Annual Report
2005
Our
Company AXTEL is a Mexican telecommunications company providing local and long-distance domestic and international telephony, data and Internet services, virtual private networks and value added services. AXTEL offers basic telecommunications infrastructure in México through an intelligent network that provides extensive coverage to all markets. AXTEL currently operates in México City, Monterrey, Guadalajara, Puebla, León, Toluca, Querétaro, San Luis Potosí, Aguascalientes, Saltillo, Ciudad Juárez, Tijuana, La Laguna, Veracruz and Chihuahua. AXTEL offers customers different access technologies, including fixed wireless telephony, point-to-point and point-to multipoint radio links, copper and fiber optic connections, according to their different communication needs.
AXTEL
Ciudad Juárez
Presence
Chihuahua Tijuana
La Laguna Monterrey Saltillo San Luis Potosí
Querétaro México Veracruz
Aguascalientes Guadalajara
León Toluca
Mission:
Values:
To lead Mexico’s transformation into an information society, by providing integrated communication services.
Simplicity: Excellence: Collaboration: Agility: Innovation:
Puebla
Our Style Our Standard Our Strength Our Advantage Our Commitment
Financial
Highlights 2005
2004
4,967 599 284
3,989 261 (80)
10,833 944 7,077
8,923 1,694 5,784
1,729
1,295
34.8% 12.1% 5.7% 0.5 4.5 0.5
32.5% 6.6% -2.0% 1.3 4.6 0.5
2,940
2,533
Results (Millions of Mexican Pesos of constant purchasing power as of December 31, 2005)
Revenues Operating Income Net Income (Loss) Financial Position (Millions of Mexican Pesos of constant purchasing power as of December 31, 2005)
Total Assets Net Debt Stockholders’ Equity Cash from Operations (Millions of Mexican Pesos of constant purchasing power as of December 31, 2005)
EBITDA Financial Ratios EBITDA / Revenues Operating Income / Revenues Net Income / Revenues Net Debt / EBITDA Interest Coverage Liabilities / Stockholders’ Equity Employees
2005 QUARTERLY EBITDA (Millions of Mexican Pesos)
2005 QUARTERLY REVENUES (Millions of Mexican Pesos)
455
605,904
1,271
427
567,191
1,228
529,650
1,147
377
Q2
(End of quarter)
1,321
470
Q1
LINES IN SERVICE
Q3
Q4
Q1
490,231
Q2
Q3
Q4
Q1
Q2
Q3
Q4
AXTEL 2005 Annual Report
To Our
Stockholders I am pleased to inform you that during 2005 we were able to strengthen our leadership in the Mexican telecommunications market. Our solid business model, based on a combination of state-of-the-art technologies, innovative offers and customer-driven services, allowed us to improve our market position and ensure our growth over the coming years.
EBITDA
(Millions of Mexican Pesos)
1,729
1,295 1,060
629
Our revenues for 2005 were Ps. 4,967 million, a 25% growth from 2004. Operating income increased 130%, from Ps. 261 million in 2004 to Ps. 599 million in 2005. Furthermore, net income grew Ps. 364 million, from a loss of Ps. 80 million in 2004 to a profit of Ps. 284 million in 2005. Another key indicator that clearly illustrates the company’s growth was the 34% year-overyear increase in the number of lines in service that reached 605,904 at year-end 2005. As part of our development plan, in 2005 we made strategic alliances that boosted the competitiveness of our operations, in acordance with the market’s dynamic.
86
2001
During 2005, the company’s main financial indicators improved significantly, in particular operating cash flow (EBITDA), which increased 34%, from Ps. 1,295 million in 2004 to Ps. 1,729 million in 2005.
2002 2003 2004 2005
One of these alliances made AXTEL the first company to provide simultaneous telephony, Internet, and cable television services, a bundle known as “Triple-Play”, in México. This alliance constitutes a step forward in our consolidation strategy in order to provide quality services and capitalize the benefits of technological convergence. We also signed an agreement with Intel to develop WiMAX technology. Through this agreement, AXTEL will become one of the first companies worldwide, and the first in México, to create a network with this revolutionary technology, enabling us to provide our residencial and business customers with broadband services for wireless and mobile equipment, among other value added services.
A X T E L 2005 Annual Report
The positive evolution of our business model WILL ALIGN US with the global trend toward technological convergence and will help us secure a position AS ONE OF THE LEADERS in the voice, data, mobility and video segments in Mexico.
One of the most significant events for us in 2005 was our listing in the Mexican Stock Exchange. In December, we completed an initial public offering of Ps. 3,360 million with a very positive response from the financial community, reflecting the company’s operational and financial strength and providing an extraordinary foundation for a profitable and sustained growth. I would like to welcome our new stockholders and thank them for their trust in us.
REVENUES
(Millions of Mexican Pesos)
4,967 3,989 3,181 2,672 2,444
During 2005, we implemented the principles and activites of the “AXTEL Vision 2006-2010”, which focuses on establishing the organizational bases for consolidating our position as a multi-service provider within a maximum period of five years. Considered one of our most important organizational improvement projects, the “AXTEL Vision 2006-2010” supports our continuous market expansion, our strategic alliances and our technological research and development initiatives. The positive evolution of our business model will align us with the global trend toward technological convergence and will help us secure a position as one of the leaders in the voice, data, mobility and video segments in México.
2001 2002 2003 2004 2005
Our company’s vision of integrated development would be meaningless without the significant efforts of AXTEL’s nearly 3,000 collaborators, to whom we recognize their dedication to make our organization an integral part of the development of our nation and the communities that we serve. On behalf of the Board of Directors and from all of us who are part of this great company, I appreciate your trust and reiterate our commitment to continue building the best option in the Mexican telecommunications market.
LINES IN SERVICE
605,904 453,519 349,144
Tomás Milmo Santos Chairman of the Board and Chief Executive Officer
295,141 290,132
2001
2002 2003 2004 2005
AXTEL 2005 Annual Report
AXTEL VISION
2006-2010
IN AXTEL, we are aware that market challenges can only be faced if our organization pursues common objectives aimed at the continuous improvement of our operations and rapid evolution in RESPONSE TO the needs of an increasingly dynamic market that seeks innovative collateral services.
The transformation of our customer needs, demands new ways of developing AXTEL’s human and technological capacities in order to respond and adapt to the new ways of doing business, as well as to achieve the goal of leading each of the markets in which the company participates. With this commitment as our central focus, over the past year we have set ourselves the task of generating guidelines for the strategic plan that will enable us to accomplish our organizational development and future growth objectives, which are based on the “AXTEL Vision 2006-2010”. Based on this vision, we have implemented strategies and procedures that will transform our organization into a multi-service company with the capability to provide customers with superior voice, data (broadband, Internet and private network), mobility and video services at competitive prices. The company’s vision includes an integral plan that will allow AXTEL to reach a market leadership in new areas of technological convergence, while reinforcing its market position in voice transmission, a segment in which, after six years of operations, AXTEL is now one of the most important players. Our vision establishes the transition from voice to data, then to mobility and video. It will be based on the following fundamental strategies: market positioning, high value added products and services, state-of-the-art technology and organization. These strategies will be implemented over the next five years, providing order and sense to the activities to be undertaken starting in 2006. The first step toward achieving our vision has been to conduct an exhaustive market survey in order to establish the ideal positioning for AXTEL as a different option, with greater scope, and then to design and plan the products and services that, as well as satisfying our customers’ requirements, will represent an innovative alternative that is better than all other options in the market.
COMMUNICATION IS THE PREVAILING ELEMENT, WHAT EVOLVES IS THE MARKET. AXTEL BUSINESS MODEL WILL CONTINUE TO PROVIDE THES BEST ACCESS SOLUTION TO TECHNOLOGICAL CONVERGENCE.
A X T E L 2005 Annual Report
A central part of the development of new options for our customers is to have a technological infrastructure that will ensure that operations are based on leading-edge technology and that customers receive world-class services. To this end, AXTEL is going to build a WiMAX network in partnership with Intel, the world’s most important computer microchip supplier. In contrast to WiFi wireless networks, this technology offers citywide broadband coverage that facilitates the mobility of our services in the cities in which we operate. Our vision is also being strengthened by strategic alliances and collaborative projects that will help us to enhance our offer of contents and services. The new and innovative modality of technological convergence has been used in our company in Tijuana, Baja California since September 2005 where we have been offering joint voice, data, and video (cable television) services that have been widely accepted. The success of this offer is a clear indicator that we are on the right track with our plans for the future. In order to support all of these projects, the “AXTEL Vision 2006-2010” also involves a transformation of the company’s culture and organizational development. One of our main priorities is the constant improvement of our people’s competitive capabilities in the generation of new products and services, and we are implementing initiatives that include specialized training, development and technological certification programs for new technologies.
We aim not only to fulfill, but to surpass, market expectations as a leading, state-of-the-art company that is committed to offering outstanding products with excellent service.
Communication is the prevailing element, what evolves is the market. AXTEL business model will continue to provide thes best access solution to technological convergence. We aim not only to fulfill, but to surpass, market expectations as a leading, state-of-theart company that is committed to offering outstanding products with excellent service. Our goal is clear: to be one of the leading multi-service companies in 2010.
AXTEL 2005 Annual Report
Mass
Market
During 2005, AXTEL GENERATED Ps. $2,348 MILLION IN REVENUES FROM MASS MARKET CUSTOMERS, AN INCREASE OF 22% COMPARED TO PREVIOUS YEAR.
LINES IN SERVICE (Mass Market)
A noteworthy action in this segment in 2005 was the running of the biggest national advertising campaign in the company’s history. This campaign used nationwide mass media and was complemented by local media-based campaigns in the cities where the company offers its services.
487,338 365,270
33.4%
This business strategy helped to increase “share of mind” awareness of the company from 53% in 2004 to 70% in 2005, and “top of mind” recognition from 6% in 2004 to 10% in 2005. These indicators, generated by an external market research company, placed AXTEL in second place for telephone company brand recognition in México. Furthermore, in 2005, AXTEL’s geographic coverage increased by 28% with the installation of 62 new radio bases. This growth allowed us to offer our services to 4.8 million more people than in 2004. Our share of the total Mexican market increased from 2.5% in 2004 to 3.1% in 2005, while the market share indicator in regions in which AXTEL operates, reached 9% on average, and up to 18% in some cities and segments. In adition to the efforts to gain new customers, we focus our sales on increasing profitability in existing customers by selling them additional products, up sell, through their current infraestructure.
