Document 6527067
Transcription
Document 6527067
COVER SHEET A S 0 9 3 - 0 0 8 8 0 9 SEC Registration Number P A C I F I C ON L I N E COR P OR A T I ON S Y S T EMS A N D S U B S I D I A R I E S (Company’s Full Name) 22 n d F l o o r , S t o c k R o a d , W e s t E x c h a n g e O r t i g a s T o w e r , P h i l i p p i n e C e n t r e , C e n t e r , E x c h a n g e P a s i g C i t y (Business Address: No. Street City/Town/Province) Mr. Rhederick B. Inciong 636-5281 (Contact Person) (Company Telephone Number) 1 2 3 1 17 - A Month Day (Form Type) Month (Fiscal Year) Day (Annual Meeting) (Secondary License Type, If Applicable) CFD Dept. Requiring this Doc. Amended Articles Number/Section Total Amount of Borrowings P 265.6 million 59 Total No. of Stockholders Domestic Foreign To be accomplished by SEC Personnel concerned File Number LCU Document ID Cashier STAMPS Remarks: Please use BLACK ink for scanning purposes. SECURITIES AND EXCHANGE COMMISSION SEC FORM 17-A ANNUAL REPORT PURSUANT TO SECTION 17 OF THE SECURITIES REGULATION CODE AND SECTION 141 OF THE CORPORATION CODE OF THE PHILIPPINES 1. For the fiscal year ended December 31, 2008 2. SEC Identification Number : AS093-008809 3. BIR Tax Identification No. 003-865-392-000 4. Exact name of registrant as specified in its charter: PACIFIC ONLINE SYSTEMS CORPORATION 5. Metro Manila, Philippines Province, Country or other jurisdiction of Incorporation or organization 6. _________________ (SEC Use Only) Industry Classification Code 7. 22/F, West Tower, PSE Centre, Exchange Road, Ortigas Center, Pasig City Address of principal office 1605 Postal Code 8. 632/636-5281 Registrant’s telephone number, including area code 9. Not applicable Former name, former address, and former fiscal year, if changed since last report. 10. Securities registered pursuant to Sections 4 and 8 of the RSA Number of Shares of Common Stock Title of Each Class Outstanding and Amount of Debt Outstanding Common Stock, P1.00 par value 199,715,000 11. Are any or all of these securities listed on the Philippine Stock Exchange. Yes [ x ] No [ ] 12. Indicate by check mark whether the registrant: (a) has filed all reports required to be filed by Section 17 of the Code and SRC Rule 17 thereunder or Sections 11 of the RSA and RSA Rule 1 (a)-1 thereunder, and Section 26 and 141 of the Corporation Code of the Philippines during the preceding 12 months (or for such shorter period that the registrant was required to file such reports): Yes [ x ] No [ ] (b) has been subject to such filing requirements for the past 90 days. Yes [ x ] No [ ] 13. Aggregate market value of voting stock held by non-affiliates : P 1.67 billion This was computed by multiplying the number of voting stocks held by non-affiliates by the stock’s closing price on March 31, 2009. TABLE OF CONTENTS PART I - BUSINESS AND GENERAL INFORMATION Item Item Item Item 1. 2. 3. 4. Page No. Business Properties Legal Proceedings Submission of Matters to a Vote of Security Holders 1 8 9 9 PART II - OPERATIONAL AND FINANCIAL INFORMATION Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters Item 6. Management Discussion and Analysis of Operating Performance and Financial Condition Item 7. Financial Statements Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 9 12 15 15 PART III - CONTROL AND COMPENSATION INFORMATION Item 9. Directors and Executive Officers of the Registrant Item 10. Executive Compensation Item 11. Security Ownership of Certain Beneficial Owners and Management Item 12. Certain Relationships and Related Transactions 16 22 23 24 PART IV - CORPORATE GOVERNANCE 26 PART V - EXHIBITS AND SCHEDULES Item 13. Exhibits and Reports on SEC Form 17-C 27 SIGNATURES 28 INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY SCHEDULES PART I - BUSINESS AND GENERAL INFORMATION Item 1. Business The Company was incorporated in the Philippines and was registered with the SEC on November 11, 1993. As of December 31, 2006, the Company had an authorized capital stock of 500,000,000 Common Shares, each with a par value of P1.00, of which 125,250,000 Common Shares have been issued and outstanding. On February 9, 2007 the Company issued an additional 54,000,000 shares from its authorized capital stock thus increasing the issued and outstanding shares to 179,250,000. On March 27, 2007 the Company offered its shares for sale to the public through an initial public offering (IPO) consisting of 11,800,000 common shares and a secondary offer of 28,000,000 common shares. On November 19, 2007, the SEC approved the issuance of 8,048,000 common shares from the Company’s unissued authorized capital stock resulting from the valuation of the deposits for future subscription as consideration for the issuance of shares, at the total subscription price of P124,744,000. On May 19, 2008, grantees of the stock options exercised 617,000 shares of the Company’s stock at P8.88 per share. On July 11, 2008, the BOD authorized the Parent Company to buy back up to 2,000,000 shares from the public as a means of preserving the value of the Company’s shares and maintaining investor confidence and on another board meeting on October 14, 2008 approved to extend its share buy back program of 10% of the Company’s outstanding capital stock. As of December 31, 2008, the Company has acquired and paid 4,414,000 shares of capital stock. The Company is engaged in the development, design and management of on-line computer systems, terminals and software for the Philippine gaming industry. It brokers technology from leading global suppliers of integrated gaming systems and leases to the PCSO the equipment needed for its on-line lottery operations in the VisMin regions under the terms of an eight-year Equipment Lease Agreement (ELA), which was entered into on November 25, 1995. The Company also provides the PCSO the necessary technical support through a Maintenance Repair Agreement (MRA) that is coterminous with the ELA. The ELA, which was last amended on February 13, 2004, allows the Company to deploy a total of 1,800 on-line terminals around its covered regions. General terms of the amended ELA and MRA stipulate a 10 per cent share by the Company of all PCSO sales from the conduct of on-line lottery and digit games in the VisMin area and a term of eight (8) years commencing from the date of commercial operations of the Company. Commercial operation, as amended, was defined to be the operation of not less than 800 terminals. However, commercial operation was formally effected on April 1, 2005, setting the term of the Company’s ELA up to 2013, even if the PCSO had actually begun operations of the Company’s on-line terminals since 1996. Major reasons for the delay in the deployment of the required number of terminals to constitute commercial operation were mainly due to strong opposition from religious sector leaders and certain Local Government Unit (LGU) officials experienced during the introductory phase and due to the absence of telecommunications service in some areas particularly in Mindanao. As of December 31, 2007 and 2008, the Company had already deployed 1,401 and 1,600 on-line terminals around the VisMin territory, respectively. From 1995 to 2005, the Company had provided the PCSO a single integrated system for its online lottery operations. On February 15, 2005, the Company, having assessed the obsolescence of its previous infrastructure, entered into a Supply and Service Contract with Scientific Games Page 1 of 28 International (Scientific Games), a global marketing and technology leader in the lottery, parimutuel, and telecommunications industries, for the provision of a new system, AEGISTM. On November 21, 2005, the Company implemented the migration from the traditional Legacy lottery system provided by GTECH, a leading gaming technology and systems corporation, into the new AEGISTM System. On March 13, 2006, the Company entered into another Contract with Intralot, a company duly existing and organized under the laws of Greece and a leading supplier of integrated gaming and transaction processing systems, for the provision of another new system using the LOTOS® application software. Since December 2006, therefore, the Company has been providing the PCSO a two-network system for its VisMin on-line lottery operations. The area covered by the Company’s ELA with the PCSO encompasses 72 cities and 841 municipalities in the VisMin regions, including the provinces of Masbate (assigned to Region 7), Romblon (assigned to Region 6) and Palawan. As of the end of 2008, the Company’s total terminal deployment covered 67 cities