• Philippine Interpretation IFRIC 8, Scope of PFRS 2 (effective for annual periods beginning on or

after May 1, 2006), requires PFRS 2 to be applied to any arrangements where equity instruments are issued for consideration which appears to be less than fair value.

• Philippine Interpretation IFRIC 9, Reassessment of Embedded Derivatives (effective for annual

periods beginning on or after June 1, 2006), establishes that the date to assess the existence of an embedded derivative is the date an entity first becomes a party to the contract, with reassessment only if there is a change to the contract that significantly modifies the cash flows.

• Philippine Interpretation IFRIC 10, Interim Financial Reporting and Impairment (effective for

annual periods beginning on or after November 1, 2006), prohibits the reversal of impairment losses on goodwill and available-for-sale equity investments recognized in the interim financial reports even if impairment is no longer present at the annual balance sheet date.

• Philippine Interpretation IFRIC 11, PFRS 2 - Group and Treasury Share Transactions (effective for

annual periods beginning on or after March 1, 2007), requires arrangements whereby an employee is granted rights to an entity’s equity instruments to be accounted for as an equity-settled scheme by the entity even if (a) the entity chooses or is required to buy those equity instruments (e.g., treasury shares) from another party, or (b) the shareholders of the entity provide the equity instruments needed. It also provides guidance on how subsidiaries, in their separate financial statements, account for such schemes when the subsidiary’s employees receive rights to the equity instruments of the parent.

• Philippine Interpretation IFRIC 12, Service Concession Arrangements, (effective for annual periods

beginning on or after January 1, 2008), covers contractual arrangements arising from private entities providing public services.

The effects of the adoption of these standards and interpretations, if any, will be included in the Group’s consolidated financial statements when these are adopted subsequent to 2006.

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- 4 - Principles of Consolidation The consolidated financial statements include the accounts of the Parent Company and the following

subsidiaries:

Subsidiaries Percentage of OwnershipCMC 100.00Landco 100.00KPC 60.00

Subsidiaries are consolidated from the date on which control is transferred to the Group and cease to be consolidated from the date on which control is transferred out of the Group. This control is normally evidenced when the Parent Company owns, either directly or indirectly, more than 50% of the voting rights of the subsidiary’s share in capital and/or is able to govern the financial and operating policies of the subsidiary so as to benefit from its activities.

The consolidated financial statements are prepared using uniform accounting policies for like transactions and other events in similar circumstances. Significant intercompany transactions and balances, including intercompany profits and unrealized gains and losses are eliminated in full.

The equity and net income attributable to minority interests of the consolidated subsidiaries are shown separately in the consolidated balance sheet and consolidated statement of income, respectively.

Minority Interest Minority interest represents the interest in subsidiaries, which is not owned, directly or indirectly through

subsidiaries, by the Parent Company. If losses applicable to the minority interest in a subsidiary exceed the minority interest’s equity in the subsidiary, the excess, and any further losses applicable to the minority interest, are charged against the majority interest except to the extent that the minority has a binding obligation to, and is able to, make good the losses. If the subsidiary subsequently reports profits, the majority interest is allocated all such profits until the minority interest’s share of losses previously absorbed by the majority interest has been recovered.

Cash and Cash Equivalents Cash includes cash on hand and in banks. Cash equivalents are short-term, highly liquid investments

that are readily convertible to known amounts of cash with original maturities of three months or less and that are subject to an insignificant risk of changes in value.

Financial Assets and Financial Liabilities Effective January 1, 2005, financial assets are classified as either financial assets at fair value through profit or loss, loans and receivables, held-to-maturity investments, and available-for-sale investments, as appropriate. Financial liabilities on the other hand, are classified as either financial liabilities through profit or loss or other liabilities, as appropriate. The Group determines the classification of its financial assets and financial liabilities after initial recognition and, where allowed and appropriate, re-evaluates this designation at each financial year-end.

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Financial assets and liabilities are recognized initially at fair value. Transaction costs, if any, are included in the initial measurement of financial assets and liabilities, except for any financial instruments measured at fair value through profit or loss. The Group recognizes a financial asset or liability in the consolidated balance sheet when it becomes a party to the contractual provision of the instrument. The fair value of investments that are actively traded in organized financial markets is determined by reference to quoted market bid prices at the close of business on the balance sheet date. For investments where there is no active market, fair value is determined using valuation techniques. Such techniques include using recent arm’s length market transactions; reference to the current market value of another instrument, which is substantially the same; discounted cash flow analysis; and option pricing models. All regular way purchases and sales of financial assets are recognized on the settlement date, (i.e. the date that the Group commits to purchase the asset). Regular way purchases or sales are purchases or sales of financial assets that require delivery of assets within the period generally established by regulation or convention in the marketplace. Financial assets or financial liabilities at fair value through profit or loss Financial assets or financial liabilities classified in this category are designated by management on initial recognition when the following criteria are met: • The designation eliminates or significantly reduces the inconsistent treatment that would otherwise

arise from measuring the assets or recognizing gains or losses on them on a different basis, or • The assets and liabilities are part of a group of financial assets, financial liabilities, respectively, or

both financial assets and financial liabilities, which are managed and their performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, or

• The financial instrument contains an embedded derivative, unless the embedded derivative does not significantly modify the cash flows or it is clear, with little or no analysis, that it would not be separately recorded.