2004
REVENUES
(Millions of Mexican Pesos)
2,348 1,929
21.8%
2004
A X T E L 2005 Annual Report
2005
2005
AXTEL has always been recognized for proposing commercial schemes that break old paradigms, such as measured service through products like “AXTEL libre” and diverse “AXTEL in a box” packages, which give customers great savings. We also offer add-ons to these packages like additional local calls, calls to cell phones and long distance minutes applicable to any product or to “AXTEL in a box” packages, in line with our strategy of offering different alternatives that adapt to our customers’ needs. During the year, we launched a package providing three new value added services that, as such, represent a unique offering in México: call forward, remote call forward and selective call forward. Another innovative service that was very well accepted and clearly differentiates our company in the mass market was call control, a versatile product that can be used for local, cell phone, or long distance calls, and is managed at the customer’s discretion. As part of our development strategy, in 2005 AXTEL began to offer telephone, cable television and Internet services, better known as “Triple-Play.” This service materializes the advantages of technological convergence in México. One of the fastest growing sectors in México is real estate development and we have paid special attention to this market. During the year, we launched a pre-activated line designed specifically to strengthen our competitiveness. This is a line ready to be activated by new home occupants as soon as they want to start using it. The service also offers free communication with the local guardhouse and neighbors via an intercom service, and is available in all the cities in which we operate. In the data and Internet segment, AXTEL obtained very positive results with the offer “axtel. next” which uses IFWA technology. During 2005, this service evidenced a 25% penetration among our existing customers in the six cities that were launched in 2004.
AXTEL 2005 Annual Report
Business
Market
AXTEL offers a broad range of products and services to the business market, from the “LINEA AXTEL NEGOCIOS” to virtual private networks (VPNs). Since OPERATIONS STARTED, the company has differentiated its market offerings by designing products and services that no other company in the sector offers and that capitalize on the advantages of the AXTEL technological platform.
We achieved an increase of 27.1% compared to 2004. Revenue from the data segment rose 58.3% in the following products: dial up, broadband and dedicated Internet, Web hosting, private lines and virtual private networks. The number of business lines grew 34.4% in 2005 compared to 2004. One of AXTEL’s most important projects in 2005 was the successful launch of the new product “Metro Ethernet,” which links local networks (LAN) at customers’ sites with Ethernet links through fiber optic connections in México City, Monterrey and Guadalajara. This product has broadband growth capacity of up to 1 Gbps and offers the possibility of delivering multiple services over the same link, such as Internet access and, in the future, IP voice services. The launching of this innovative solution has strengthened the company’s position in the data market. Another notable project offered to the business market in 2005 was “Smart Voice,” which forms part of the extensive family of “AXTEL in a box” service bundles. This innovation allows AXTEL to offer its business customers personalized products with specific solutions for their particular communication needs, such as the combination of a certain number of local calls, national and international long distance minutes, and cellular minutes. “AXTEL in a box”, launched in 2002, constitutes one of the products that distinguishes AXTEL as a pioneer in the integration of services in packages for both business and mass markets. By the end of 2005, this revolutionary product offered over 130 different business packages designed to adapt to the diverse needs of the Mexican telecommunications market. In 2005, we also sold two major virtual private network projects that use last mile access with Alvarion technology, thus providing customers with connectivity between branches or offices in different locations.
A X T E L 2005 Annual Report
LINES IN SERVICE (Business Market)
118,566 88,249
34.4%
We also strengthened our switching equipment portfolio with the addition of Avaya products. Since 2003, we have offered Panasonic equipment, and in 2004, we began delivering Nortel Networks equipment. In 2005, we also launched the international private line linking customers’ sites to anywhere in the world, as well as services in US-México border towns, in particular Tijuana and Ciudad Juárez. Our world-class service differentiates AXTEL in the business market. Based on a CRM strategy, this year we will begin the implementation of a sales methodology that will standarize the customer acquisition process in all the cities where we offer our services.
2004
2005
REVENUES
(Millions of Mexican Pesos)
2,619 2,060
2004
27.1%
2005
One of AXTEL’s most important projects in 2005 was the successful launch of the new product “Metro Ethernet,” which links local networks (LAN) AT customers’ sites with Ethernet links through fiber optic connections in Mexico City, Monterrey and Guadalajara.
AXTEL 2005 Annual Report
Board of
Directors Tomás Milmo Santos (41) (1)
Founding member, CEO, Member of the Board since 1994 and Chairman of the Board since 2003. Member of the Boards of Cemex, the Monterrey Institute of Technology (Instituto Tecnológico y de Estudios Superiores de Monterrey), HSBC, Cemex México and the Instituto Nuevo Amanecer.
Thomas Milmo Zambrano (70) (1)
Founding member, Member of the Board since 1997 and Chairman of the Board from 1997 to 2003. He was the founder and Chairman of the Board of Grupo Javer and Incasa. He was Chairman of the Board and CEO of Carbonífera de San Patricio and Carbón Industrial.
Alberto Santos de Hoyos (64) (1, C)
Founding member and Member of the Board since 1997. He is a Member of the Boards of Banco de México (regional), Grupo Cydsa, Sigma Alimentos and Seguros Comercial América. He has been a Senator and Representative in the Mexican Congress, President of the Nuevo León Chamber of Industry (CAINTRA), Vice-President of the Confederation of Industrial Chambers (CONCAMIN) and President of the National Chamber of the Sugar and Alcohol Industries. He was Chairman of the Board, CEO and a Board Member of Gamesa.
Lorenzo Zambrano Treviño (62) (1, C)
Member of the Board since 1997. He is CEO and Chairman of the Board of Cemex and Chairman of the Board of the Monterrey Institute of Technology (Instituto Tecnológico y de Estudios Superiores de Monterrey) and of the Americas Society. He is a Board Member of IBM, member of the International Advisory Board of Citigroup and a member of the Chairman’s Council of DaimlerChrysler AG. He is also a Member of the Boards of Alfa, Empresas ICA, Femsa, Grupo Financiero Banamex, Televisa and Vitro, and a member of Stanford University’s Graduate School of Business Advisory Council.
Alberto Garza Santos (42) (1, C)
Member of the Board since 2003. He is a Founder and Chairman of the Board of Promotora del Viento and of Promotora Ambiental, and a Member of the Boards of Maquinaria Diesel, Desarrollo Inmobiliario Delta and Gemini.
Héctor Medina Aguiar (55) (A) Member of the Board since 2003. He is Executive Vice-President of Planning and Finance of Cemex and Chairman of the Board of Universidad Regiomontana. He is also a Member of the Boards of Compañía Minera de Chihuahua, Nacional Monte de Piedad and Mexfrutas. Member of the Vigilance Council of the Monterrey Institute of Technology (Instituto Tecnológico y de Estudios Superiores de Monterrey).
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A X T E L 2005 Annual Report
Everett J. Santos (65) (2, A, C)
Member of the Board since 2003 and previously from October 1997 to December 1998. He is CEO of Latin America Group of Emerging Markets Partnership and principal advisor to AIG-GE Capital Latin American Infrastructure Fund. He is Co-founder and Chairman of the Latin American Venture Capital Association and was Director of Infrastructure Investments for the World Bank’s International Financial Corporation.
Bertrand F. Guillot (42) (2, C) Member of the Board since 2003. He is Director of the Private Equity Latin America Group of the AIG Global Investment Corp. and Co-founder of WestNord. He was the Media & Telecom Project Finance Head, Senior Vice-President and Relationship Management Head of ANZ Investment Bank and VicePresident of the Telecom Unit of the Citibank Project Finance Group.
Iain Aitken (51) (3)
Member of the Board since 1997. He is Director of Bedminster Capital Management LLC and advisor to Soros Funds Management LLC. He served as Senior Vice-President of ABN AMRO Bank and held various posts in the European American Banking Corporation. He is a Board Member of Hainan Airlines Co., Limited (China), Batavia Investment Fund Limited and Philippine Discovery Investment Company Ltd.
Lawrence H. Guffey (37) (3, A1, C)
Member of the Board since 2000. He is Managing Director of Private Equity at Blackstone. He previously worked in the area of acquisitions at Trammell Crow Ventures. He is a Member of the Boards of Centennial Communications, Encoda Systems, Orcom and FiberNet.
Alternate
Directors(3)
Federico Gil Chaveznava Patricio Jiménez Barrera Alberto Santos Boesch Francisco Garza Zambrano David Garza Santos David Páez González Gabriel Montaña Patricio D’Apice Ron Drake Benjamin Jenkins
(1) Director (2) Independent Director (3) Alternate Directors substitute Directors when they are not present. (A1) Chairman of the Auditing Committee (A) Member of the Auditing Committee (C) Member of the Compensations Committee AXTEL 2005 Annual Report
11
Company
Officers
Tomás Milmo Santos
Chairman of the Board and Chief Executive Officer
Patricio Jiménez Barrera Chief Financial Officer
Iván Alonso Hernández
Executive Director of Operations
Samuel Lee Belmonte
Executive Director Northwestern Region
Andres Velázquez Romero
Executive Director México City-Central Region
Alberto De Villasante Herbert
Vice-President of Negotiations, Alliances and Institutional Relations
Rafael Garza Blanc
Vice-President of Human Resources
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A X T E L 2005 Annual Report
AXTEL
Foundation
This institution seeks to combine our company’s strengths, discipline, and visionary capacity with its empathy and flexibility to promote integrated development initiatives in the marginalized inner city sectors of the urban areas in which we operate.
Aware of ITS social responsibility and in ITS quest to play an important role in the development of the communities in which IT operateS, in 2005 AXTEL formalized its commitment to the common good by creating the foundation Fundación AXTEL, A.C.