and 461 municipalities. For the year ended December 31, 2008, the Company generated P 809.6 million of revenues primarily through equipment rentals and maintenance and repair fees charged to PCSO, and posted P 139.4 million of net income. As of the same date, the Company had total assets of P779.8 million and shareholders’ equity of P 400.2 million. Other Gaming-Related Investments In addition to its core gaming operations, the Company, on April 13, 2004, purchased 50 per cent of the outstanding capital stock of Innovative Solutions Consultancy Group, Corp. (Innovative), a joint stock company incorporated to manage enterprises engaged in the gaming business. On May 31, 2004, Synergy, in turn, acquired 80 per cent of the outstanding capital stock of Total Gaming Technologies, Inc. (TGTI), a domestic corporation founded in October 2002 to develop new games for the Philippine gaming industry and to provide consultancy service and state-of-the-art equipment to the local gaming operators through its strategic partnership with Intralot. TGTI has entered into an Equipment Lease Agreement with the PCSO for the nationwide operation of the Fast Keno game. A Shareholders’ Agreement was executed whereby Innovative shall provide management counsel and expertise to TGTI to ensure proper execution of the Fast Keno game, among others. Recent Developments ¾ Acquisitions and investments. In April 2008, the Company purchased 37.38 percent of the other venturer in Innovative, which effectively increased its stake from 50 to 87.38 percent. ¾ Increase in terminal roll-out. The Company increased its presence in the VisMin territory through the roll-out of about 200 terminals, from 1,401 terminals as of December 31, 2007 to 1,600 terminals by December 31, 2008. Page 2 of 28 ¾ Aggressive distribution. The Company secured approval from PCSO for 8 instant scratch ticket variants and launched 40 million tickets. ¾ Wider network of retail lotto outlets. Through its subsidiaries – Loto Pacific Leisure Corporation and Lucky Circle Corporation, operated lotto sites grew from 39 to 68. Agreement with the Philippine Charity Sweepstakes Office The Company has an Equipment Lease Agreement with the PCSO which provides for the lease to PCSO of the Equipment needed for its on-line lottery operations in VisMin for a period of eight years from the start of commercial operations. For purposes of the ELA, a terminal is deemed ready for commercial operation if it is capable of issuing a lottery ticket. Rental billed to PCSO is equivalent to 4.3 per cent of the gross amount of ticket sales from all on-line lottery operations in the VisMin regions or a fixed annual rental of = P35,000 per terminal in commercial operation, whichever is higher. The ELA also provides PCSO an option to purchase the equipment upon the expiration of the lease period for a sum of P =25.0 million. Furthermore, the ELA provides that the total number of betting stations that should be installed to constitute commercial operations is 1,250 terminals. A Maintenance and Repair Agreement which runs concurrently with the ELA, was also entered into by the Company with the PCSO, whereby, the Company will provide maintenance and repair services on the equipment leased by PCSO for a fee equivalent to 0.15 per cent of the gross amount of ticket sales from all on-line lottery operations in VisMin. On February 13, 2004, the Company and PCSO agreed on certain amendments to the ELA to address the financial viability of the agreement. Under the terms of the amended ELA, the Company will charge PCSO an adjusted pre-agreed fee based on 10 per cent of the gross amount of lotto ticket sales from the operation of all PCSO’s lotto terminals in VisMin to cover for equipment rental, maintenance and repairs fee and communication and service fee. The amended ELA reduced the number of betting stations that should be installed to constitute commercial operations from 1,250 to 800 terminals. Furthermore, the option to purchase the equipment upon the expiration of lease period was reduced to P15.0 million. On April 1, 2005, the PCSO and the Company mutually agreed to effect commercial operation of the on-line terminals, setting the ELA’s term up to March 31, 2013. Government Regulation and Environmental Compliance The Company does not need any government approval for its principal products or services since its business is in the development, design and management of on-line computer systems, terminals and software for the Philippine gaming industry and not in the operation of the lottery business. The Company is not required to comply with specific environmental laws. Page 3 of 28 Technology Development, Supply and Service Contracts Scientific Games From 1995 to 2005, the Company had provided the PCSO a single integrated system for its online lottery operations. On February 15, 2005, the Company, having assessed the obsolescence of its previous GTECH infrastructure, entered into a Contract with Scientific Games for the provision of a new system, AEGISTM. On November 20, 2005, the Company implemented the migration from the traditional Legacy lottery system provided by GTECH into the new AEGISTM System. Under the terms of the Contract, Scientific Games will provide the Company with 900 Extrema® terminals as well as the required training necessary for its operation. In consideration of the foregoing, the Company shall pay Scientific Games 12.5% of its revenue from the conduct of online lottery games running under the system provided by Scientific Games. This Contract is coterminous with the Company’s ELA with the PCSO. Intralot On March 13, 2006, the Company entered into a contract with Intralot, a company incorporated under the laws of the Greece, for the supply of Equipment necessary for the operation of a new on-line lottery system effective December 8, 2006. Under the terms of the Contract, Intralot will provide the Company with the computer hardware, the license to use Intralot’s Lottery Application Software consisting of the software platform, LOTOS® Application Software, and the Games Application Software, the terminals as well as the required training necessary to operate the system. Based on the amended contract signed on July 7, 2006, Intralot will provide the Company with 600 Coronis HEE terminals. In consideration of the foregoing, the Company shall pay Intralot 15% of the revenue generated by the terminals from the conduct of on-line lottery and digit games running on its system or a fixed amount of US$110 per terminal per month, whichever is higher. On July 10, 2006, Intralot entered into an agreement with its subsidiary, Intralot Inc., a company domiciled in Atlanta, Georgia, through which Intralot assigned whole of the contract, including all its rights and obligations arising from its said subsidiary. This Contract is coterminous with the Company’s ELA with the PCSO. Having two (2) on-line lottery systems running in parallel has expanded the availability of lottery terminals in VisMin and provides a safety net for PCSO’s operations in the unlikely event of either system crashing for whatever reasons. The new technology also helps provide versatility in connectivity given the country’s hybrid telecommunications network. The new systems are now capable of being connected using GPRS technology (mobile phone connectivity) and are also capable of using Internet connectivity (IPbased). Terminal connectivity is now a lot easier due to compatibility of the lottery terminals with widespread mobile phone cell sites in VisMin. On-line connectivity in VisMin is now available wherever there is a cell site of Globe Telecoms and Smart Telecoms. In addition, GPRS connectivity is also the least cost among all communication links (leased-line, radio modem and satellite) Page 4 of 28 Terminal Deployment As of December 31, 2008, the Company had deployed a total of 1,600 on-line lottery terminals in the covered VisMin regions. Philippine Lottery Sector The Philippine lottery sector is regulated by the PCSO, a government-owned and controlled corporation. PCSO was created primarily to raise funds for health and charity programs, generate funds for the government, and regulate gambling and games of chance in order to protect certain sectors of society, especially the youth. It is estimated that the gaming market in the Philippines is worth over P100 billion per year, and illegal gaming accounts for half of the country’s gaming industry revenues. Government-authorized Lotteries Although there are many types of lottery games worldwide, government-authorized