Financial assets classified as held for trading are included in the category “financial assets at fair value through profit or loss”. Financial assets are classified as held for trading if they are acquired for the purpose of selling in the near term. Derivatives are also classified as held for trading unless they are designated as effective hedging instruments. Gains or losses on investments held for trading are recognized in the consolidated statement of income. The Group has not designated any financial assets or financial liabilities as financial assets or liabilities at fair value through profit or loss as of December 31, 2006 and 2005. Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments and fixed maturities that are not quoted in an active market. Such assets are carried at amortized cost using the effective interest method. Gains and losses are recognized in the consolidated

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statement of income when the loans and receivables are derecognized or impaired, as well as through the amortization process. Loans and receivables are included in current assets if maturity is within 12 months from the balance sheet date. Otherwise, these are classified as noncurrent assets. Classified as loans and receivables are the Group’s trade receivables, due from related parties and receivable from Manila Electric Company (MERALCO). Held-to-maturity investments Non-derivative financial assets with fixed or determinable payments and fixed maturities are classified as held-to-maturity when the Group has the positive intention and ability to hold to maturity. Investments intended to be held for an undefined period are not included in this classification. Other long-term investments that are intended to be held to maturity, such as bonds, are subsequently measured at amortized cost. This cost is computed as the amount initially recognized minus principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between the initially recognized amount and the maturity amount less allowance for impairment. This calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums and discounts. For investments carried at amortized cost, gains and losses are recognized in the consolidated statement of income when the investments are derecognized or impaired, as well as through the amortization process. Assets under this category are classified as current assets if maturity is within 12 months from the balance sheet date. Otherwise, these are classified as noncurrent assets. The Group has not designated any financial assets as held-to-maturity as of December 31, 2006 and 2005. Available-for-sale investments Available-for-sale investments are those non-derivative financial assets that are designated as available-for-sale or are not classified in any of the three preceding categories. After initial recognition, available-for-sale investments are measured at fair value with gains or losses being recognized as a separate component of equity until the investment is derecognized or until the investment is determined to be impaired at which time the cumulative gain or loss previously reported in equity is included in the consolidated statement of income.

Classified as available-for-sale investments are the Group’s investments in club shares and other proprietary shares (Note 9).

Other financial liabilities Other financial liabilities pertain to financial liabilities that are not held for trading or not designated as fair value through profit or loss upon the inception of the liability. These include liabilities arising from operations (e.g., payables, accruals) and borrowings (e.g., bank loans, notes payable). The liabilities are recognized initially at fair value and are subsequently carried at amortized cost, taking into account the impact of applying the effective interest method of amortization (or accretion) for any related premium, discount and any directly attributable transaction costs.

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Derecognition of Financial Assets and Financial Liabilities Financial Assets A financial asset (or, where applicable, a part of a financial asset or part of a group of similar financial assets) is derecognized when: • the rights to receive cash flows from the asset have expired; or • the Group retains the right to receive cash flows from the asset, but has assumed an obligation to pay

them in full without material delay to a third party under a ‘pass-through’ arrangement; or • the Group has transferred its rights to receive cash flows from the asset and either (a) has transferred

substantially all the risks and rewards of the asset, or (b) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset.

Where the Group has transferred its rights to receive cash flows from an asset and has neither transferred nor retained substantially all the risks and rewards of the asset nor transferred control of the asset, the asset is recognized to the extent of the Group’s continuing involvement in the asset. Continuing involvement that takes the form of a guarantee over the transferred asset is measured at the lower of the original carrying amount of the asset and the maximum amount of consideration that the Group could be required to repay. Where continuing involvement takes the form of a written and/or purchased option (including a cash-settled option or similar provision) on the transferred asset, the extent of the Group’s continuing involvement is the amount of the transferred asset that the Group may repurchase, except that in the case of a written put option (including a cash-settled option or similar provision) on an asset measured at fair value, the extent of the Group’s continuing involvement is limited to the lower of the fair value of the transferred asset and the option exercise price. Financial Liabilities A financial liability is derecognized when the obligation under the liability is discharged, cancelled or has expired. Where an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability, and the difference in the respective carrying amounts is recognized in the consolidated statement of income.

Impairment of Financial Assets The Group assesses at each balance sheet date whether or not a financial asset or group of financial assets is impaired. Assets Carried at Amortized Cost If there is objective evidence that an impairment loss on loans and receivables carried at amortized cost has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset’s original effective

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interest rate (i.e., the effective interest rate computed at initial recognition). The carrying amount of the asset is reduced either directly or through the use of an allowance account. The amount of the loss shall be recognized in the consolidated statement of income. The Group first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If it is determined that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, the asset is included in a group of financial assets with similar credit risk characteristics and that group of financial assets is collectively assessed for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognized are not included in a collective assessment of impairment. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized, the previously recognized impairment loss is reversed. Any subsequent reversal of an impairment loss is recognized in the consolidated statement of income, to the extent that the carrying value of the asset does not exceed its amortized cost at the reversal date. Assets Carried at Cost If there is objective evidence that an impairment loss on an unquoted equity instrument that is not carried at fair value because its fair value cannot be reliably measured, or on a derivative asset that is linked to and must be settled by delivery of such an unquoted equity instrument has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the current market rate of return for a similar financial asset.