The mission of this institution is to “Promote the sustainable development of México through alliances that facilitate equal access for its people to opportunities that allow them to strengthen their own capabilities and those of their communities, while respecting fundamental human rights.” In order to achieve its mission, the Foundation supports projects aimed at developing specific skills and focuses on three major areas: human development, community development, and environmental protection and development. Our Foundation represents AXTEL’s social conviction seeking to conduct the support of the company, and its employees, suppliers and customers toward specific causes related to its mission. AXTEL is committed to supporting the actions of this new institution, and visualizes 2006 as the year of opportunity to enhance the Foundation’s actions, with increased participation from the company’s internal and external collaborators expanding its scope and social impact.
AXTEL 2005 Annual Report
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Financial
14
A X T E L 2005 Annual Report
Information
Management’s Discussion and Analysis of AXTEL’s Results of Operations and Financial POSITION
Year ended December 31, 2005 compared to Year ended December 31, 2004
Revenues The Company’s 2005 revenues were Ps. $4,966.8 million, compared to Ps. $3,988.7 million in 2004, an increase of Ps. $978.1 million or 25%. The number of lines in service grew 34% to 605,904 at the end of 2005, compared to 453,519 for the previous year. Local Services. Revenues from local services reached Ps. $3,567.1 million in 2005, a growth of Ps. $727.4 million, or 26%, compared to the Ps. $2,839.7 million posted for 2004. This growth reflects an increase in lines in service, combined with high value offers that improve revenues from monthly rent. Long Distance Services. Revenues from long distance services reached Ps. $451.9 million for 2005, an increase of Ps. $57.4 million, or 15%, compared to the Ps. $394.5 million reported in the previous year, primarily due to the growth in the number of lines in service. Other Services. Revenues from other services totaled Ps. $947.8 million in 2005, a growth of Ps. $193.2 million, or 26%, over the Ps. $754.6 million of 2004. This revenue improvement reflects an increase minutes of international traffic completed on our network, combined with a growth in the data and value added services contracted by our customer base.
Cost of Sales and Operating Expenses Cost of Sales. The Company’s cost of sales were Ps. $1,550.5 million in 2005, compared to Ps. $1,270.1 million in 2004, for an increase of Ps. $280.4 million, or 22%, year-over-year. This growth was mainly due to a Ps. $181.7 million increase in costs related to the “calling party pays” scheme and Ps. $63.2 million in long-distance costs as a result of growth in lines in service during the year. Operating Expenses. In 2005, the Company’s operating expenses totaled Ps. $1,687.4 million, compared to Ps. $1,423.8 million in 2004, a growth of Ps. $263.6 million. This increase reflects an increase in rents, salaries and sales commissions resulting from the Company’s geographic expansion. Operating expenses represented 34% of revenues in 2005, compared favorably to the 36% posted in 2004. Depreciation and Amortization. For 2005, the heading of depreciation and amortization totaled Ps. $1,130.2 million, compared to Ps. $1,034.2 million in 2004, a growth of Ps. $96.0 million or 9%. The year-over-year increase reflects the Company’s capital expenditures.
Comprehensive Financial Cost The comprehensive financial cost for 2005 totaled Ps. $(165.9) million, compared to Ps. $(206.6) million in 2004. A favorable diference of Ps. $40.7 million in this item is the result of two main factors: a positive variation in foreign exchange gain of Ps. $111.4 million, due to the appreciation of the Mexican peso against the U.S. dollar during the year; and a negative variation in interest expenses of Ps. $58.2 million due to the 75 million dollar increase in the Company’s debt.
AXTEL 2005 Annual Report
15
Net Income For 2005, the Company posted a net income of Ps. $284.4 million, compared to a loss of Ps. $79.7 million for 2004, representing a growth of Ps. $364.1 million. This result reflects the different factors described above.
Changes in the Company’s Financial Position During 2005, the Company’s cash and cash equivalents grew Ps. $1,318.5 million, from Ps. $572.5 million in 2004 to Ps. $1,891.0 million at the end of 2005. This increase is explained as follows: resources generated by operations provided Ps. $1,411.7 million, resources generated from financing activities were Ps. $1,597.8 million. In addition, the company invested Ps. $1,691.1 million pesos resulting in a net increase of the cash and cash equivalents mentioned above.
Debt Several events affected the Company’s debt in 2005. The main occurrence was the re-opening of our bond facility maturing in 2013, through which the Company issued 75 million dollars of new debt. This new issuance was placed in the market at a price of 106.75, thereby improving the Company’s financing cost. During the year, Standard & Poor’s and Moody’s increased AXTEL’s corporate rating. At yearend 2005, the Company’s debt totaled Ps. $2,782.9 million, compared to Ps. $2,266.9 million at the end of 2004, an increase of Ps. $516.0 million. Net debt at the end of 2005 was Ps. $944.4 million, compared to Ps. $1,694.2 million at yearend 2004. The net debt-to-EBITDA ratios were 0.55 and 1.31 times for 2005 and 2004, respectively.
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A X T E L 2005 Annual Report
INDEPENDENT AUDITORS’ REPORT
KPMG Cárdenas Dosal Oficinas en el Parque Torre II Blvd. Díaz Ordaz Pte. 140 Pisos 16 y 17 Col. Santa María 64650 Monterrey, N.L.
Teléfono: +01 (81) 81 22 18 18 Fax: +01 (81) 83 33 05 32 www.kmpg.com.mx
The Board of Directors and Stockholders Axtel, S.A. de C.V.:
We have audited the accompanying consolidated balance sheets of Axtel, S.A. de C.V. and subsidiaries (the Company) as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders’ equity, and changes in financial position for each of the years in the two-year period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States) and auditing standards generally accepted in Mexico. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Axtel, S.A. de C.V. and its subsidiaries as of December 31, 2005 and 2004, and the consolidated results of their operations, the changes in their stockholders’ equity and the changes in their financial position for each of the years in the two-year period ended December 31, 2005, in conformity with accounting principles generally accepted in Mexico.
KPMG Cárdenas Dosal, S.C.
Rafael Gómez Eng Monterrey, N,L., México March 3, 2006
KPMG Cárdenas Dosal, S.C. la firma Mexicana miembro de KPMG Internacional, una cooperativa Suiza
Aguascalientes, Ags. Ciudad Juárez, Chih. Culiacan, Sin. Chihuahua, Chih. Guadalajara, Jal. Hermosillo, Son. Mérida, Yuc. Mexicali, B.C.
México, D.F. Monterrey, N.L. Puebla, Pue. Querétaro, Qro. Reynosa, Tamps. Tijuana, B.C. Toluca, Edo. de Méx. AXTEL 2005 Annual Report
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AXTEL, S. A. DE C. V. AND SUBSIDIARIES
Consolidated Balance Sheets
(Thousands pesos of constant purchasing power as of December 31, 2005)
Assets
Current assets: Cash and cash equivalents Restricted cash Accounts receivable (note 5) Refundable taxes and other accounts receivable Prepaid expenses Inventories (note 8) Accounts receivable from related parties (note 7)
$
2005
2004
1,891,045 34,479 653,259 42,276 50,530 61,366 6,138
572,696 524,337 85,213 34,574 60,172 -
2,739,093
1,276,992
18,800 7,035,032
20,420 6,415,625
674,015
726,780
178,155 17,193 171,085
209,309 128,179 145,673
$
10,833,373
8,922,978
$
545,625 12,750 47,017 40,979 219,161 23 83,397
615,346 11,238 42,093 112,005 50,607 207,279 394 966
948,952
1,039,928
2,781,758 3,280 2,979 19,000
2,093,077 3,660 2,473 -
3,755,969
3,139,138
8,037,600 515,849 (1,540,333) 122,419 (58,131)
7,341,233 145,256 (1,824,759) 122,419 (309)
7,077,404
5,783,840
10,833,373
8,922,978
Total current assets Long-term accounts receivable Property, systems and equipment, net (notes 9 and 13) Telephone concession rights, net of accumulated amortization of $319,952 and $267,187 in 2005 and 2004, respectively Pre-operating expenses, net (note 10) Deferred income taxes (note 17) Other assets, net (note 11) Total assets
December 31
Liabilities and Stockholders’ Equity Current liabilities: Accounts payable and accrued liabilities Accrued interest Taxes payable Short-term debt (note 12) Current maturities of long-term debt (note 13) Other accounts payable (note 14) Due to related parties (note 7) Derivative financial instruments (note 6) Total current liabilities Long-term debt, excluding current maturities (note 13) Other long-term accounts payable Seniority premiums (note 15) Allowance for severance payments (note 16) Total liabilities Stockholders’ equity (note 18): Common stock Additional paid-in capital Deficit Cumulative deferred income tax effect Change in the fair value of derivative instruments (note 6) Total stockholders’ equity Commitments and contingencies (note 20) Subsequent events (note 21) Total liabilities and stockholders’ equity The accompanying notes are an integral part of the consolidated financial statements. 18
A X T E L 2005 Annual Report
$
AXTEL, S. A. DE C. V. AND SUBSIDIARIES
Consolidated Statements of Operations
(Thousands pesos of constant purchasing power as of December 31, 2005)
Years ended December 31, Rental, installation, service and other revenues (note 19)
$
Operating costs and expenses: Cost of sales and services Selling and administrative expenses Depreciation and amortization
Operating income Comprehensive financing result: Interest expense Interest income Foreign exchange gain (loss), net Monetary position gain Comprehensive financing result, net Other income, net Income before income taxes Income tax expense (note 17) Net income (loss)
$
Weighted average common shares outstanding Basic and diluted earnings per share (pesos)
2005
2004
4,966,796
3,988,733
(1,550,500) (1,687,447) (1,130,232)
(1,270,072) (1,423,788) (1,034,203)
(4,368,1 79)
(3,728,063)
598,617
260,670
(380,871) 56,755 103,857 54,400
(283,123) 17,193 (7,563) 66,889
(165,859)
(206,604)
7,164
21,697
439,922
75,763
(155,496)
(155,441)
284,426
(79,678)
2,552,224,839 0.11
2,533,706,866 (0.03)
The accompanying notes are an integral part of the consolidated financial statements.