lotteries generally can be categorized into three principal groups: instant ticket, on-line and traditional draw-type lotteries. An instant ticket lottery is typically played by removing a coating from a preprinted ticket to determine whether it is a winner. On-line lotteries are based on a random selection of a series of numbers. On-line lottery prizes are generally based on the number of winners in which lottery terminals in retail outlets are continuously connected to a central computer system. On-line lottery systems may also be used to validate instant tickets to confirm large prize levels and prevent duplicate payments. Internationally, the older form of traditional draw-type lottery games, in which players purchase tickets which are manually processed for a future drawing for prizes on a fixed amount is a popular form of play. In addition, lotteries may offer Keno, video lottery, sports and other lottery games. On-line Lottery For over 60 years, since the inception of PCSO, the traditional Sweepstakes had been the lone source of funds for the PCSO. In 1995, the PCSO launched the very first on-line lottery, better known as the lotto, in the Philippines. This innovation brought a new dimension of fun and excitement for the betting public. The Company bids out the use of its terminals to prospective investors who, upon approval and appointment by the PCSO, become its agents with regard to the conduct of lottery and digit games. The PCSO currently holds three (3) 6-pick number games, the 6/42 Lotto, 6/45 Mega Lotto, and the 6/49 Super Lotto, and also conducts four (4) digit games, 6-digit (6D), 4-digit (4D), 3-digit (Suertres Lotto), and 2-digit (EZ2). Modifications and enhancements of existing games and/or the introduction of new games are directed by the PCSO. Market Segmentation Due to the manner by which the Philippine gaming market is segmented, the on-line lottery system providers associated with PCSO do not directly compete with each other. On-line lottery operations in the country are segmented as Luzon operations and VisMin operations. While the Company is the on-line lottery system provider in the VisMin regions, Prime Gaming Management Corporation (PGMC) is the system provider in the Luzon regions. Although Page 5 of 28 approximately 75 per cent of the lottery fund is being contributed by PCSO’s Luzon operations, its growth for the past three (3) years has been driven by the 23 per cent average growth of its VisMin operations. Lottery operations in Luzon, whose largest market is in the National Capital Region, generate thrice as much as that of VisMin mainly due to the disparity in the average disposable income that is earned by the residents of the two (2) segments. Of the eight (8) games held by the PCSO, all games are currently being played in Luzon; seven (7) games are being played in VisMin. The 6-digit game is held by the PCSO only in Luzon. On-line Lottery Operations and Products The sales generated by PCSO, and, in turn, by the Company, highly depend on the average sales generated by the different on-line games and the number of terminals deployed by the Company. As mentioned, the Company had already deployed a total of 1,600 on-line terminals as of December 31, 2008. The table below shows the minimum jackpot, or MGA, and the draw frequencies of the different on-line games played in VisMin. Games 6/42 Lotto ……….. 6/45 Mega Lotto … 6/49 Super Lotto … 5/55 + 1/10 Power Lotto 4D ……………….. Suertres Lotto …... EZ2 ……………… Minimum Jackpot / Minimum Guaranteed Amount Draw Frequencies Php 3,000,000.00 2x a week - Tuesdays and Saturdays Php 4,500,000.00 3x a week - Mondays, Wednesdays, and Fridays Php 16,000,000.00 3x a week – Tuesdays, Thursdays, and Sundays Php 50,000,000.00 Php10,000.00 Php 4,500.00 Php 4,000.00 1x a week-Saturdays 3x a week - Mondays, Wednesdays, and Fridays Thrice daily Daily In support of PCSO’s operations and in order to continuously innovate the on-line lottery sector and bring fun and excitement to the betting public, the Company spent a total of P 392.72 million from 2006 to 2008 for its development activities broken down as follows: Development Activities Revenues % of Revenues 2008 138.20 809.6 17.1% 2007 130.35 511.5 25.5% 2006 124.17 413.60 30.0% Market Penetration The area covered by the Company’s ELA with the PCSO encompasses 72 cities and 841 municipalities in the VisMin regions, including the provinces of Masbate (assigned to Region 7), Romblon (assigned to Region 6) and Palawan. As of the end of 2008, the Company’s total terminal deployment covered 67 cities and 461 municipalities. Page 6 of 28 Competition The Company does not expect to face any competition, at least until 2013, when its ELA with the PCSO expires. However management is aware of the prevalence of illegal gambling similar to lotto particularly in interior towns and remote areas. In spite of this, improved sales of lotto under PCSO have exhibited growth due to better payouts under a more transparent system. Organization and Manpower As of December 31, 2008, the Company had a total of 88 employees. While Loto Pacific Leisure Corporation and its subsidiary Lucky Circle Corporation had a total headcount (including contractual personnel) of 216 as of December 31, 2008. In view of the planned expansion in the deployment of terminals and more aggressive distribution of instant scratch tickets, at least 25 staff members will be added to the manpower complement. None of the employees of the Company have organized themselves into any labor union. The Company believes that it has maintained amicable relationships with the rank and file and does not anticipate any labor-management issues to arise in the near term. The Company believes that its relationship with its employees have been consistently good and productive. The Company has a stock option plan as part of its remuneration to all its directors and key employees which was approved by the Board of Directors on December 12, 2006. Risks Some of the risks that the Company and its subsidiary may be exposed to are the following: 1. General Risks The Company experienced some opposition from Local Government Unit (“LGU”) officials in certain VisMin areas during its introductory phase. Future opposition from government officials in certain areas is difficult to predict. Any opposition may hinder or slowdown the opening of other untapped areas in VisMin into Lotto. Any incidence of, or a perception of political resistance may adversely affect the Company’s business and financial growth. 2. Risks Relating to the Equipment Lease Agreement with Philippine Charity Sweepstakes Office The Company entered into an ELA with the PCSO for its VisMin operations. The ELA provides for the lease of, among others, the central computer, communication equipment including its accessories, terminals and draw equipment for a period of eight (8) years commencing on the date of commercial operations by PCSO. The MRA was also entered into by the Company and the PCSO whereby the Company provides maintenance and repair services on the equipment leased by PCSO. Equipment rental and maintenance and repair charges billed to PCSO are fixed at a pre-agreed fee based on a certain percentage, currently at 10 per cent, of the gross amount of ticket sales from all on-line lottery operations in the VisMin territory, which for the periods ending December 31, 2008, 2007, and 2006 amounted P 652.3 million, P 479.6 million, and P 413.6 million, respectively. Page 7 of 28 Any subsequent amendments to the Company’s ELA with PCSO may affect the Company’s future results of operations. More importantly, the term of the Company’s ELA with PCSO shall terminate by the year 2013. In the event that the ELA’s term is not extended, the Company will stop generating revenues from PCSO’s on-line lottery operations. 