Available-for-sale Investments If an available-for-sale investment is impaired, an amount comprising the difference between its cost (net of any principal payment and amortization) and its current fair value, consolidated less any impairment loss previously recognized in the consolidated statement of income, is transferred from equity to the consolidated statement of income. Reversals in respect of equity instruments classified as available-for-sale are not recognized in the consolidated statement of income. Reversals of impairment losses on debt instruments are reversed through the consolidated statement of income, if the increase in fair value of the instrument can be objectively related to an event occurring after the impairment loss was recognized in the consolidated statement of income.

Marketable Securities Prior to January 1, 2005, marketable securities are stated at the lower of the aggregate cost and market value, determined at the balance sheet date. The amount by which aggregate cost exceeds market value is accounted for as a valuation allowance and changes in the valuation allowance are included in income. Realized gains and losses from the sale of marketable securities are included in income.

The cost of marketable securities used for determining the gain or loss on the sale of such securities is

computed using the average method.

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Offsetting of Financial Instruments Financial assets and financial liabilities are offset and the net amount reported in the consolidated balance sheet if, and only if, there is a currently enforceable legal right to offset the recognized amounts and there is an intention to settle on a net basis, or to realize the asset and settle the liability simultaneously. This is not generally the case with master netting agreements, and the related assets and liabilities are presented gross in the consolidated balance sheet.

Inventories

Inventories are valued at the lower of cost and net realizable value. Costs incurred in bringing each product to its present location and condition are accounted for as follows:

Raw materials, spare parts and factory supplies

- Cost is determined on a moving-average method.

Finished goods - Cost includes direct materials and labor and a

proportion of manufacturing overhead costs determined on a moving-average method.

Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs

of completion, marketing and distribution. Property, Plant and Equipment

Property, plant and equipment are stated at cost less accumulated depreciation and any impairment in value, except for parcels of land which are carried at revalued amount as determined as of December 31, 2006 by an independent firm of appraisers.

The net appraisal increment from revaluation is shown as “Revaluation increment in land” account under the stockholders’ equity section of the consolidated balance sheet.

Revaluation is made with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. Any resulting increase in the asset’s carrying amount as a result of the revaluation is credited directly to “Revaluation increment in land”, net of related deferred tax liability. Any resulting decrease is directly charged against any related revaluation increment to the extent that the decrease does not exceed the amount of the revaluation increment in respect of the same asset. The initial cost of property, plant and equipment consists of its purchase price, including import duties, taxes, and any directly attributable costs of bringing the asset to its working condition and location for its intended use. Expenditures incurred after the property, plant and equipment have been put into operation, such as repairs and maintenance and overhaul costs, are normally charged to income in the period in which the costs are incurred. In situations where it can be clearly demonstrated that the expenditures have resulted in an increase in the future economic benefits expected to be obtained from the use of an item of property, plant and equipment beyond its originally assessed standard of performance, the expenditures are capitalized as an additional cost of property, plant and equipment.

Construction in progress is stated at cost. This includes cost of construction, equipment, and other direct costs. Construction in progress is not depreciated until such time that the relevant assets are completed and becomes available for use.

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Depreciation and amortization is computed on a straight-line basis over the estimated useful life of the asset as follows:

Years Land improvements 10 Buildings and structures 8-10 Machinery and equipment 10 Transportation equipment 5 Office furniture and fixtures 2-5

The residual values, useful lives and depreciation and amortization method are periodically reviewed and adjusted if appropriate at each balance sheet date.

When property and equipment carried at cost are retired or otherwise disposed of, the cost and the related accumulated depreciation and amortization and impairment in value are removed from the accounts and any resulting gain or loss is recognized in the consolidated statement of income. Upon disposal of revalued land, the related revaluation increment realized in respect of the latest valuation will be released from the revaluation increment directly to retained earnings.

Investment Property Investment property, which is included under “Other noncurrent assets” in the consolidated balance

sheet, pertains to a parcel of land not used in operations and stated at cost less any impairment in value. This is used by the Group to earn rentals under operating lease arrangements or for capital appreciation or both, rather than use in the production or supply of goods or services, or for administrative purposes, or sale in the ordinary course of business.

Investment property is derecognized when it has been either disposed of or when it is permanently

withdrawn from use and no future economic benefit is expected from its disposal. Any gains or losses on the retirement or disposal of investment property is recognized in the consolidated statement of income in the year of retirement or disposal.

Transfers are made to investment property when, and only when, there is a change in use, evidenced by

ending of owner-occupation, commencement of an operating lease to another party or ending of construction or development. Transfers are made from investment property when, and only when, there is a change in use, evidenced by commencement of owner-occupation or commencement of development with a view to sell.