AXTEL 2005 Annual Report
19
AXTEL, S. A. DE C. V. AND SUBSIDIARIES
Consolidated Statements of Changes in Financial Position
(Thousands pesos of constant purchasing power as of December 31, 2005)
Years ended December 31, Operating activities: Net income (loss) Add charges (deduct credits) to operations not requiring (providing) resources: Depreciation Amortization Allowance for severance payments Accrual for seniority premiums Deferred income tax Resources provided by operations Net (investment in) financing from operations Resources provided by operating activities Financing activities: Increase in common stock Additional paid-in capital Proceeds (payments) from loans, net Restricted cash Other accounts payable Resources provided by (used in) financing activities Investing activities: Acquisition and construction of property, systems and equipment, net Pre-operating expenses Other assets Resources used in investing activities Increase (decrease) in cash and cash equivalents Cash and cash equivalents at beginning of year Cash and cash equivalents at end of year
The accompanying notes are an integral part of the consolidated financial statements.
20
A X T E L 2005 Annual Report
$
2005
2004
284,426
(79,678)
1,017,321 112,911 6,784 842 155,496 1,577,780 (166,113) 1,411,667
$
926,336 107,867 751 155,441 1,110,717 37,360 1,148,077
696,367 370,593 568,560 (34,479) (3,228) 1,597,813
(96,616) (32) (96,648)
(1,636,728) (10,234) (44,169) (1,691,131) 1,318,349 572,696 1,891,045
(1,509,290) (29,829) (43,252) (1,582,371) (530,942) 1,103,638 572,696
AXTEL, S. A. DE C. V. AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders’ Equity years ended december 31, 2005 and 2004 (Thousands pesos of constant purchasing power as of December 31, 2005)
Balances as of December 31, 2003
Common stock
Additional paid-in capital
$ 7,341,233
145,256
Deficit
Cumulative deferred income tax effect
Change in Total the fair value stockholders’ of derivative equity instruments
(1,745,081)
122,419
-
-
(309)
5,863,827
-
-
Balances as of December 31, 2004
7,341,233
145,256
(1,824,759)
122,419
(309)
5,783,840
Issuance of common stock (note 18a)
696,367
370,593
-
-
-
1,066,960
-
-
Comprehensive loss (note 18c)
Comprehensive income (note 18c) Balances as of December 31, 2005
$ 8,037,600
515,849
(79,678)
284,426 (1,540,333)
(79,987)
-
(57,822)
226,604
122,419
(58,131)
7,077,404
The accompanying notes are an integral part of the consolidated financial statements.
AXTEL 2005 Annual Report
21
AXTEL, S. A. DE C. V. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(Thousands pesos of constant purchasing power as of December 31, 2005)
(1) Organization and description of business AXTEL, S.A. de C.V. and subsidiaries (the Company or AXTEL) is a Mexican corporation engaged in operating and/or exploiting a public telecommunication network to provide voice, sound, data, text, and image conducting services, and local, national, and international long-distance calls. To provide these services and carry out the Company’s activity, a concession is required (see note 20f). In June 1996, the Company obtained a concession from the Mexican Federal Government to install, operate and exploit public telecommunication networks for an initial period of thirty years. AXTEL offers different access technologies, including fixed wireless access, point-to-point, point-to-multipoint, a fiber optic radio links and copper technology, which are used depending on the communication needs of the clients. The Company has been granted the following licenses over the spectrum of frequencies necessary to provide the services: •
60MHz for Point-to-Multi-Point in the 10.5GHz band to cover each one of the nine regions of the Mexican territory. The acquisition of these twenty-year concessions, with an extension option, represented an investment of $149,060 for the Company.
•
112MHz for Point-to-Point in the 15GHz band and a 100MHz in the 23GHz band with countrywide coverage. The acquisition of these twenty-year concessions, with an extension option, represented an investment of $75,174 for the Company.
•
50MHz in the 3.4GHz. The licenses obtained allow coverage in the nine regions of the country, and the investment was $769,733 for a period of twenty years with an extension option.
The Company has commercial services in Monterrey, Mexico City, Guadalajara, Puebla, Toluca, Leon, Queretaro, San Luis Potosí, Aguascalientes, Saltillo, Ciudad Juárez and Tijuana. (2) Summary of significant accounting policies The accounting policies and practices followed by the Company in the preparation of the consolidated financial statements are described below: (a) Financial statement presentation The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in Mexico (Mexican GAAP), which include the recognition of the effects of inflation on the financial information, and are expressed in Mexican pesos of constant purchasing power as of December 31, 2005 based on the National Consumer Price Index (NCPI) published by Banco de Mexico. The indexes used in recognizing the effects of inflation were as follows: NCPI December December
22
A X T E L 2005 Annual Report
2005 2004
425.232 411.648
Inflation % 3.30 5.47
For purposes of disclosure in the notes to the consolidated financial statements, references to pesos or “$”, are to Mexican pesos; likewise, references to dollars or U.S. $, are to dollars of the United States of America. Certain prior period amounts for prepaid expenses have been reclassified to conform with the current period presentation. (b) Principles of consolidation The consolidated financial statements include the financial statements of AXTEL and its majority owned subsidiaries. The balances and transactions between companies have been eliminated in the preparation of the consolidated financial statements. As of December 31, 2005 and 2004, the subsidiaries of the Company are listed below: Instalaciones y Contrataciones, S. A. de C. V. (“Icosa”) Impulsora e Inmobiliaria Regional, S. A. de C. V. (“Inmobiliaria “) Servicios AXTEL, S. A. de C. V. (“Servicios Axtel”)
% ownership 99.998 % 99.998 % 99.998 %
The subsidiaries of the Company except for Inmobiliaria, have employees and only provide services to Axtel. (c) Cash equivalents Cash equivalents of $1,866,152 and $547,595 at December 31, 2005 and 2004, respectively, consist of overnight repurchase agreements and certificates of deposit with an initial term of less than three months. Cash equivalents are carried at the lower of acquisition cost plus accrued interest as of the most recent balance sheet date or net estimated realizable value. Interest and foreign currency exchange fluctuation are included in the statements of operations as part of the comprehensive financing result. (d) Trade accounts receivable Trade accounts receivable includes the amount billed to customers and a provision for services rendered at the balance sheet date but not billed. Amounts billed are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on historical write-off experience. The Company reviews its allowance for doubtful accounts monthly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential recovery is considered remote. (e) Inventories Inventories are carried at the lower of restated cost and net realizable value. The restated cost is determined by application of the NCPI factor to current costs.
AXTEL 2005 Annual Report
23
(f) Property, systems and equipment Property, systems and equipment are recorded at acquisition cost and restated by NCPI factors. Property under capital leases are stated at the present value of minimum lease payments. Comprehensive financing results incurred up to June 1999 during construction or installation periods were capitalized as part of the cost of the assets that were acquired during the pre-operating stage. Since that date, comprehensive financing results have been recognized as part of the results of the year in which they are incurred. Depreciation of property, systems and equipment is calculated using the straight-line method, based on useful lives estimated by management. Useful lives are described in note 9. Leasehold improvements are amortized over the shorter of the useful life of the improvement or the lease term. Maintenance and repairs, including the cost of replacing minor items not constituting substantial betterments are expensed as incurred and charged principally to selling and administrative expenses. (g) Telephone concession rights Telephone concession rights are restated by NCPI factors and amortized under the straight-line method over a period of 20 years (the initial term of the concession rights). (h) Pre-operating expenses Pre-operating expenses include administrative services, technological advice and comprehensive financing results incurred through June 1999 and also the expenses incurred during 2000, 2004 and 2005 in opening offices in other cities throughout the country. The Company started providing business services beginning in 2001. These expenses were capitalized, and restated by NCPI factors and are amortized under the straight-line method over a period of 10 years (see note 10). (i) Other assets Other assets mainly include costs related to Telmex / Telnor infrastructure special projects, guarantee deposits, notes issuance costs and, beginning 2005, the intangible asset related to the labor obligations (see note 11). (j) Seniority premiums and post employment benefits Pension, seniority premium benefits and other post-retirement plans, and, beginning 2005 (see note 3), severance compensation for reasons other than restructuring, to which employees are entitled are charged to operations for the year based on actuarial computations of the present value of this obligation. Amortization of prior service costs is based on the estimated average service lives of existing personnel. As of December 31, 2005, the average service life of employees entitled to plan benefits approximates 6 years.
24
A X T E L 2005 Annual Report
(k) Derivative financial instruments The Company accounts for derivatives and hedging activities in accordance with Bulletin C-10 for Mexican GAAP and FASB Statement No. 133, for US GAAP, Accounting for Derivative Instruments and Certain Hedging Activities, as amended, which require that all derivative instruments be recorded on the balance sheet date at their respective fair values, including those derivatives embedded in financial or non financial contractual agreements. The Company uses financial derivative instruments in order to manage financial exposures, specially foreign exchange related, included on either recognized assets or liabilities, or exposures derived from firm commitments or highly expected forecast transactions not has not yet been recognized as assets or liabilities within the Company’s Balance Sheet. On the date derivatives contracts are entered into, the Company formally designates them into a hedging relationship, as foreign currency hedge to either mitigate the fair value risk or the variability of foreign-currency related exposures, under the corresponding fair value or through the cash flow hedge accounting model. For all hedging relationships the Company formally documents them, including its risk-management objective and strategy for undertaking the hedge, the hedged item, the nature of the hedge risk(s) within such hedged item, the hedge instrument and how the hedging instrument’s effectiveness will be robust enough in offsetting the hedged risk on both a prospective and retrospective basis, including a description on how hedge ineffectiveness will be measured and recognized within earnings. Changes in the fair value of a derivative that is highly effective in mitigating the foreign exchange variability is recorded net of deferred taxation in the Other Comprehensive Income section of equity. The Company uses Currency Swap (CS) contracts to reduce the risk resulting from foreign exchange rate fluctuations of the Mexican Peso (MXP) versus the United States Dollar (U.S. Dollar). The CS involves the exchange of cash flows originated by the exchange of currencies fluctuations. Net amounts paid or received are reflected as adjustments to interest expense within earnings. The Company will discontinue hedge accounting prospectively when it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of the hedged item, the derivative expires or is sold, terminated, or exercised, the derivative is designated as a hedging instrument, because management determines that the designation of the derivative as a hedging instrument is no longer appropriate. In all situations in which hedge accounting is discontinued and the derivative is retained, the Company continues to carry the derivative at its fair value on the balance sheet and recognizes any subsequent changes in its fair value in earnings. (see note 6). (l) Income tax (IT) tax on assets (TA) and employee’s statutory profit sharing (ESPS) IT is accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred ESPS is recognized for timing differences arising from the reconciliation of book income to income for profit sharing purposes with respect to which it may reasonably be estimated that a future liability or benefit will arise and there is no indication that the liabilities or benefits will not materialize.