3. Risks Relating to the Company and its Subsidiary a. Dependence on Suppliers The Company’s lottery operations are anchored on a two-system network. The Company has existing contracts, each distinct and entered into separately, with two global leaders in the lottery industry, namely Scientific Games and Intralot, for the supply of computer supported lottery on-line gaming systems. In the event that the contracts, whether collectively or individually, are terminated or suspended, operations and business of the Company may be impaired. b. Business Interruption Risk The operations of the Company and its subsidiary are dependent on the reliability of its system and the communications infrastructure needed to run it. Any breakdown or failure in the system provided by its suppliers, failure in the communication infrastructure may negatively affect the Company’s financial performance. However, this risk of business interruption is unlikely due to the double redundancy offered by the two suppliers 4. Management of Risks Aside from the discussions above, the Company in general, will mitigate the risks above through the implementation of its Plans and Prospects. Item 2. Properties The Parent Company’s operations are substantially conducted in its head office in Pasig City and its business/data center in Cebu. The major assets of the Company are lottery equipment under finance lease which consist mainly of lottery terminals, data center equipment, software and operating systems. It is planned that the present lottery terminals of 1,600 will be increased by at least 200 at year-end 2009. There are no real properties owned and there are no plans to acquire them in the next twelve (12) months. The Company leases the premises for the offices in Manila and Cebu and the warehouse in Mabolo, Cebu. These aforementioned properties are not mortgaged nor are there any liens and encumbrances that limit ownership or usage of the same. The leased property for offices and business center is approximately 700 sq.m. and the warehouse is about 360 sq.m. Lease terms for certain office spaces are for a period of one to five years. All lease agreements have provisions for renewal subject to terms and conditions mutually agreed Page 8 of 28 upon by all parties. The lease agreements provide for minimum rental commitment with annual rental escalation rate of 5 per cent. Rent expense charged to operation amounted to P 2.8 million in 2008 and P3.3 million in 2007. The equipment provided by the Company to PCSO for its lottery operations are described under the “Business” section. The contracts for the supply of online lottery system entered into by the Company with Scientific Games and Intralot contain a lease which is accounted for as finance lease. These are included as part of lottery equipment under “Property and Equipment” account in the balance sheets. The details are as follows: Property and equipment under finance lease Less accumulated depreciation TOTAL Item 3. 2008 2007 P 383,357,899 129,405,650 P 253,952,249 P 356,675,393 75,991,428 P280,683,965 Legal Proceedings There are no legal proceedings, material or otherwise, pending or threatened against the Company or its subsidiaries, or in which the property and/or equipment of the Company or its subsidiaries is the subject thereof, that could potentially affect their operations and financial capabilities. Item 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the period covered by this report. PART II - OPERATIONAL FINANCIAL INFORMATION Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters Market Information The Company became a listed company with the listing of its shares on April 12, 2007. As of December 31, 2006, the Company had an authorized capital stock of 500,000,000 Common Shares, each with a par value of P1.00, of which 125,250,000 Common Shares have been issued and outstanding. On February 9, 2007 the Company issued an additional 54,000,000 shares from its authorized capital stock thus increasing the issued and outstanding shares to 179,250,000. On March 27, 2007, the Company offered its shares for sale to the public through an initial public Page 9 of 28 offering (IPO) made a primary offer of 11,800,000 common shares and a secondary offer of 28,000,000 common shares. Prior to the Offer, there has been no public trading market for the Company’s Common Shares. On November 19, 2007, the SEC approved the issuance of 8,048,000 common shares from the Company’s unissued authorized capital stock resulting from the valuation of the deposits for future subscription as consideration for the issuance of shares, at the total subscription price of P124,744,000. On May 19, 2008, grantees of the stock options exercised 617,000 shares of the Company’s stock at P8.88 per share. On July 11, 2008, the BOD authorized the Parent Company to buy back up to 2,000,000 shares from the public as a means of preserving the value of the Company’s shares and maintaining investor confidence and on another board meeting on October 14, 2008 approved to extend its share buy back program of 10% of the Company’s outstanding capital stock. As of December 31, 2008, the Company has acquired and paid 4,414,000 shares of capital stock. There is no provision in the Company’s charter or by-laws that would delay, deter, or prevent a change in control of the Company. Stock Prices 2008 High Low First Quarter Second Quarter Third Quarter Fourth Quarter 10.75 10.50 9.60 9.30 8.90 7.80 7.30 7.20 As of December 31, 2008, POSC’s market capitalization amounted to P 1,497,862,500 based on the closing price of P 7.50 per share. Likewise, POSC’s market capitalization as of March 31, 2009 amounted to P 1,817,406,500 based on the closing price of P 9.10 per share. Security Holders Pacific Online Systems Corporation had 59 shareholders as of December 31, 2008. Common shares outstanding as of December 31, 2008 totaled 199,715,000. The top 20 stockholders as of December 31, 2008, with their corresponding shareholdings and percentage thereof to total shares outstanding, are: Name No. of Shares Held % to Total 1 PCD NOMINEE CORPORATION-FILIPINO 73,959,500 37.03 2 ABACUS CONSOLIDATED RESOURCES & HOLDING 36,295,522 18.17 3 PACIFIC AUTOMATED SYSTEMS CORPORATION 26,659,407 13.35 4 BELLE CORPORATION 24,608,761 12.32 5 SUBCO TECHNOLOGY, INC. 17,733,610 8.88 6 OCIER, WILLY N. 15,868,900 7.95 Page 10 of 28 7 8 9 10 11 12 13 14 15 16 17 18 19 20 PCD NOMINEE CORPORATION NON-FILIPINO SY, HANS TAN WS FAMILY FOUNDATION, INC. KILAYKO, GREGORIO U. OCIER, MISCHEL GABRIELLE E.Y DE LEON, MANUEL, A. BENITEZ, ALFREDO B. MEDALLA, TARCISIO M. ZARRAGA, CLARITA T. INCIONG, RHEDERICK B TAN, A. BAYANI K. CHAN, CARMELITA NACORDA, CLODOVEO G. DAVID, LAMBERTO V. 3,456,600 400,000 100,000 100,000 70,000 50,100 34,100 34,100 34,100 34,000 34,000 34,000 25,000 25,000 1.73 0.20 0.05 0.05 0.035 0.025 0.017 0.017 0.017 0.017 0.017 0.017 0.012 0.012 Recent Sale of Unregistered Securities Other than the issuance of a total 54,000,000 new shares out of its unissued and authorized capital stock, the Company has not issued or sold new shares within the past three (3) years which were not registered pursuant to the requirements of the SRC. The foregoing issuance of 54,000,000 new shares was made to less than twenty (20) persons or entities, hence, exempt from the SRC registration requirements pursuant to Section 10.1 (k). The Commission’s confirmation of such exempt status was not sought for the purpose. The shares were issued at the par value of One Peso (P1.00) per share and were paid for in cash. No underwriter was engaged in connection with the foregoing share issuance. Voting Rights At each meeting of the shareholders, every stockholder entitled to vote on a particular question or matter involved shall be entitled to one vote for each share of stock standing in his name in the books of the Company at the time of closing of the transfer books for such meeting. Dividend Rights of Common Shares The Company’s board of directors is authorized to declare cash, property, or stock dividends or a combination thereof. A cash dividend declaration requires the approval of the Board and no shareholder approval is necessary. A stock dividend declaration requires the approval of the Board and shareholders representing at least two-thirds of the Company’s outstanding capital stock. Holders of outstanding shares on a dividend record date for such shares will be entitled to the full dividend declared without regard to any subsequent transfer of shares. Other than statutory limitations, there are no restrictions that limit the Company from paying dividends on common equity. Page 11 of 28 Appraisal Rights As provided for by law, any stockholder shall have a right to dissent and demand payment of the fair value of his shares in the following instances: 1. In case any amendment of the articles of incorporation has the effect of changing or restricting the rights of any stockholders or class of shares, or of authorizing preferences in any respect superior to those of outstanding shares of any class, or of extending or shortening the term of corporate existence; 2. In case of sale, lease, exchange, transfer, mortgage, pledge or other disposition of all or substantially all of the corporate property and assets as provided in the Corporation Code of the