License Fee License fee, presented as part of “Other noncurrent assets” in the consolidated balance sheet, is accounted for under the cost model. Costs incurred for the license agreement have been capitalized and are amortized over the period covered by the agreement of 10 years until November 2007 (see Note 9). The carrying value of the license fee is reviewed for impairment and any impairment loss is recognized in the consolidated statement of income.

Impairment of Non-financial Assets

The carrying values of property, plant and equipment, investment property and license fee are reviewed for impairment when events or changes in circumstances indicate that the carrying values may not be recoverable. If any such indication exists and where the carrying values exceed

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the estimated recoverable amounts, the assets are written down to their recoverable amounts. An asset’s recoverable amount is the greater of net selling price and value in use. In assessing value in use, the estimated future cash flows are discounted to their present values using a pre-tax discount rate that reflect current market assessments of the time value of money and the risks specific to the asset. Any impairment loss is recognized in the consolidated statement of income. An assessment is made at each balance sheet date as to whether there is any indication that previously recognized impairment losses may no longer exist or may have decreased. If such indication exists, the recoverable amount is estimated. A previously recognized impairment loss is reversed only if there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognized. If that is the case, the carrying amount of the asset is increased to its recoverable amount. That increased amount cannot exceed the carrying amount that would have been determined, net of depreciation, had no impairment loss been recognized for the asset in prior years. Such reversal is recognized in the consolidated statement of income.

Treasury SharesThe Parent Company’s common shares which are reacquired (treasury shares) are deducted from stockholders’ equity. No gain or loss is recognized in the consolidated statement of income on the purchase, sale or cancellation of the Parent Company’s common shares.

Revenue Revenue is recognized to the extent that it is probable that the economic benefits will flow to the Group and the revenue can be reliably measured. The following specific recognition criteria must also be met before revenue is recognized:

Sales

Sales revenue is recognized when the significant risks and rewards of ownership of the goods have passed to the buyer and the amount of revenue can be measured reliably.

Rental Income Rental income is recognized on a straight-line basis over the term of the lease.

Interest Income Interest income is recognized as the interest accrues taking into account the effective yield on the asset.

Retirement Benefits Cost

Retirement benefits cost is actuarially computed using the projected unit credit method. This method reflects services rendered by employees up to the date of valuation and incorporates assumptions concerning employees’ projected salaries. Actuarial valuations are conducted with sufficient regularity, with option to accelerate when significant changes to underlying assumptions occur. Retirement benefits cost includes current service cost, interest cost, expected return on any plan assets, actuarial gains and losses, past service cost and the effect of any curtailment or settlement. Actuarial gains and losses are recognized as income or expense when the net cumulative unrecognized actuarial gains and losses of the defined benefit plan at the end of the previous reporting year exceeded 10% of the higher of the defined benefit obligation and the fair value of plan assets at that date. These gains or losses are recognized over the expected average remaining working lives of the employees participating in the defined benefit plan.

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The net retirement liability recognized by the Group in respect of the defined benefit retirement plan is the aggregate of the present value of the defined benefit obligation and actuarial gains and losses not recognized reduced by the past service cost not yet recognized and the fair value of plan assets out of which the obligations are to be settled directly.

The net retirement asset recognized by the Group in respect of the defined benefit retirement plan is the lower of: (a) the present value of the defined benefit obligation at the balance sheet date less the fair value of the plan assets, together with adjustments for unrecognized actuarial gains or losses and past service costs that shall be recognized in later periods or (b) the total of any cumulative unrecognized net actuarial losses and past service cost and the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan.

The present value of the defined benefit obligation is determined by discounting the estimated future cash outflows using risk-free interest rates of government bonds that have terms to maturity approximating to the terms of the related retirement liability.

Operating LeaseThe determination of whether the arrangement is, or contains a lease is based on the substance of the arrangement at inception date of whether the fulfillment of the arrangement is dependent on the use of a specific asset or assets or the arrangement conveys a right to use the asset. A reassessment is made after inception on the lease only if one of the following applies: (a) there is a change in contractual terms, other than a renewal or extension of the arrangement; (b) a renewal option is exercised or extension granted, unless the term of the renewal or extension was initially included in the lease term; (c) there is a change in the determination of whether fulfillment is dependent on a specified asset; or (d) there is substantial change to the asset. Where a reassessment is made, lease accounting shall commence or cease from the date when the change in circumstances gave rise to reassessment for scenarios (a), (c), or (d) and at the date of renewal or extension period for scenario (b). Leases where the Group as lessor, retains substantially all the risks and benefits of ownership of the asset are classified as operating leases.

Borrowing CostsBorrowing costs are expensed as incurred. Income Taxes Current Tax Current tax assets and liabilities for the current and prior periods are measured at the amount expected to be recovered from or paid to the taxation authorities. The tax rates and tax laws used to compute the amount are those that have been enacted or substantively enacted at the balance sheet date. Deferred Tax Deferred tax is provided, using the balance sheet liability method, on temporary differences at the balance sheet date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax liabilities are recognized for all taxable temporary

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differences. Deferred tax assets are recognized for all deductible temporary differences to the extent that it is probable that taxable profit will be available against which the deductible temporary differences and unused MCIT and NOLCO can be utilized.