AXTEL 2005 Annual Report
25
(m) Inflation adjustment of common stock, other contributions and deficit This adjustment is determined by multiplying stockholder contributions and deficit by NCPI factors, which measure accumulated inflation from the dates contributions were made and losses arising through the most recent year end. The resulting amounts represent the constant value of stockholders’ equity. (n) Comprehensive income (loss) The comprehensive income (loss) represents the net income or loss for the year plus the effect of those items reflected directly in stockholders’ equity, other than capital contributions, reductions and distributions. (o) Cumulative deferred income tax effect The Company adopted Bulletin D-4, “Accounting for income tax, tax on assets and employee statutory profit sharing” effective January 1, 2000, which required the adoption of the asset and liability method for determining deferred income taxes. The cumulative effect represents the cumulative previously unrecognized deferred taxes as of the date of adoption. (p) Comprehensive financing result (CFR) The CFR includes interest income and expense, foreign exchange gain and loss, the monetary position gain and valuation effects of financial instruments, less the amounts capitalized, as part of fixed assets and preoperating expenses. Foreign currency transactions are recorded at the rate of exchange prevailing on the date of execution or settlement. Foreign currency assets and liabilities are translated at the exchange rate in force at the balance sheet date. Exchange differences arising from assets and liabilities denominated in foreign currencies are recognized in the results of operations. Monetary position gains and losses are determined by multiplying the difference between monetary assets and liabilities at the beginning of each month, including the deferred taxes, by inflation factors through year-end. The aggregate of these results represents the monetary gain or loss for the year arising from inflation, which is recognized in the CFR. (q) Revenue recognition The Company’s revenues are recognized when earned, as follows: • Telephone service – Based on monthly service fees, measured service based on the number of local calls made, consumption of minutes of calls to cellular numbers and long distance calls and value added services to customers. • Activation – At the time the equipment is installed. • Equipment – At the time of sale and the customer takes ownership and assumes risk of loss.
26
A X T E L 2005 Annual Report
(r) Business and risk concentration The Company rendered services to one client that represents approximately 17% of total net rental, installation, service and other revenues during 2005, 2004 and 2003. This client’s accounts receivable balances as of December 31, 2005 and 2004 represent approximately 1% of total accounts receivable in both years. The Company provides an allowance for doubtful accounts based on management’s analyses and estimations. The allowance expense is included as selling and administrative expenses in the consolidated statement of operations. (s) Contingencies Liabilities for loss contingencies are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. When a reasonable estimation can not be made, qualitative disclosure is provided in the notes to the consolidated financial statements. Contingent revenues, earnings or assets are not recognized until their realization is virtually assured. (t) Impairment of property, systems and equipment and other non-current assets The Company evaluates, at least once a year, the adjusted values of its property, systems and equipment and other noncurrent assets subject to amortization to determine whether there is an indication of potential impairment or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed off are separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. (u) Use of estimates The preparation of consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant items subject to such estimates and assumptions include the carrying amount of property, plant and equipment, valuation allowances for receivables, inventories and deferred income tax assets; valuation of derivative instruments; and assets and obligations related to employee benefits. Actual results could differ from these estimates and assumptions. (v) Segment information The Company believes that it operates in one business segment. Management does view the business as consisting of two revenues streams (Mass market and Business Market); however it is not possible to attribute direct or indirect costs to the individual streams other than selling expenses.
AXTEL 2005 Annual Report
27
(3) Accounting changes Labor obligations The new Bulletin D-3, issued in January 2004, substitutes and supersedes former Bulletin D-3, published in January 1993 and revised in 1998. The provisions of this Bulletin are effective immediately, except for those relating to payments upon termination of labor relationships, which are effective January 1, 2005. This Bulletin adds the issue of post-retirement benefit payments, to supersede Circular 50, “Interest Rates to be Used for Valuing Labor Obligations and Supplementary Application of Accounting Principles, Relating to Labor Obligations.” Also, this Bulletin eliminates the issue of unforeseen payments, and replaces it with the one relating to “Payments Upon Termination of the Labor Relationship,” defining them as those payable to workers upon termination of the labor relationship before retirement age. These payments are of two types: (i) for restructuring reasons, for which the provisions of Bulletin C-9, “Liabilities, Accruals, Contingent Assets and Liabilities, and Commitments,” should be applied, and (ii) for reasons other than restructuring, which valuation and disclosure requirements are the same as those for pension and seniority premium payments, permitting that, upon adoption of the Bulletin, the transition asset or liability be immediately recognized in the results of operations, or else, that it be amortized over the average remaining service life of employees. As of December 31, 2005, the allowance for severance payments included in the accompanying consolidated financial statements amounts $19,000 (see note 16). (4) Foreign currency exposure Monetary assets and liabilities denominated in dollars as of December 31, 2005 and 2004 are as follows:
Current assets Current liabilities Long-term liabilities Foreign currency liability position, net
(Thousands of dollars) 2005 2004 101,370 62,351 (42,328) (73,384) (253,514) (180,121) (194,472) (191,154)
The U.S. dollar exchange rates as of December 31, 2005 and 2004 were $10.77 and $11.26 respectively. As of March 3, 2006, the exchange rate was $10.46. As of December 31, 2005, the Company had foreign exchange derivative instruments (see note 6). As of December 31, 2005 and 2004, the Company had the following non-monetary assets of foreign origin, the replacement cost of which may only be determined in dollars:
Inventories Systems and equipment, gross
28
A X T E L 2005 Annual Report
(Thousands of dollars) 2005 2004 3,042 2,798 791,726 732,181 794,768 734,979
Following is a summary for the years ended December 31, 2005 and 2004, of transactions carried out with foreign entities, excluding imports and exports of systems and equipment:
Interest expense Commissions Administrative and technical advisory services
(Thousands of dollars) 2005 2004 30,869 21,429 223 471 1,311 1,004 32,403 1,004
(5) Accounts receivable Accounts receivable consist of the following:
Trade Less allowance for doubtful accounts Accounts receivable, net
2005 $ 832,302 179,043 $ 653,259
2004 627,863 103,526 524,337
The activity in the allowance for doubtful accounts for the years ended December 31, 2005 and 2004 was as follows:
Balances at beginning of year Bad debt expense Write-offs Balances at end of year not adjusted for inflation Effects of inflation Balances at year end at constant pesos
2005 $ 100,219 78,873 (49) 179,043 $ 179,043
2004 66,719 33,500 100,219 3,307 103,526
AXTEL 2005 Annual Report
29
(6) Derivative instruments and hedging activities The Company has Cross Currency Swaps (CCS) transactions, denominated “Coupon Swap” agreement to hedge its U.S. dollar foreign exchange exposure resulting from the issuance of the U.S.$250 million senior notes. The Company does not enter into derivative instruments for any purpose other than hedging activities. That is, the Company does not speculate using derivative instruments. By using derivative financial instruments to hedge exposures to changes in currency exchange rates fluctuations, the Company exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit counterparty risk for the Company. When the fair value of a derivative contract is negative, the Company owes the counterparty and, therefore, it does not possess credit risk. The Company minimizes the credit risk in derivative instruments by entering into transactions with high-quality foreign financial counterparties. On June 6, 2005, the Company entered into a new derivative CCS. The purpose of this agreement was to hedge the remaining portion of its U.S. dollar foreign exchange exposure. Under this agreement, AXTEL will receive semiannual payments calculated based on the aggregate notional amount of U.S. $136.25 million at an annual rate of 11%, and the Company will make semiannual payments calculated based on the aggregate of $1,480,356 (nominal value) at annual rate of 12.26%. On March 29, 2004, the Company entered into a derivative CCS to hedge a portion of its U.S. dollar foreign exchange exposure resulting from the issuance of the U.S. $175 million 11% senior notes which mature in 2013. Under the CCS transactions, AXTEL will receive semiannual payments calculated based on the aggregate notional amount of U.S. $113.75 million at an annual U.S. rate of 11%, and the Company will make semiannual payments calculated based on the aggregate of $1,270,019 (nominal value) at annual rate of 12.30%. Both of the CCS will expire in December 2008. During the life of the contracts, the cash flows originated by the exchange of interest rates under the CCS those contractual terms in interest payment dates and those conditions of the underlying debt, except that the underlying debt is due in 2013. The Company has been accounting these partial term hedge fixed for fixed CCS under the cash flow hedge accounting model. As of December 31, 2005, the CCS information is as follows: (Amounts in charts are expressed in millions) Currencies Maturity date 15 de diciembre de 2008 15 de diciembre de 2008
Tasas de Interés
Notional amount
National amount (nominal value)
AXTEL receives
AXTEL pays
Estimated fair value
U.S.$ 113.75 U.S.$ 136.25
$ 1,270 $ 1,480
11.00% 11.00%
12.30% 12.26%
U.S.$ (4.1) U.S.$ (3.6)
For the year ended December 31, 2005, the change in the fair value of these CCS is a negative unrealized loss amount of U.S. $(7.7) million recognized within the other comprehensive income section of equity, net of deferred taxes. Since the critical terms of the hedged item and those of the hedging derivatives do match on a partial term and notional basis, no hedge ineffectiveness was recognized during 2005 and 2004, under the cash flow hedge accounting model. The estimated fair values of derivative instruments used for the exchange of interest rates and/or currencies fluctuate over time and will be determined by future interest rates and currency prices. These values should be viewed in relation to the fair values of the underlying transactions and as part of the overall Company’s exposure to fluctuations in interest rates and foreign exchange rates.