Philippines and; 3. In case of merger or consolidation. Item 6. Management Discussion and Analysis of Operating Performance and Financial Condition Results of Operations and Financial Condition For the year ended and as of December 31, 2008 compared to the year ended and as of December 31, 2007. The Company posted significant growth in its operating revenues in 2008 compared to the previous year. From 2007 level of P511.5 million, it realized a 58 percent growth in revenues, pushing revenues to P809.6 million in 2008 mainly due to record high PCSO sales from lottery operations, increased terminal roll-out, aggressive distribution of instant scratch tickets, and wider reach of retail operations by the Company’s subsidiaries. As a result of this, operating income before other income and charges grew by 42 percent from P 200.8 million in 2007 to P 285.6 million in 2008. Total operating expenses, including depreciation and amortization increased by P212.0 million or 74 per cent from P285.4 million in 2007 to P497.4 million in 2008. This variance was principally due to increases in various operating expenses, as follows: Depreciation and amortization increased by P20.1 million or 36 percent from P55.5 million in 2007 to P75.6 million in 2008, because of additional depreciation charges of assets under finance lease as a result of the increase in terminals deployed from 1,401 terminals at year-end 2007 to 1,600 terminals at year-end 2008. Personnel costs increased from P33.1 million in 2007 to P 71.5 million in 2008 or a growth of 116 percent or P 38.4 million due to salary increases given and after consolidating the people Page 12 of 28 costs of subsidiaries which were acquired by the Company in 2007, and the expansion of the instant ticket division due to the growth of ticket sales and distribution. Travel and accommodation increased by P 50.7 million or 336 percent from P 15.1 million in 2007 to P 65.8 million in 2008 principally due to higher traveling expenses related to aggressive terminal roll-out; instant scratch tickets product launch, development and distribution; and lotto site expansion and the growth of Keno operations. Communication costs of P 2.3 million or 5.6 percent increased from P 40.5 million in 2007 to P 42.8 million in 2008. This is attributed to the increase in the number of communication links which is directly proportional to surge in terminal deployment for Lotto and Keno.. Increase in management fees by P15.1 million or 59 per cent from P25.6 million in 2007 to P40.7 million in 2008 was due to the Company’s improvement in financial performance. Management fees are based on the Company’s earnings before tax. Rent and utilities increased by P 16.9 million or 144 percent from P11.7 million in 2007 to P28.6 million in 2008, due to escalation of rental rates accompanied by higher rates of utilities in the offices. Rental costs for retail lotto outlets in various locations incurred by the Company’s subsidiaries, attendant to the opening of new sites, substantially accounted for the increase. Software and license fees are based on sales, thus it increased by P16.5 million or 717 percent from P2.3 million in 2007 to P18.8 million in 2008 which was accrued to the suppliers - SGI and Intralot. Operating supplies increased by P 14.5 million or 453 percent from P 3.2 million in 2007 to P 17.7 million in 2008 due to rise in spare parts consumption after the lapse of warranty period on some installed terminals. Professional fees increased by P 21.9 million or 664 percent from P 3.3 million in 2007 to P25.2 million in 2008 due to the resolution of some legal issues. Increase in taxes and licenses of P 5.9 million or 104 percent from P5.6 million in 2007 to P11.4 million in 2008 was due to higher business taxes paid because of higher gross revenues. Repairs and maintenance expenses increased marginally by P 0.48 million or 4.6 percent from P10.6 million in 2007 to P11.0 million in 2008 due to increase in various maintenance costs and outside services. Representation expenses such as entertainment amusement, recreation and other expenses increased by P4.8 million or 94 percent from P5.1 million in 2007 to P9.9 million in 2008 due to marketing efforts employed. “Others” account increased by P 14.8 million or 59 percent from P25.0 million in 2007 to P39.8 million in 2008 due mainly to wider promotional campaigns for the Instant Scratch tickets. Consultancy fees decreased by P10.4 million or 21 percent from P48.9 million in 2007 to P 38.5 million in 2008 due to the termination of some consultancy contracts held by the Company. Page 13 of 28 The Company equitized losses of P 5.9 million and P 9.2 million, 2007 and 2006 respectively, because of the losses incurred by Total Gaming Technologies, Inc. (TGTI) where the Company had an indirect interest of 40 per cent through their subsidiary, Innovative Solutions Consultancy Group Corp. (Innovative). In April 2008, the existing Company’s interest in Innovative increased by 37.38 percent from 50 percent in 2007 to 87.38 percent in 2008. Indirect ownership in TGTI also increased from 40 percent to 69.9 percent. From the date of acquisition to December 31, 2008, Innovative and TGTI reduced the net income of the Group by P 9.3 million. After considering the foregoing other items, which were deducted from the Company’s operating income, this resulted in a 3.2 per cent marginal rise in net income from P135.0 million in 2007 to P 139.4 million in 2008. Total assets as of December 31, 2008 of P779.8 million increased by P43.3 million or 6 per cent growth compared to P736.5 million as of December 31, 2007. The trade and other receivables are principally receivables from PCSO representing 10 per cent ELA/MRA share of the Company. The increase of 73 per cent or P49.1 million from P67.7 million in 2007 to P116.8 million in 2008 was due to the increase in sales. Total current liabilities increased by P66.4 million from P 109.7 million in 2007 to P 176.1 million in 2008 mainly due to higher trade payables, which consist of payables to PCSO for unremitted cash receipts from the sale of lotto tickets and payable to suppliers of sweepstakes and other tickets; higher income tax payable; and obligations under finance lease. Cash and cash equivalents as of December 31, 2008 decreased to P103.4 million from P151.4 million as of December 31, 2007 or a decrease of P48.0 million. The principal reasons for the decrease were payment of cash dividends of P 99.4 million and acquisition of treasury shares amounting to P 37.1 million. Summarized below are relevant measures used in analyzing the Company’s result of operations. Return on Stockholders’ Equity ……………………. Return on Assets ……………………………………. Earnings per Share …………………………………. Revenues Growth …………………………… Net Profit Margin …………………………………… 2008 34.8% 17.9% 0.71 58.3% 17.2% 2007 33.98% 18.28% 0.73 23.7% 26.3% Due to its consistent profitability over recent years, the Company’s debt to equity ratio still maintained at a healthy level of 0.95 from 0.86. The Company’s working capital efficiency, measured by current ratio at 1.86 from 2.93. The Company and subsidiaries: a) Have no known trends or any demands, commitments, events or uncertainties that will result in or that are likely to result in the liquidity increasing or decreasing in any material way; b) Have no events that will trigger direct or contingent financial obligation that is material to the company, including any default or acceleration of an obligation; Page 14 of 28 c) Have no material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships with unconsolidated entities or other persons created during the reporting period; and d) Have not breached any loans, leases or other indebtedness or financing agreement. Plans and Prospects As of December 31, 2008, the Company has deployed a total of 1,600 on-line lottery terminals. With the approval of the PCSO and as provided by the Contracts held with Scientific Games and Intralot, the Company targets to roll out 1,800 terminals by year-end 2009 by way of a finance lease. In order to realize this terminal roll-out, the Company plans to penetrate into identified untapped areas. The PCSO also plans to increase the draw frequency of lotto and digit games. Through its subsidiaries, Loto Pacific Leisure Corporation and Lucky Circle Corporation, the Company targets to have about 120 operating retail outlets within the next 12 to 18 months from 68 outlets as of December 31, 2008. These outlets, selling exclusively PCSO products are strategically located in SM Malls and other