The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred tax asset to be utilized. Unrecognized deferred tax assets are reassessed at each balance sheet date and are recognized to the extent that it has become probable that future taxable profit will allow the deferred tax asset to be recorded.

Deferred tax assets and liabilities are measured at the tax rates that are expected to apply in the year when the asset is realized or the liability is settled based on the tax rates that have been enacted or substantively enacted at the balance sheet date.

Deferred tax assets and deferred tax liabilities are offset if a legally enforceable right exists to set off the

deferred tax assets against the deferred tax liabilities and the deferred taxes relate to the same taxable entity and the same taxation authority.

Income tax relating to items recognized directly in equity is recognized in equity and not in the

consolidated statement of income.

Foreign Currency Transactions and Translations Transactions denominated in foreign currencies are recorded in Philippine peso based on the exchange

rates prevailing at the transaction dates. Outstanding foreign currency-denominated monetary assets and liabilities are translated to Philippine peso at exchange rates prevailing at the balance sheet date. Foreign exchange differentials between rate at transaction date and rate at settlement date or balance sheet date of foreign currency-denominated monetary assets or liabilities are recognized in the consolidated statement of income.

Provisions and Contingencies Provisions are recognized when the Group has a present obligation (legal or constructive) as a result of a past event, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation. If the effect of the time value of money is material, provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessment of the time value of money and, where appropriate, the risks specific to the liability. Where discounting is used, the increase in the provision due to the passage of time is recognized as an interest expense. Contingent liabilities are not recognized in the consolidated financial statements. These are disclosed unless the possibility of an outflow of resources embodying economic benefits is remote. Contingent assets are not recognized in the consolidated financial statements but disclosed when an inflow of economic benefit is probable.

Earnings (Loss) Per Share Basic earning or loss per share is computed by dividing net income or loss by the weighted average

number of common shares issued and outstanding after considering the retroactive effect, if any, of stock dividends declared during the year.

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Diluted earnings per share amounts are calculated by dividing the net income by the weighted average number of ordinary shares outstanding during the year and adjusted for the effects of all dilutive potential common shares, if any.

Events after the Balance Sheet Date Post year-end events up to the date of the approval of the BOD that provide additional information about

the Group’s position at balance sheet date (adjusting events) are reflected in the consolidated financial statements. Post year-end events that are not adjusting events are disclosed in the notes to the consolidated financial statements when material.

Segment Reporting The Group’s operating businesses are organized and managed separately according to the nature of the products and services provided, with each segment representing a strategic business unit that offers different products and serves different markets. The Group’s asset-producing revenues are located in the Philippines (i.e., one geographical location). Therefore, geographical segment information is no longer presented.

3. Significant Accounting Judgments and Estimates

The preparation of the accompanying consolidated financial statements in compliance with PFRS requires management to make judgments, estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The judgments, estimates and assumptions used in the accompanying consolidated financial statements are based upon management’s evaluation of relevant facts and circumstances that are believed to be reasonable as of the date of the consolidated financial statements. While the Group believes that the assumptions are reasonable and appropriate, differences in the actual experience or changes in the assumptions may materially affect the estimated amounts. Actual results could differ from such estimates.

The estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised if the revision affects only that period, or in the period of the revision and future periods if the revision affects both current and future periods.

Determination of Parent Company’s Functional Currency The Parent Company, based on the relevant economic substance of the underlying circumstances, has determined its functional currency to be the Philippine peso. It is the currency of the primary economic environment in which the Parent Company and its subsidiaries operate.

Classification of Financial Instruments The Group classifies a financial instrument, or its components, on initial recognition as a financial liability, a financial asset or an equity instrument in accordance with the substance of the contractual arrangement and the definitions of a financial liability, a financial asset or an equity instrument. The substance of a financial instrument, rather than its legal form, governs its classification in the Group’s consolidated balance sheet.

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The Group determines the classification at initial recognition and re-evaluates this classification at every reporting date.

The carrying value of financial assets amounted to P=86,386,587 and P=88,184,736 and the carrying value

of financial liabilities amounted to P=84,471,609 and P=161,352,679 as of December 31, 2006 and 2005, respectively (see Note 22).

Operating Leases The Group has entered into property leases, where it has determined that the risks and rewards related to those properties are retained by the Group. As such, these lease agreements are accounted for as operating leases.

Estimation of Allowance for Doubtful Accounts The Group maintains allowance for doubtful accounts based on the result of the individual and collective assessment under PAS 39. Under the individual assessment, the Group is required to obtain the present value of estimated cash flows using the receivable’s original effective interest rate. Impairment loss is determined as the difference between the receivable’s carrying balance and the computed present value. The collective assessment would require the Group to group its receivables based on the credit risk characteristics (industry, customer type, customer location, past-due status and term) of the customers. Impairment loss is then determined based on historical loss experience of the receivables grouped per credit risk profile. The methodology and assumptions used for the individual and collective assessments are based on management’s judgment and estimate.