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A X T E L 2005 Annual Report
The Company has conducted an initiative to identify, analyze and segregate if applicable, those contractual terms and clauses that implicitly or explicitly embed derivatives characteristics within financial or non financial agreements. These instruments are commonly known as embedded derivatives and do follow the same accounting treatment as of those free-standing contractual derivatives. Based on the above, the Company identified and considered that the amount of embedded derivatives for the years ended December 31, 2005 and 2004 were immaterial and no amount was registered in the accounting records. (7) Related parties transactions The main transactions with related parties, during the years ended December 31, 2005 and 2004 are as follows:
Lease expense Installations services expense Marketing and advertising expense Other
$
2005 43,389 5,778 8,977 269
2004 38,969 5,575 377 482
The balances receivable from and payable to related parties as of December 31, 2005 and 2004 are as follows: 2005 Accounts receivable: Operadora de Parques y Servicios, S.A. de C.V. Accounts Payable: GEN Industrial, S.A. de C.V. Instalaciones y Desconexiones Especializadas, S.A. de C.V.
$ 6,138 $ $
23 23
2004 62 332 394
(8) Inventories Inventories consist of the following:
Telephones and caller identification devices Installation material Tools Network spare parts Other Total inventories
2005 $ 17,440 7,258 7,427 17,189 12,052 $ 61,366
2004 17,875 7,874 3,034 16,893 14,496 60,172
AXTEL 2005 Annual Report
31
(9) Property, systems and equipment Property, systems and equipment are analyzed as follows:
Land Building Computer and electronic equipment Transportation equipment Furniture and fixtures Network equipment Leasehold improvements Construction in progress Advances to suppliers Less accumulated depreciation Property, systems and equipment, net
2005 39,681 128,855 1,126,757 30,365 109,499 8,504,913 171,987 1,133,612 128,397 11,374,066 4,339,034 $ 7,035,032 $
2004 39,275 128,050 1,084,310 19,544 103,055 6,881,144 156,057 1,224,250 101,653 9,737,338 3,321,713 6,415,625
Useful lives 25 years 3 years 4 years 10 years 6 a 28 years 5 a 14 years
As of December 31, 2005 the Company has capitalized CFR as a component of the acquisition cost of property, systems and equipment aggregating $2,366. (10) Pre-operating expenses, net The capitalized pre-operating expenses incurred up to June 1999 and expenses incurred during 2000, 2004 and 2005 in opening new operations are as follows:
Salaries Legal and financial advisory Operating expenses Depreciation Comprehensive financing result Service and other revenues Other
32
Less accumulated amortization Pre-operating expenses, net
A X T E L 2005 Annual Report
2005 $ 208,491 109,515 82,919 9,517 (24,017) (13,576) 37,850 410,699 232,544 $ 178,155
2004 203,200 109,515 77,976 9,517 (24,017) (13,576) 37,850 400,465 191,156 209,309
(11) Other assets Other assets consist of the following:
Notes issuance costs Telmex / Telnor infrastructure costs Guarantee deposits Other Less accumulated amortization Other assets, net
2005 $ 92,038 63,242 20,638 28,396 204,314 33,229 $ 171,085
2004 73,009 57,751 19,495 12,920 163,175 17,502 145,673
Notes issuance costs Notes issuance costs mainly consists of legal and audit fees, documentation, advising, printing, rating agencies, registration fees and out of pocket expenses incurred in relation to the issuance of notes payable and are amortized over the life of the related debt. Telmex / Telnor infrastructure costs As part of the opening of the telecommunications market in Mexico, new telecommunications companies must have interconnection with Telefonos de Mexico (Telmex) and Telefonos del Noroeste (Telnor). These two companies made agreements with the new entrants by which they must compensate Telmex and Telnor for their investment in infrastructure that Telmex / Telnor made in order to provide interconnection for the new telephone companies in Mexico. During 2005, the Company recognized the remaining portion of the amount related to the infrastructure costs. These costs will be amortized under the straight line method over a period of fifteen years. (12) Short-term debt Short-term debt as of December 31, 2004 and its main characteristics is as follows: 2004 Revolving line of credit with Banco Mercantil del Norte, S.A. (Banorte) used for letters of credit, denominated in U.S. dollars up to 360 days Revolving lines of credit with different institutions used for letters of credit denominated in U.S. dollars up to 360 days Total short-term notes payable
87,609
24,396 $ 112,005
AXTEL 2005 Annual Report
33
(13) Long-term debt Long-term debt as of December 31, 2005 and 2004 consist of the following: 2005 U.S. $250,000,000 in aggregate principal amount of 11% Senior Notes due 2013. Interest is payable semi-annually in arrears on June 15, and December 15 of each year.
$ 2,694,425
Premium on Senior Notes issuance
52,564
Promissory Notes with Hewlett Packard Operations Mexico, S. de R.L. de C.V. denominated in U.S. dollars, payable in 12 quarterly installments maturing in December 2007. The interest rate is 7.0%.
28,771
Other long-term financing with several credit institutions with interest rates fluctuating between 6% and 9% for those denominated in dollars and TIIE (Mexican average interbank rate) plus six percentage points for those denominated in pesos Total long-term debt Less current maturities Long-term debt, excluding current maturities
2004 2,036,392
55,309
46,977
51,983
2,822,737 40,979 $ 2,781,758
2,143,684 50,607 2,093,077
Annual installments of long-term debt are as follows: Year 2007 2008 2009 2010 and thereafter
Amount 27,253 6,739 777 2,746,989 $ 2,781,758 $
During January 2005, the Company issued U.S. $75 million under the current indenture. This issuance matures on December 2013. The bonds were issued at a price of 106.75% over face value, thus resulting in a premium of US $5.1 million, which will be amortized as a reduction of interest expense over the term of the notes from 11.0% to 9.84%. Each of the Company’s consolidated subsidiaries, Instalaciones y Contrataciones, S.A. de C.V. (Instalaciones), Impulsora e Inmobiliaria Regional, S.A. de C.V. (Impulsora) and Servicios Axtel, S.A. de C.V. (Servicios), are guaranteeing the notes with unconditional guaranties that are unsecured. Some of the debt agreements that remain outstanding establish certain covenants, the most significant of which refer to limitations on dividend payments and comprehensive insurance on pledged assets. For the year ended December 31, 2005, the Company was in compliance with all of its covenants and obligations.
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A X T E L 2005 Annual Report
(14) Other Accounts Payable As of December 31, 2005 and 2004 other accounts payable consist of the following:
Guarantee deposits (note 20a) Interest payable (note 20a) Other
2005 $ 140,110 41,296 37,755 $ 219,161
2004 151,274 32,981 23,024 207,279
(15) Seniority premiums The cost of the obligations and other elements of seniority premiums mentioned in note 2(j) have been determined based on independent actuarial calculations as of December 31, 2005 and 2004. The components of the net periodic cost for the years ended December 31, 2005 and 2004 are as follows:
Net periodic cost Labor cost Financial cost Amortization of transition obligation Variances in assumptions and experience adjustments Inflationary effect Net periodic cost
2005
2004
$ 697 98 1 13 33 $ 842
631 80 1 9 30 751
2005
2004
$ 2,958 223 3,181
2,474 189 2,663
(462) (6) 266 $ 2,979
(385) (7) 202 2,473
The actuarial present value of plan benefit obligations is as follows:
Present benefit obligation Present value of benefits attributable to future salary increases Projected benefit obligation (PBO) Items pending amortization: Variances in assumptions and experience adjustments Transition liability Minimum additional liability Net projected liability recognized on the consolidated balance sheets
AXTEL 2005 Annual Report
35
The most significant assumptions used in the determination of the net periodic cost of plan are the following: 2005 4.00% 1.00% 4.00% 17 years
Discount rate Rate of increase in future salary levels Estimated inflation for the period Amortization period of the transition liability
2004 4.00% 1.00% 4.00% 17 years
During 2004 the amortization period of the transition liability was increase for additional six years as the variable of probability for payments of pension (when personnel reach 65 years old) was incorporated in the new actuarial calculations. The effect of this change was not material. (16) Severance payments The cost of the obligations and other elements of severance payments mentioned in note 2(j) have been determined based on independent actuarial calculations as of December 31, 2005. The components of the net periodic cost for the year ended December 31, 2005 are as follows: 2005 Net periodic cost Labor cost Financial cost Amortization of transition obligation Inflationary effect Net periodic cost
$
4,222 709 1,527 326 $ 6,784
The actuarial present value of plan benefit obligations is as follows: 2005 Present benefit obligation Present value of benefits attributable to future salary increases Projected benefit obligation (PBO) Items pending amortization: Variances in assumptions and experience adjustments Transition liability Minimum additional liability Net projected liability recognized on the consolidated balance sheets
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A X T E L 2005 Annual Report
$ 18,813 1,087 19,900 376 (17,276) 16,000 $ 19,000
The most significant assumptions used in the determination of the net periodic cost of plan are the following: 2005 4.00% 1.00% 4.00% 17 years
Discount rate Rate of increase in future salary levels Estimated inflation for the period Amortization period of the transition liability
(17) Income tax (IT), tax on assets (TA), employee statutory profit sharing (ESPS) and tax loss carryforwards The parent company and its subsidiaries file their tax returns on a stand-alone basis, and the consolidated financial statements show the aggregate of the amounts determined by each company. In accordance with the current tax legislation, companies must pay either the IT or TA, whichever is greater. Both taxes recognize the effects of inflation, in a manner different from Mexican GAAP. The TA law establishes a 1.8% tax on assets adjusted for inflation in the case of inventory, property, systems and equipment and deducted from certain liabilities. TA levied in excess of IT for the year can be recovered in the succeeding ten years, updated for inflation, provided that in any of such years IT exceeds TA. Effective January 1, 2002 a new Income Tax Law had been enacted, which provided for a 1% annual reduction in the income tax rate beginning in 2003, so that the income tax rate would have been 32% in 2005. In December 2004 the Mexican Congress approved changes to the Income Tax Law where the tax rate for 2005 was further reduced to 30%. Also, for years 2006 and 2007 the tax rates will decrease to 29% and 28%, respectively. Consequently, the deferred income taxes were calculated assuming a 30% tax rate for current assets and current liabilities; 29% and 28%, for assets and liabilities whose tax effects will be reversed after 2005. The effect of the reduction in the deferred income tax assets calculation for 2004 was $52,604. The tax expense attributable to the income before IT differed from the amount computed by applying the tax rate of 30% in 2005 and 33% in 2004 to pretax income, as a result of the items mentioned below: 2005 Computed “expected” income tax expense Increase (decrease) resulting from: Effects of inflation, net Change in valuation allowance Adjustments to deferred tax assets and liabilities for enacted changes in tax rates Amendment to 2003 income tax return Non-deductible expenses Other Deferred income tax (expense)