large malls, nationwide. With the variety of product lines being offered by PCSO, it is envisioned that this network of retail outlets will be able to provide professional excellent service to customers. The PCSO instant scratch ticket project ushered the entry of the Company into instant games in mid 2007. The successful launch of their first products, the “Triple Cash” and “Money Bags” tickets opened the door to provide customers with another PCSO product, thereby not limiting the Company’s role to lotto alone. In November 2007, the Company entered into a new Memorandum of Agreement (MOA) with PCSO to undertake the printing, distribution and sale of 20 million tickets “Lucky 8, Payday, Fast Cash and Diamond Dash Promo” in the amount of P400 million. In June 2008, the PCSO’s BOD authorized the amendment of the MOA signed in November 2007 to increase the number of scratch tickets from the initial 20 million tickets to 40 million tickets. The additional 20 million tickets dubbed as: “Mega Money, Red Hot 7, Gold Rush and Double Dollar” all in the amount of P400 million. With the new tickets being offered, the Company is building up a marketing network that would readily provide a distribution system to reach PCSO customers. Item 7. Financial Statements The audited Financial Statements and Supplementary Schedules as of and for the year ended December 31, 2008 listed in the accompanying index to Financial Statements and Supplementary Schedules are filed as part of this Form 17-A. Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure SGV & Co. audited the Company’s balance sheets as at December 31, 2008, and the statements of income, statements of changes in stockholders’ equity and statements of cash flows for each of the three years in the period ended December 31, 2008, 2007 and 2006 and a summary of significant accounting policies and other explanatory notes. SGV & Co.’s responsibility is to Page 15 of 28 express an opinion on these financial statements based on their audit. The audits were conducted in accordance with Philippine Standards on Auditing. The Company’s Board of Directors in the annual shareholders’ meeting on June 25, 2008 recommended, and the shareholders approved, the reappointment of SGV & Co. as the Company’s independent public accountant for the fiscal year ending December 31, 2008. The previous SGV & Co. audit partner of the Company was Mr. Jose Joel M. Sebastian, on engagement for less than 5 years and handled audit of calendar years ending December 31, 2006 and December 31, 2005. Belle Corporation, one of the major stockholders of the Company, recommended that their SGV & Co. audit partner, Mr. Juanito A. Fullecido, be likewise requested to handle the Company’s external audit. The Company adopted the recommendation of Belle Corp. In the Company’s two (2) most recent fiscal years, there has neither been a change in nor disagreement with its auditor on accounting and financial disclosures. The aggregate fees billed for each of the last three (3) fiscal years for professional services rendered by the external auditor are as follows: Audit fee Tax services Other fees Total 2008 660,000.00 2007 600,000.00 2006 550,000.00 n/a 660,000.00 n/a 600,000.00 n/a 550,000.00 PART III - CONTROL AND COMPENSATION INFORMATION Item 9. Directors and Executive Officers of the Registrant Directors and Senior Management The following sets forth certain information as to the Directors and executive officers of the Company: Name Willy N. Ocier Manuel A. de Leon Alfredo B. Benitez Manuel A. Gana Clarita T. Zarraga Tarcisio M. Medalla Leonardo S. Gayao Jerry C. Tiu Position with the Company Chairman / President* Vice Chairman – EVP* Director* Director Director Director Director Independent Director Page 16 of 28 Roger S. Go Clodoveo G. Nacorda Lamberto V. David Valentino L. Kintanar Romeo J. Roque, Jr. A. Bayani K. Tan Independent Director SVP – Corporate Affairs & Marketing Chief Financial Officer and VP – Finance and Administration VP – Computer Operations Senior Manager-Technical Services Senior Manager – Communications Corporate Secretary Stanley L. Tan Assistant Corporate Secretary Rhederick B. Inciong * Members of the Executive Committee Board of Directors The present members of the Board of Directors (“BOD”) were elected during the annual stockholders’ meeting held on June 25, 2008. The term of the current members of the BOD shall be until the next stockholders’ meeting in June 2009. The following are the incumbent members of the Board of Directors (“BOD”) of the Company: Willy N. Ocier, Filipino, 52, is the Chairman and President of the Company and a director since July 29, 1999. He also serves as Co-Vice Chairman of Belle Corporation and Highlands Prime, Inc.; as Chairman of Tagaytay Midlands Golf Club, Inc., APC Group, Inc., and Sinophil Corporation; as Vice Chairman of Tagaytay Highlands International Golf Club, Inc.; and as a Director of iVantage Corporation. He was also previously affiliated with Eastern Securities Development Corporation being its past President and Chief Operations Officer. Manuel A. de Leon, Filipino, 77, is the Vice Chairman and Executive Vice President of the Company since August 25, 2000. He was the former Chairman, and is currently a Director, of listed firm Abacus Consolidated Resources and Holdings, Inc. He is also presently a Director of the Philippine Regional Investment Development, Corp., Asean Publishers, Inc., and Asean Integrated Management, Inc. He also served as Director of the Manila Banking Corporation. He likewise served as the Advertising and Marketing Director of the Manila Chronicle Newspaper from 1968 to 1969, as Advertising and Marketing Manager at the Philippine Refining Company from 1964 to 1968 and was assigned to work in Spain and the United Kingdom for a year during that term, and as Account Group Head at J. Walter Thompson (Phil.) Inc. from 1960 to 1964. Alfredo B. Benitez, Filipino, 42, is a Director of the Company since December 10, 2001. He is also currently the President of Sinophil Corporation, Leisure and Resorts World Corporation, AB Leisure Exponent Inc., AB Gaming Leisure Specialist, Inc., ABLE Holdings Inc., First Cagayan Leisure and Resorts Corporation, Binondo Leisure Resources, Inc. and, Royal Highland Leisure and Resorts Corporation. He is currently the Chairman of Zoraymee Holdings Inc and a Director of Mango Orchard Resources & Development and Manila Building Loan Association. He graduated from St. Mary’s College, Williamsburg, Virginia with a degree in B.S. Mathematics in 1988. Manuel A. Gana, Filipino, 51, is a Director of the Company since December 10, 2001. He also serves as Senior Vice President for Finance and Chief Financial Officer of Belle Corporation and Page 17 of 28 Sinophil Corporation. He joined Belle Corporation in 1997 as Vice President for Corporate Development and Special Projects, during which time he was also assigned as the Vice PresidentFinance and Chief Financial Officer for a Sinophil subsidiary, MagiNet Corporation. He is also a Director of APC Group, Inc. and was previously a Director of Investment Banking at Nesbitt Burns Securities Incorporated in New York. He also previously worked for Bank of Montreal and Merrill Lynch Capital Markets (both in New York), and for Procter and Gamble Philippine Manufacturing Corp. Mr. Gana holds a Master of Business Administration degree from the Wharton School of the University of Pennsylvania. He is a Certified Public Accountant. Clarita T. Zarraga, Filipino, 68, is a Director of the Company since May 15, 1996. She is also currently the President of listed firm Abacus Consolidated Resources and Holdings, Inc. She also serves as director and Treasurer of Philippine Regional Investment Development Corp. and director of Blue Stock Development Farms, Inc., Rural Bank of Batangas, Inc., Batangas Plaza, Inc., Montemayor Aggregates and Mining Corporation and Alpha Asia Hotels and Resorts, Inc. She is a Certified Public Accountant and a licensed real estate broker. Tarcisio M. Medalla, Filipino, 60, is a Director of the Company since December 10, 2001. He is currently the Chairman and President of listed firm Paxys, Inc. (formerly Fil-Hispano Holdings Corp.) and the Chairman of the Board of Advanced Contract Solutions, Inc. He is concurrently a director of NGL Pacific Limited, a privately-held investment company with an RHQ in Manila and affiliated with ACSH Ltd. He has been connected with NGL since 1983. He graduated with the BSC degree, major in Accounting, from De La Salle University. He attended the Advanced