Therefore, the amount and timing of recorded expense for any period would differ depending on the judgments and estimates made for the year. Receivables, net of allowance for doubtful accounts, amounted to P=44,940,577 and P=42,222,932 as of December 31, 2006 and 2005, respectively. Allowance for doubtful accounts amounted to P=4,668,379 and P=6,586,778 as of December 31, 2006 and 2005, respectively (see Note 5).

Impairment of Available-for-sale Investments The Group treats available-for-sale investments as impaired when there has been a significant or

prolonged decline in the fair value below their cost or where other objective evidence of impairment exists. The determination of what is ‘significant’ or prolonged’ requires judgment. The Group treats ‘significant’ generally as 20% more of the original cost of investment, and ‘prolonged’, greater than 6 months. In addition, the Group evaluates other factors, including normal volatility in share price for quoted equities and the future cash flows and the discount factors for unquoted equities. No impairment loss was recognized in 2006, 2005 and 2004.

Determination of Net Realizable Value of Inventories The Group’s estimates of the net realizable values of inventories are based on the most reliable evidence available at the time the estimates are made, of the amount that the inventories are expected to be realized. These estimates consider the fluctuations of price or cost directly relating to events occurring after the end of the period to the extent that such events confirm conditions existing at the end of the period. A new assessment is made of net realizable value in each subsequent period. When the circumstances that previously caused inventories to be written down

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below cost no longer exist or when there is a clear evidence of an increase in net realizable value because of change in economic circumstances, the amount of the write-down is reversed so that the new carrying amount is the lower of the cost and the revised net realizable value. The Group’s inventories as of December 31, 2006 and 2005 amount to P=42,115,558 and P=55,619,870, respectively (see Note 6).

Revaluation of Land The Group’s parcels of land are carried at revalued amounts, which approximate their fair values at the date of the revaluation, less any subsequent accumulated impairment losses. The valuations of land are performed by professionally qualified appraisers. Revaluation is made with sufficient regularity such that the carrying amount does not differ materially from that which would be determined using fair value at the balance sheet date. The resulting increase in the valuation of land, net of the related deferred tax liability based on the 2006 valuation, amounted to P=181,942 and is presented under “Revaluation increment in land” in the consolidated balance sheet. The carrying value of land amounts to P=701,802,905 and P=746,182,494 as of December 31, 2006 and 2005, respectively (see Note 8).

Estimation of Useful Lives of Property, Plant and Equipment

The Group estimates the useful lives of its property, plant and equipment based on the period over which the assets are expected to be available for use. The Group reviews annually the estimated useful lives of property, plant and equipment based on factors that include asset utilization, internal technical evaluation, technological changes, environmental and anticipated use of the assets tempered by related industry benchmark information. It is possible that future results of operation could be materially affected by changes in these estimates brought about by changes in factors mentioned. A reduction in the estimated useful lives of property, plant and equipment would increase depreciation expense and decrease noncurrent assets. The carrying value of property, plant and equipment, excluding land, amounted to P=142,645,732 and P=173,489,553 as of December 31, 2006 and 2005, respectively. Total depreciation expense charged to operations amounted to P=37,006,590 in 2006, P=36,471,450 in 2005 and P=36,310,333 in 2004 (see Notes 8, 15 and 16).

Impairment of nonfinancial assets The Group determines whether its nonfinancial assets are impaired, at least on an annual basis. This

requires an estimation of the value in use of the cash-generating units to which the assets belong. Estimating the value in use requires the Group to make an estimate of the expected future cash flows from the cash-generating unit and also to choose an appropriate discount rate in order to calculate the present value of those cash flows. The carrying value of property, plant and equipment at cost amounted to P=142,645,732 and P=173,489,553 as of December 31, 2006 and 2005, respectively, of which no impairment loss of assets was recognized (see Note 8).

Estimation of Retirement Benefits

The determination of the obligation and cost of retirement benefits is dependent on the selection of certain assumptions used by actuaries in calculating such amounts. Those assumptions are described in Note 18 and include, among others, discount rates, expected returns on plan asset and salary increase rates. Actual results that differ from the Group’s assumptions are accumulated and amortized over future periods and thereafter, generally affect the recognized expenses and recorded obligation in such future periods. While the Group believes that the assumptions are reasonable and appropriate, significant differences in the actual experience or significant changes

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in the assumptions may materially affect the retirement obligations. Accrued retirement benefits payable amounted to P=36,180,188 and P=44,843,513 as of December 31, 2006 and 2005, respectively. Retirement expense charged to operations amounted to P=3,400,926 in 2006, P=10,189,362 in 2005, and P=9,903,936 in 2004 (see Note 18).

Recognition of Deferred Tax Assets The Group reviews the carrying amounts at each balance sheet date and adjusts the balance of deferred tax assets to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred tax assets to be utilized. Deferred tax assets recognized amounted to P=31,323,675 and P=27,177,313 as of December 31, 2006 and 2005, respectively (see Note 20).