2004
(131,977)
(25,002)
(1,729) (3,099)
(16,692) (7,524)
10,118
(52,604)
(21,742) (7,067) (155,496)
(31,077) (14,204) (8,338) (155,441)
AXTEL 2005 Annual Report
37
In June 2004 the Company filed before the Mexican tax authority its Statutory Tax Report and also filed an amended Income Tax Return for the year ended December 31, 2003. In that filing, the net tax operating loss carryforwards were decreased by approximately $92,970 as a result of certain expenses originally reported as deductible expenses and in the amended return reported as non-deductible expenses. As a consequence, the tax assets associated with these carryforwards were reduced resulting in an increase in the deferred tax expense for 2004 of approximately $31,077. This decrease and the enacted changes in tax rates are the main factors as to why the effective rate for the year ended December 31, 2004 is approximately 200% as compare to the 35% effective rate for the same period in 2003 and 2005. Other factors contributing to the large effective tax rate mainly include non-deductible expenses and certain inflationary effects. The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 2005 and 2004 are presented below: 2005
2004
Deferred tax assets: Net operating loss carryforwards Allowance for doubtful accounts Accrued liabilities Tax on assets Premium on bond issuance Fair value of derivative instruments Accrued vacations Total gross deferred tax assets Less valuation allowance Net deferred tax assets
$ 310,187 50,142 11,154 20,187 15,267 22,606 2,262 431,805 22,665 409,140
532,004 28,987 4,172 17,874 2,089 585,126 19,566 565,560
Deferred tax liabilities: Property, systems and equipment Telephone concession rights Pre-operating expenses Other assets Inventories Total deferred tax liabilities Deferred tax assets, net
146,233 184,410 50,875 10,429 391,947 $ 17,193
183,900 170,618 59,631 5,180 18,052 437,381 128,179
Income tax expense for the years ended December 31, 2005 and 2004 is summarized as follows: 2005 Deferred taxes Current taxes
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A X T E L 2005 Annual Report
$ 155,459 37 $ 155,496
2004 146,362 9,079 155,441
The rollforward for the net deferred income tax asset for the years ended December 31, 2005 and 2004 is presented below: 2005 $ 128,179 (155,459) 22,606 21,867 $ 17,193
Balances at beginning of year Deferred IT expense Deferred IT of derivative financial instruments Additional paid-in capital Balances at end of year
2004 274,541 (146,362) 128,179
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon of future taxable income during periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. In order to fully realize the deferred tax asset, the Company will need to generate future taxable income of approximately $1,108,497 prior to the expiration of the net operating loss carryforwards in various dates as disclosed below. Taxable income for the years ended December 31, 2005 and 2004 were $766,814 and $115,026, respectively. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences, net of the existing valuation allowances at December 31, 2005. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced. As of December 31, 2005 and 2004, a deferred tax asset valuation allowance was established for tax loss carryforwards from the subsidiaries and TA from the Company. According to the IT law, the tax loss of a year, restated by inflation, may be carried to the succeeding ten years. The tax losses have no effect on ESPS. As of December 31, 2005, the tax loss carryforwards expire as follows: Year 2009 2010 2011 2012 2013 2014 2015
Inflation-adjusted tax loss carryforwards $ 371 416,064 230,770 455,484 538 1,318 3,952 $ 1,108,497
Recoverable TA 9,104 8,998 2,085 20,187
Effective January 1, 2002, AXTEL transferred all of its personnel to a subsidiary Company, which eliminated any deferred ESPS liability.
AXTEL 2005 Annual Report
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(18) Stockholders’ equity The principal characteristics of stockholders’ equity are described below: (a) Common stock structurel The main characteristics and issuances of common stock for 2005 and 2004 are described below:
Date December 9, 2005 Total 2005
Issued and paid shares 307,230,000 307,230,000
Common stock
$
696,367 696,367
Additional paid-in capital 370,593 370,593
At the Extraordinary Shareholders Meeting held on September 8, 2004 the shareholders approved a proposal to increase the variable portion of the capital stock of the Company in the amount in Mexican pesos equal to $3,167 through the issuance of 124,957,212 non-voting Series “N” shares which will represent 4.7% of the total issued capital stock of the Company. These series “N” stocks have not been issued. By resolutions adopted by the Extraordinary Shareholders Meeting held on August 26, 2005, the shareholders of the Company approved a proposal to cancel the increase of the variable portion of the common stock of the Company that was previously approved in a Extraordinary Shareholders Meeting held on September 8, 2004 in the amount equal to $3,167 through the issuance of 124,957,212 non-voting Series “N” shares. These Series “N” shares were never subscribed and paid. By resolutions adopted by the Extraordinary Shareholders´ Meetings held on August 26, 2005, the shareholders of the Company (i) approved a proposal to reduce the variable portion of the capital stock of the Company by $5,217 (see note 20c) (ii) approved a proposal to increase the variable portion of the capital stock of the Company for an amount equal to $5,217 (see note 20c) (iii) approved a proposal to carry out a merger through which the Company (Merging company) absorbed Telinor Telefonía S. de R.L. de C.V (Merged company). These resolutions had no significant effects on the financial position or on the result of operations of the Company. By resolutions adopted by the Ordinary and Extraordinary Shareholders´ Meetings held on November 11, 2005 (10 a.m.), the shareholders of the Company: (i) ratified all shareholders resolutions adopted prior to the date of this meeting; (ii) approved the financial statements of the Company for the fiscal year that ended on December 31, 2004, and (iii) reported about the current structure of the capital stock. At this meeting it was resolved and confirmed that the total subscribed and paid capital stock of the Company was $5,742,897,450 pesos, represented by 1,253,233,984 common, non par value, Series “A” shares; 888,152,627 common, non par value, Series “C” shares; and 392,320,255 non voting, non par value, Series “N” shares. By resolutions adopted by the Ordinary and Extraordinary Shareholders´ Meetings held on November 11, 2005 (12 p.m.), the shareholders of the Company: (i) approved the conversion of 2,533,606,866 shares of the variable portion of the capital stock into the same number of shares of the minimum fixed capital stock; (ii) approved an increase of the minimum fixed capital stock of the Company in the amount of $5,742,797,450 pesos; (iii) approved that the shares representative of the minimum fixed capital stock of the Company will be identified as Class “I” and the shares representative of the variable portion will be identified as Class “II”, and the reclassification of all the shares of the capital stock of the Company so that the capital stock will be represented by two series of nominative, common and non par value shares identified as Series “A” and Series “B” shares; (iv) approved that the subscribed and paid capital stock of the Company is represented by 32,212,209 nominative, common, non par value, Class “I”, Series “A” shares, and by 2,501,494,657 nominative, common, non par value, Class “I”, Series “B” shares; (v) approved an increase of the minimum fixed capital stock of the Company in the amount of up to $778,644,305 pesos through the issuance of up to 343,529,802 nominative, common, non par value, Class “I”, Series “B” shares, to be offered, subscribed and paid as part of a public and private offering (the offering) to be carry out by the Company no later than December 31, 2005.
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A X T E L 2005 Annual Report
In connection with the capital increase described in item (v) of the precedent paragraph, it was also resolved in such meeting to delegate in the Board of Directors and certain officers of the Company the authority (i) to determine, once the offering is completed, the number of shares subscribed in the offering, (ii) to determine the exact amount of the capital increase approved in such meeting based on the results of the offering, (iii) to cancel the unsubscribed and unpaid shares as a result of the offering, and (iv) to modify the text of Clause Sixth of the bylaws to reflect the subscribed and paid capital stock as a result of the offering. Immediately after giving effect to the resolutions of the meeting referred to in the preceding two paragraphs, the Company’s capital stock was $6,521,541,755 pesos, represented by 32,212,209 common, non par value, Class “I”, Series “A” subscribed and paid shares; 2,501,494,657 common, non par value, Class “I”, Series “B” subscribed and paid shares; and 343,529,802 common, non par value, Class “I”, Series “B” unsubscribed and unpaid shares to be offered in the offering. Based on the results of the offering carried out on December 6, 2005, and considering that 307,230,000 shares were subscribed in such offer (out of the 343,529,802 common, non par value, Class “I”, Series “B” shares that were issued for the increase of the minimum fixed capital stock of the Company as approved at the shareholders meeting of November 11, 2005), the Company’ capital stock (at December 31, 2005) is $6,439,264,660.77 pesos, represented by 32,212,209 common, non par value, Class “I”, Series “A”, subscribed and paid shares; and 2,808,724,657 common, non par value, Class “I”, Series “B”, subscribed and paid shares. (b) Stockholders’ equity restrictions Stockholders’ contributions, restated as provided in the tax law, totaling of $6,466,825 may be refunded to stockholders tax-free. No dividends may be paid while the Company has a deficit. Some of the debt agreements mentioned in note 13 establish limitations on dividend payment. (c) Comprehensive income (loss) The comprehensive income (loss) reported on the statements of stockholders’ equity represents the results of the total performance of the Company during the year, and includes the items mentioned below which, in accordance with Mexican GAAP, are reported directly in stockholders’ equity, except for net income.