Management Program (AMP) at the Harvard Business School. He is a Certified Public Accountant. Leonardo Gayao, Filipino, 62, is a Director of the company since February 21, 2007. He is also the President of the Philippine Regional Investment Development Corporation and Omnicor Industrial Estate & Realty Center, Inc. and Legal Counsel/Director/Vice President of Abacus Consolidated Resources & Holdings, Inc., Director/Vice President of Abacus Global Technovisons, Inc., and other Directorship in Blue Stock Development Farms, Inc., Batangan Plaza, Inc., Alpha Asia Hotels & Resorts, Inc. and Rural Bank of Batangas. He graduated with a degree of Bachelor of Laws in San Beda College , 1973. Independent Director Pursuant to the requirements of Section 38 of the SRC, the Company’s Board of Directors and stockholders approved the amendment of the Company’s By-Laws adopting the requirement on the nomination and election of independent directors. In line with this, the Board of Directors has elected Messrs. Jerry C. Tiu and Roger Go as the Company’s independent directors. Jerry C. Tiu, Filipino, 52, is an independent director of the Company since February 21, 2007. He is the Director and the President of Tagaytay Highlands Community Condominium Association, Inc., Tagaytay Midlands Community Homeowners’ Association, Inc., and Greenlands Community Homeowners’ Association, Inc. He is likewise the President of reporting companies such as: Tagaytay Highlands International Golf club, Inc., The Country Club at Tagaytay Highlands, Inc., Tagaytay Midlands Golf Club, Inc., The Spa & Lodge at Tagaytay Highlands, Inc. He is also the Chairman of Mega Magazine Publishing, Inc. and a former Director of the Manila Polo Club. He holds a Bachelor of Science degree in Commerce (Marketing) from the University of British Columbia.. Page 18 of 28 Roger S. Go, Filipino, 53, is an independent director of the Company since April 11, 2007. He is also the President and General Manager of London Biscuit Company, Inc. Executive Officers Clodoveo G. Nacorda, Filipino, 58, is Senior Vice President for Corporate Affairs and Marketing of the Company. He joined the Company in January 1996. He served as Vice President for VisMin Division at Vitarich Corporation from 1994 to 1995, as Vice President for Sales and Marketing-South Philippines at La Tondeña Distillers, Inc. (LTD) from 1991 to 1994, and as an Assistant Vice President of LTD from 1987 to 1991. He also served as Department Manager-General Services Division at San Miguel Corporation from 1983 to 1987. He graduated with the Bachelor of Arts in Economics degree from University of Santo Tomas. He was credited with Master in Business Administration academic units from Letran College of Business. He obtained his Diploma in Urban and Regional Planning from the University of the Philippines and earned his Doctor in Public Administration degree from Cebu Normal University. Rhederick B. Inciong, Filipino, 42, is Chief Financial Officer and Vice President for Finance and Administration of the Company. He is concurrently the Chief Financial Officer of Total Gaming Technologies, Inc. and Lucky Circle Corporation, indirect subsidiaries of the Company. He joined the Company in April 1996. He served as Administrative and Finance Manager for Rentokil (Philippines), Inc. from 1995 to 1996. He also served as Comptroller for Philippine Telephone Directory, Inc. during his employment from 1991 to 1995. He graduated with the degree of Bachelor in Accountancy from Polytechnic University of the Philippines. He holds a Master of Business Administration degree from De La Salle University. He is a Certified Public Accountant. Lamberto V. David, Filipino, 59, is Vice President for Computer Operations of the Company. He joined the Company in February 1997. He was the sole proprietor of Sweet Mannah Marketing distributing consumer products from 1994 to 1996. He served as Division Manager for Information Systems from 1990 to 1993 and as Manager for Computer Operations of Atlas Consolidated Mining and Development Corporation from 1981 to 1989. He graduated with the degree of Bachelor of Science in Electronic Engineering from the University of Santo Tomas. Valentino L. Kintanar, Filipino, 48, is Senior Manager for Technical Services of the Company. He joined the Company in 1996. He served as Technical Services Manager of EMCOR, Inc. He also served as a Systems Engineer of Technics, Philippines from 1983-1987. He also previously worked as Senior Shift Technician of Fairchild Semiconductors, Phil. from 1980-1983.He graduated with Bachelor of Science in Electronics and Communications Engineering at the University of Southern Philippines. Romeo J. Roque, Jr., Filipino, 41, is Senior Manager for the Communications Department of the Company. He joined the Company in February 1996. He served as Product Support Manager for Infonet Solutions, Inc. from 1995 to 1996. He also served as Systems Engineer for ATS Software Pte Ltd in Singapore from 1993 to 1995. He also previously worked for Electroword as Systems Consultant from 1991 to 1993. He graduated with the Bachelor of Science in Computer Engineering degree from University of San Carlos. He was credited with Master in Business Administration academic units from University of the Philippines. A. Bayani K. Tan, Filipino, 53, is the Corporate Secretary of the Company. He is also currently a Director, Corporate Secretary, or both, of the following reporting companies: First Abacus Page 19 of 28 Financial Holdings Corporation, Belle Corporation, Sinophil Corporation, Tagaytay Highlands International Golf Club, Inc., Tagaytay Midlands Golf Club, Inc., The Country Club at Tagaytay Highlands, Inc., The Spa and Lodge at Tagaytay Highlands, Inc., iVantage Corporation, Destiny Financial Plans, Inc., Philequity Funds, Inc., Philequity PSE Index Funds, Inc., Philequity Dollar Income Fund, Inc., Philequity Money Market Fund, Inc. and TKC Steel Corporation. He is the Managing Partner of Tan Venturanza Valdez Law Offices and also a Director, Corporate Secretary, or both of private companies such as Sterling Bank of Asia Inc, Belle Bay City Corporation, Oakridge Properties, Inc., JTKC Equities, Inc., The Discovery Leisure Company, Inc., Goodyear Steel Pipe Corporation, Hella-Phil, Inc., Metro Manila Turf Club, Inc., Monte Oro Resources & Energy Inc., Herway, Inc. and Highlands Gourmet Specialist Corp. Atty. Tan is a member of the Philippine Bar. He holds a Bachelor of Arts Degree from the San Beda College, a Bachelor of Laws Degree from the University of the Philippines College of Law, and a Master of Laws Degree from the New York University School of Law. Stanley L. Tan, Filipino, 38, is the Assistant Corporate Secretary of the Company. He is concurrently the Corporate Secretary of the Electroparts Development Corporation, Shamrock Development Corp., Phil. Asahi Material Corp., and Destiny Financial Plans, Inc. Mr. Tan was formerly Corporate Secretary of SCT Wood Products, Inc., Taiyo Machineries, Inc., , SCT Electro-Component Corp., Tagum Mining and Development Corp., City Cane Corp., Starmakers, Inc., and the Philippine Fireworks Exporters Association, Inc. as well as the President & Director of the Paseo de Magallanes Commercial Center Association, Inc. He is also the Assistant Corporate Secretary of the following reporting companies: Tagaytay Highlands International Golf Club, Inc., The Country Club at Tagaytay Highlands, Inc., Tagaytay Midlands Golf Club, Inc., and the Spa and Lodge at Tagaytay Highlands, Inc. Mr. Tan is a member of Integrated Bar of the Philippines and holds a Bachelor’s Degree in Laws as well as Bachelor of Science’s Degree in Economics from the University of the Philippines. Family Relationships Stanley L. Tan is the nephew of A. Bayani K. Tan Significant Employees The Company is not dependent on the services of any particular employee. It does not have any special arrangements to ensure that any employee will remain with the Company and will not compete upon termination. Stock Option Plan The Company’s Board (“BOD”) approved the proposed Stock Option Plan (“the Plan”) on December 12, 2006. The Company’s Stock Option Plan provides an incentive and mechanism to employees and officers to become stockholders of the Company, as well as to qualified directors, officers and employees, who are already stockholders, to increase their equity in the Company and thereby increase their concern for the Company's well-being. All such full-time and regular employees of the Company, its subsidiaries and affiliates, their officers