Provisions The Group provides for present obligations (legal or constructive) where it is probable that there will be an outflow of resources embodying economic benefits that will be required to settle said obligations. An estimate of the provision is based on known information at balance sheet date, net of any estimated amount that may be reimbursed to the Group. If the effect of the time value of money is material, provisions are discounted using a current pre-tax rate that reflects the risks specific to the liability. The amount of provision is being re-assessed at least on an annual basis to consider new relevant information. The Group has no provisions in 2006, 2005 and 2004.

4. Cash and Cash Equivalents

2006 2005Cash on hand and in banks P=6,544,271 P=8,463,419Short term investments 8,500,000 – P=15,044,271 P=8,463,419

Cash in bank earns interest at the respective bank deposit rates. Short-term investments are made for varying periods of up to three months depending on the immediate cash requirements of the Group, and earn interest at the respective short-term investment rates.

5. Receivables

2006 2005Trade P=40,912,385 P=40,973,464Others (Note 9) 8,696,571 7,836,246 49,608,956 48,809,710Less allowance for doubtful accounts 4,668,379 6,586,778 P=44,940,577 P=42,222,932

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2006 2005 At lower of At lower of

At cost At NRV cost and

NRV

At cost

At NRV cost and

NRV Finished goods P=2,569,505 P=2,060,978 P=2,060,978 P=20,543,702 P=20,035,176 P=20,035,176 Semi-processed goods 7,036,392 7,036,392 7,036,392 8,695,759 8,695,759 8,695,759 Merchandise on hand 1,523,269 1,523,269 1,523,269 1,430,470 1,430,470 1,430,470 Raw materials: On hand 19,391,505 18,477,556 18,477,556 13,819,347 12,905,396 12,905,396 In transit 1,657,621 1,657,621 1,657,621 17,295 17,295 17,295 Spare parts and factory supplies in transit 12,886,427 11,359,742 11,359,742 14,062,458 12,535,774 12,535,774 P=42,115,558 P=55,619,870

Under the terms of the trust receipt agreements covering liabilities under letters of credit, open accounts, and/or documents against payment, some raw materials amounting to P=103,981 as of December 31, 2006 were released to the Parent Company in trust for the banks. The Parent Company is accountable to the banks for the trusteed raw materials or their sales proceeds.

Allowance for inventory losses amounted to P=2,949,161 in both years. 7. Other Current Assets

2006 2005Prepaid taxes P=36,244,616 P=34,043,152Input taxes 8,782,866 10,101,575Prepaid expenses 1,961,025 4,442,835Others (Note 9) 2,315,103 266,300 P=49,303,610 P=48,853,862

8. Property, Plant and Equipment

2006 Office Land Buildings and Machinery Transportation Office Furniture Construction Improvements Improvements and Equipment Equipment and Fixtures in Progress TotalAt Cost: Beginning balance P=25,883,931 P=143,514,045 P=398,011,626 P=16,681,176 P=15,793,902 P=3,467,738 P=603,352,418Additions – – 4,830,563 61,448 25,046 1,296,983 6,214,040Reclassifications – – 1,013,446 102,600 45,455 (1,161,501) –Disposals (2,081,134) (4,808,417) – (3,186,717) (5,284,883) – (15,361,151)Ending balances 23,802,797 138,705,628 403,855,635 13,658,507 10,579,520 3,603,220 594,205,307Accumulated Depreciation and Amortization Beginning balance 17,965,097 108,051,658 274,555,651 14,112,162 15,178,297 – 429,862,865Depreciation and amortization 1,442,658 9,879,830 23,862,447 1,536,348 285,307 – 37,006,590Disposal (2,081,134) (4,808,417) – (3,186,714) (5,233,615) – (15,309,880)Ending balances 17,326,621 113,123,071 298,418,098 12,461,796 10,229,989 – 451,559,575Net Book Values P=6,476,176 P=25,582,557 P=105,437,537 P=1,196,711 P=349,531 P=3,603,220 P=142,645,732

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2005 Office Land Buildings and Machinery Transportation Furniture Construction Improvements Structures and Equipment Equipment and Fixtures in Progress TotalAt Cost: Beginning balances P=25,539,871 P=147,232,851 P=474,385,630 P=15,295,589 P=15,400,105 P=2,299,473 P=680,153,519Additions 344,060 – 5,821,644 1,546,614 393,797 4,521,484 12,627,599Disposals/retirement – (3,718,806) (85,198,867) (161,027) – – (89,078,700)Reclassifications – – 3,003,219 – – (3,353,219) (350,000)Ending balances 25,883,931 143,514,045 398,011,626 16,681,176 15,793,902 3,467,738 603,352,418Accumulated Depreciation and Amortization Beginning balances 16,535,881 99,875,941 335,197,220 12,798,894 14,799,497 – 479,207,433Depreciation and 1,429,216 10,097,329 23,091,811 1,474,294 378,800 – 36,471,450 amortization Disposal/retirement – (1,921,612) (83,733,380) (161,026) – – (85,816,018)Ending balances 17,965,097 108,051,658 274,555,651 14,112,162 15,178,297 – 429,862,865Net Book Values P=7,918,834 P=35,462,387 P=123,455.975 P=2,569,014 P=615,605 P=3,467,738 P=173,489,553

2006 2005Land At revalued amount: Beginning balances P=746,182,494 P=746,182,494 Appraisal increase 279,911 – Disposals (44,659,500) – Ending balance P=701,802,905 P=746,182,494Cost P=75,869,857 P=76,732,055

Certain parcels of land with a carrying value amounting to P=27,136,000 and P=37,594,800 as of December 31, 2006 and 2005, respectively, are used as collaterals for bank loans and long-term debt (see Notes 10 and 12).