Net income (loss) Fair value of derivative instruments Deferred IT of derivative financial instruments Comprehensive income (loss)
2005 $ 284,426 (80,428) 22,606 $ 226,604
2004 (79,678) (309) (79,987)
(19) Rental, installation, service and other revenues Revenues consist of the following:
Local calling services Long distance services Other services
2005 $ 3,567,064 451,902 947,830 $ 4,966,796
2004 2,839,678 394,455 754,600 3,988,733
AXTEL 2005 Annual Report
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(20) Commitments and contingencies As of December 31, 2005, there are the following commitments and contingencies: (a) On January 24, 2001 a contract was signed with Global Towers Communications Mexico, S. de R.L. de C.V. (Formerly Spectrasite Communications Mexico, S. de R.L. de C.V.) expiring on January 24, 2004, to provide the Company with services to locate, construct, set up and sell sites within the Mexican territory. As part of the operation, the Company agreed to build 650 sites, subject to approval and acceptance by Global Towers Communications Mexico, S. de R.L. de C.V. (Global Towers) and, in turn, sell or lease them under an operating lease plan. On January 24, 2001, the Company received 13 million dollars from Global Towers to secure the acquisition of the 650 sites at 20,000 dollars per site. These funds are not subject to restriction per the contract for use and destination. However, the contract provides for the payment of interest at a Prime Rate in favor of Global Towers on the amount corresponding to the number of sites that as of June 24, 2004 had not been sold or leased in accordance with the terms of the contract. The Company has recognized a liability to cover such interest for $41,296, included within other accounts payable in the balance sheet as of December 31, 2005. During 2002, Global Towers filed an Ordinary Mercantile Trial against the Company before the Thirtieth Civil Court of Mexico City, demanding the refund of the guarantee deposit mentioned above, plus interest and trial-related expenses. The Company countersued Global Towers for unilateral rescission of the contract. As of December 31, 2005, the trial is at a stage where evidence is being shown. (b) On October 2002, Metronet, S.A. de C.V. (“Metronet”) filed an action against the Company in the Fourth Civil Court in Monterrey (Mexico). Metronet claims that the Company wrongfully terminated a letter of intent and is seeking payment for services and direct damages of approximately U.S. $3.8 million, plus other expenses and attorneys’ fees. The trial court ruled against the Company in first instance. The Company appealed such judgment before the Appeal Court and on October 22, 2004 ruled in favor of the Company, discharging Axtel of any liability, damages or payment in favor of Metronet. On November 12, 2004 Metronet requested constitutional review. On May 27, 2005, the Mexican Federal Court resolved the constitutional review requested by Metronet by ordering the State Superior Court of Appeals to review the case and to issue a new resolution. The State Superior Court of Appeals on July 7, 2005 ruled again in favor of the Company, releasing Axtel of any liability and responsibility. On August 5 2005, Metronet requested constitutional review challenging such State Superior Court’s decision. Currently the Mexican Federal Court is reviewing and the resolution is pending. (c) On December 23, 2003, LAIF X filed a demand for arbitration against the Company, Telinor, Blackstone Capital Partners Merchant Banking Fund, L.P., Blackstone Offshore Capital Partners III, L.P. and Blackstone Family Investment Partnership III, L.P. (collectively the “Blackstone Entities”) disputing the validity of the transfer of Series “A” shares held by Telinor to the Blackstone Entities, and the conversion of the series “A” shares into series “C” shares in connection with such transfer. LAIF X claims that such transfer and conversion were not authorized by the Company’s bylaws or shareholder resolution, and then the Blackstone Entities’ ownership of the Company’s shares is therefore invalid. LAIF X also challenges the composition of the Company’s Board of Directors. In addition to the declaratory relief, LAIF X’s demand for Arbitration seeks unspecified damages and cost from the Company, Telinor and the Blackstone Entities.
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On August 26, 2005, the Company, Telinor, Blackstone Capital Partners III Merchant Banking Fund L.P., Blackstone Offshore Capital Partners III L.P. and Blackstone Family Investment Partnership III L.P. (collectively “Blackstone”), LAIF X sprl and LAIF IV Ltd. entered into a settlement agreement (the “Settlement Agreement”) pursuant to which all issues in an arbitration and other previously disclosed judicial proceedings in the United States and Mexico relating to the issuance and ownership of certain shares were resolved. As a consequence of the Settlement Agreement, shareholders held an Ordinary and Extraordinary Shareholders Meeting dated August 26, 2005 pursuant to which, among other matters, they acknowledged and ratified all current shareholdings in Axtel including the issuance and subscription of the previously issued shares which were the subject of dispute, and also they resolved a decrease in an immaterial amount of Telinor’s and Blackstone’s ownership of our shares and a subsequent increase in the same amount in LAIF X sprl’s ownership share, and on a number of ancillary matters. All of the proceedings between the parties to the Settlement Agreement have been definitely resolved.
A X T E L 2005 Annual Report
(d) The Company is involved in a number of lawsuits and claims arising in the normal course of business. It is expected that the final outcome of these matters will not have significant adverse effects on the Company’s financial position and results of operations. (e) In compliance with commitments made in the acquisition of concession rights, the Company has granted surety bonds to the Federal Treasury and to the Ministry of Communication and Transportation amounting $33,187 and to other service providers amounting $162,967. (f) The concessions granted by the Ministry of Communications and Transportation (SCT), mentioned in note 1, establish certain obligations to the Company, including, but not limited to: (i) filing annual reports with the SCT, including identifying main shareholders of the Company, (ii) reporting any increase in common stock, (iii) providing continuous services with certain technical specifications, (iv) filing monthly reports about disruptions, (v) filing the services’ tariff, and (vi) providing a bond. (g) The Company leases some equipment and facilities under operating leases. Some of these leases have renewal clauses. Lease expense for 2005 and 2004 was $346,499 and $297,050, respectively. The annual payments under these leases as of December 31, 2005 are as follows: Contracts in:
2006 2007 2008 2009 2010 Thereafter
Pesos (thousands) $ 257,038 254,844 246,987 234,908 216,718 1,640,486 $ 2,850,981
Dollars (thousands) 7,256 6,226 4,032 3,032 2,870 9,723 33,139
(h) As of December 31, 2005, the Company has placed purchase orders which are pending delivery from suppliers for approximately $649,731. (i)
As of December 31, 2005, the Company has already placed the required purchase orders to fulfill and satisfy the purchase commitments set forth in the following agreements: (1) Purchase and License Agreement (“PLA”) of Fixed Wireless Access (“FWA”) Equipment entered by and between Axtel, Nortel Networks Limited and Nortel Networks de México, S.A. de C.V dated March 20, 2003; (2) PLA of Non FWA Equipment entered by and between Axtel, Nortel Networks Limited and Nortel Networks de México, S.A. de C.V dated March 20, 2003; (3) Amendment Agreement No. 2 to the PLA of FWA Equipment and the Technical Assistance Support Services (TASS) for FWA Agreement, both dated March 20, 2003, entered by and between Axtel and Airspan Communications Limited, dated April 20, 2004, and; (4) Restated and Amended PLA for FWA Equipment entered by and between Axtel and Airspan Communications Limited dated December 28, 2004.
AXTEL 2005 Annual Report
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(j)
On July 20, 2004 Axtel, Nortel Networks Limited and Nortel Networks de México, S.A. de C.V., entered into a Purchase and License Agreement for the supply of next generation soft switch equipment and related services (the “NGN PLA”). This NGN PLA contains standard commercial and legal terms. In this NGN PLA, Axtel has a purchase commitment to acquire from Nortel Networks the equipment and the software licenses required to have 100,000 lines in services by the end of the five (5) year term of such agreement. As of December 31, 2005, the Company has acquired the equipment and software licenses required to have 70,451 lines in service.
(21) Subsequent events (a) On January 30, 2006, February 1, 2006 and March 1, 2006 the Company launched the operation in the cities of Torreón, Veracruz and Chihuahua, respectively. (b) On February 22, 2006 the Company redeemed U.S. $87,500,000 aggregate principal amount of its 11% senior notes due 2013, or 35% of the U.S. $250,000,000 original aggregate principal amount of the notes. The redemption was made at a price of 111% of the principal amount of the notes, plus accrued and unpaid interest to the redemption date. (22) Recently issued accounting standards Through May 2004, the Accounting Principles Commission (Comisión de Principios de Contabilidad or CPC) of the Mexican Institute of Public Accountants was in charge of issuing accounting standards in Mexico. Those standards are contained in the Bulletins of Generally Accepted Accounting Principles (Bulletins), which are deemed standards, and in the Circulars, that are regarded as opinions or interpretations. Beginning June 1, 2004, the aforementioned function was transferred to the Mexican Board for Research and Development of Financial Reporting Standards (Consejo Mexicano para la Investigación y Desarrollo de Normas de Información Financiera or CINIF). CINIF is an entity whose objectives are to develop Financial Reporting Standards (FRS) in Mexico that are useful to both issuers and users of financial information, as well as to achieve as much consistency as possible with the International Financial Reporting Standards (IFRS), issued by the International Accounting Standards Board. Through December 2005, CINIF has issued eight series A and one series B Financial Reporting Standards. Therefore, Mexican FRS currently include both the standards issued by CINIF and the Bulletins and Circulars issued by CPC, that have not been revised, substituted or superseded by the new FRS. The principal changes included in the aforementioned FRS, which are effective for fiscal years beginning after December 31, 2005, are the following: (a) (b) (c) (d)
44
Donations received are included in the results of operations, instead of in contributed capital. Elimination of special and extraordinary items, classifying income statement items as ordinary and non-ordinary. Retroactive recognition of the effects of changes in particular standards. Disclosure of the authorized date for issuance of financial statements, as well as the officer or body authorizing issuance.
A X T E L 2005 Annual Report
INVESTOR RELATIONS
Adrián de los Santos
Design: Infobrand Printing: Grafotec
[email protected]
MEDIA RELATIONS
José Manuel Basave
[email protected]
AXTEL CORPORATE OFFICE Blvd. Diaz Ordaz km. 3.33 Col. Unidad San Pedro San Pedro Garza Garcia, N.L CP 66215 Mexico
AXTEL