In 2006, a parcel of land in Pinamucan, Batangas with cost amounting to P=862,197 was sold. Its revalued amount at the time of sale was P=44,659,500. Proceeds from the sale amounted to P=59,546,000 resulting to a gain of P=14,886,500 recognized in the 2006 consolidated statement of income. The related revaluation increment transferred to related earnings amounted to P=40,224,543, net of deferred capital gains tax of P=3,572,760.

The Parent Company’s property, plant and equipment include those not used in operations as follows:

Buildings Office Land and Transportation Furniture 2006 2005 Improvements Structures Equipment and Fixtures Total TotalCost Beginning balances P=2,037,100 P=16,336,423 P=2,338,102 P=5,284,883 P=25,996,508 P=114,914,181Disposals (2,037,100) (4,852,451) (2,338,102) (5,284,883) (14,512,536) (88,917,673)Ending balances – 11,483,972 – – 11,483,972 25,996,508Accumulated Depreciation

Beginning balances 1,991,473 10,723,090 2,338,102 5,233,615 20,286,280 104,038,702Additions 45,627 1,856,943 – – 1,902,570 1,902,570Disposal (2,037,100) (4,852,451) (2,338,102) (5,233,615) (14,461,268) (85,654,992)Ending balances – 7,727,582 – – 7,727,582 20,286,280Net Book Values P=– P=3,756,390 P=– P=– P=3,756,390 P=5,710,228

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2006 2005Receivable from local government P=7,129,168 P=8,181,479License fee (Note 13) 2,549,475 5,098,950Receivable from MERALCO - net of deferred

interest income 2,289,014 2,863,078Investment property 1,815,388 1,815,388Refundable deposits 1,184,934 2,803,297Available-for-sale investments 905,751 933,490Other noncurrent assets 2,002,431 2,000,428 P=17,876,161 P=23,696,110

Receivable from Local Government

Receivable from local government represents the balance of the local tax credit from the Municipality of San Pascual, Batangas which management believes is expected to be recovered in due time but beyond one year. This will be offset against future tax liabilities of the Parent Company to the Municipality of San Pascual, Batangas.

Receivable from MERALCO

In 2005, MERALCO, informed the Group that in reference to the MERALCO Phase IV-B of the refund approved by the Energy Regulatory Board, the Group’s electric service was qualified for refund under Phase IV-B.

Under the refund MERALCO scheme, the refund may be received through postdated checks or as a fixed monthly credit to bills with cash option. The Group intends to recover the refund through postdated checks to be collected over 5.25 years, starting in April 2006 up to July 2011.

The Group recognized a receivable in 2005 from MERALCO amounting to P=4,345,981, net of deferred interest income of P=960,631, and income from refund of P=3,385,350. The receivable was discounted using an effective interest rate of 9.57%. Breakdown of outstanding balance as of December 31, 2006 and 2005 are as follows:

2006 2005 Current Noncurrent Current Noncurrent

Receivable from MERALCO P=827,806 P=2,690,369 P=827,806 P=3,518,175Deferred interest income 253,742 401,355 305,534 655,097

The current portion of the receivable from MERALCO amounting to P=574,064 in 2006 and

P=522,272 in 2005 is included under “Receivables-others” account (see Note 5). Investment Property

Investment property is carried at cost. The market value of investment property amounted to P=70,173,000 and P=72,248,400 as determined by independent appraisers in 2006 and 2005, respectively. The excess of the appraised value of the land over their carrying amount is not recognized in the consolidated financial statements.

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Refundable Deposits Refundable deposits include deposit to Pasig City environmental fund for possible environmental

disaster amounting to P=500,000. This will be applied against future charges that will be incurred by the Group.

Available-for-sale Investments Available-for-sale investments consist of:

a. Investment in Petrochemicals Corporation of Asia-Pacific (Petrocorp) amounting to P=216,607,775, representing 9.11% ownership, which was fully impaired in previous years following Petrocorp losses, substantial negative working capital and capital deficiency. In 2006, portion of investments in Petrocorp amounting to P=9,528,261 was recovered and received by the Group and recognized in the consolidated statement of income.

b. Investment in All Asia Capital and Trust Corporation (All Asia) amounting to P=8,377,473 which was

fully impaired in previous years following all Asia’s losses, negative working capital and capital deficiency.

c. Other investments amounting to P=905,751 in 2006 and P=933,490 in 2005 represent club shares and

other proprietary shares. 10. Notes Payable The Parent Company’s short-term loans from local banks consist of:

2006 2005Secured loan with interest rate of 12.25% per annum.

Principal amount is payable in August 2007 P=6,000,000 P=6,000,000Secured loan with inter