and directors, and such other qualified persons who may be recommended from time to time by the Executive Committee or the Board to the Committee as qualified, are eligible to participate in the Plan. Shares of stock Page 20 of 28 subject to the Plan amount to five per cent (5%) of the Company’s total outstanding common stock. The purchase price of the shares shall not in any case be less than the Fair Market Value of the Company’s shares at the time of grant, and, in no case, be less than the Offer Price at which the Company’s shares are initially offered for sale to the public. Further, the purchase price shall be subject to adjustment for subsequent stock dividends or splits. The shares covered by any one grant shall be offered for subscription over a period of Three (3) years from and after the effectivity date of each grant that may be determined by the Committee. The Participants may exercise their right to subscribe to shares under the Plan in accordance with the following schedule: • 1/3 of total grant within One (1) year from the effectivity date of each grant • 1/3 of total grant within Two (2) years from the effectivity date of each grant • 1/3 of total grant within Three (3) years from the effectivity date of each grant On February 15, 2008, SEC approved the Company’s application requesting that its proposed issuance on 9,954,900 common shares is exempt from the registration requirements of the Securities Regulation Code. On May 6, 2008, the BOD approved the allocation of 2,174,000 shares to its executives and employees and to the officers of Lucky Circle under the Plan which is exercisable over of a period of three years from May 6, 2008 until May 6, 2011. The purchase price upon exercise of the option was fixed at P8.88 per share. On May 19, 2008, grantees of the stock options exercised 617,000 shares of the Company’s stock at P8.88 per share. Involvement in Certain Legal Proceedings There are no legal proceedings, material or otherwise, pending or threatened against the Company or its subsidiaries, or in which the property and/or equipment of the Company or its subsidiaries is the subject thereof. At present, the Company is not aware of: any bankruptcy petition filed by or against any business of which the incumbent Directors or senior management of the Company was a general partner or executive officer, either at the time of the bankruptcy or within five years prior to that time; any conviction by final judgment in a criminal proceeding, domestic or foreign, pending against any of the incumbent Directors or senior management of the Company; any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction, domestic or foreign, permanently or temporarily enjoining, barring, suspending or otherwise limiting the involvement of any of the incumbent Directors or senior Page 21 of 28 management of the Company in any type of business, securities, commodities or banking activities; and any finding by domestic or foreign court of competent jurisdiction (in civil action), the SEC or comparable foreign body, or a domestic or foreign exchange or electronic marketplace or said regulatory organization, that any of the incumbent Directors or senior management of the Company has violated a securities or commodities law, and the judgment has not been reversed, suspended or vacated. Item 10. Executive Compensation The following table shows the aggregate compensation received by the directors and officers of the Company for calendar years 2007 and 2008, as well as the estimated aggregate compensation for calendar year 2009. Name and Principal Position Year Salary Bonus Other Annual Compensation Willy N. Ocier Chairman & President Manuel A. de Leon Vice Chairman & Executive Vice President Clodoveo G. Nacorda SVP for Corporate Affairs & Marketing Rhederick B. Inciong Treasurer & Chief Financial Officer Total for the Executive Officers as a group Total for the Directors and Executive Officers as a group 1 2009 1 2008 2007 2009 P12,825,805 P11,659,823 P9,655,981 P18,981,734 2008 2007 P17,256,121 P12,272,648 2009 figures are estimates only. Other than those disclosed above, there are no other standard or other arrangements wherein directors of the Company are compensated, or are to be compensated, directly or indirectly, for any services provided as a director. There is no compensatory plan or arrangement, including payments to be received from the Company, with respect to any of its executive officer, which will result from the resignation, retirement or any other termination of any of its executive officer’s employment with the Company and its subsidiaries or from a change-in-control of the Company or in any of its executive officer’s responsibilities, following a change-in-control and the amount involved, including all periodic payments or installments, which exceeds P 2.5 million. Page 22 of 28 Item 11. Security Ownership of Certain Beneficial Owners and Management Security Ownership of Certain Record and Beneficial Owners The following persons or group are known to the Company as directly or indirectly the record or beneficial owners of more than five percent (5%) of the Company’s voting securities as of 31 December 2008: Title of Class Common Common Common Common Common Common Name and Address of Record Owner and Relationship with Issuer Name of Beneficial Owner PCD NOMINEE CORPORATION PCD NOMINEE CORPORATION ABACUS GLOBAL TECHNOVISIONS, INC. 28-I N. Domingo St., New Manila, Quezon City PACIFIC AUTOMATED SYSTEMS CORP. 4/F Centrum II, 150 Valero St. Salcedo Village, Makati City BELLE CORPORATION 28/F East Tower, PSE Centre Exchange Road, Ortigas Center Pasig City SUBCO TECHNOLOGY, INC. 28/F East Tower, PSE Centre Exchange Road, Ortigas Center Pasig City WILLY N. OCIER 28/F East Tower, PSE Centre Exchange Road, Ortigas Center Pasig City ABACUS GLOBAL TECHNOVISIONS, INC. PACIFIC AUTOMATED SYSTEMS CORP. Citizens hip No. of Shares Held % Filipino 73,959,500 37.03 Filipino 36,295,522 18.17 Filipino 26,659,407 13.35 Filipino 24,608,761 12.32 Filipino 17,733,610 8.88 Filipino 15,868,900 7.95 BELLE CORP. SUBCO TECHNOLOGY, INC. WILLY N. OCIER Security Ownership of Directors and Management The following table shows the shares beneficially owned by the directors and executive officers of the Company as of 31 March 2009: Title of Class Common Common Name of Beneficial Owner Willy N. Ocier Manuel A. de Leon Amount and nature of beneficial ownership 15,883,900 Direct 50,100 Direct Citizenship Filipino Filipino Percent of Class 7.95 0.02 Page 23 of 28 Common Common Common Common Common Common Common Alfredo B. Benitez Manuel A. Gana Clarita T. Zarraga Tarcisio M. Medalla Jerry C. Tiu Roger S. Go Leonardo S. Gayao 34,100 100 34,100 34,100 100 1,000 2,100 Direct Direct Direct Direct Direct Direct Direct Filipino Filipino Filipino Filipino Filipino Filipino Filipino 0.02 0.00 0.02 0.02 0.00 0.00 0.00 Common Clodoveo G. Nacorda 25,000 Direct Filipino 0.01 Common Common Common Rhederick B. Inciong Lamberto V. David Carmelita D.L. Chan 34,000 25,000 34,000 Direct Direct Direct Filipino Filipino Filipino 0.02 0.01 0.02 Common A.Bayani K. Tan 34,000 Direct Filipino 0.02 Common Stanley L. Tan 17,000 Direct Filipino 0.00 Common All directors and executive officers as a group Item 12. 16,208,600 8.11 Certain Relationships and Related Transactions The Company has had significant transactions with related parties in the normal course of business. The amounts included in the financial statements with respect to these transactions are as follows: a. PMP Management Services Sdn Bhd (“PMP”), an affiliate of Pacific Automated Systems Corp. (“PASC”) (a 20% shareholder of the Company) provides consultancy support in the operation and development of the leased online lottery equipment and accessories and the provision of maintenance and repair services. PASC provides operational support services to the Company similar to the scope of PMP. Both PMP and PASC are wholly-owned subsidiaries of Tanjong Public Limited Company, an English company. Agreements with PMP and PASC were terminated on March 16, 2006 and April 6, 2006, respectively. b. AB Gaming manages the day-to-day operations of the Company as provided in a MA entered into on June 10, 2002. Under the terms of the MA, the Company shall elect the president of AB Gaming as the President, Chief Executive Officer and Administrative Officer of the Company. The MA shall be effective for five years until June 10, 2007 and shall be automatically renewed for a similar period unless terminated by either party. In March 2004, the Company and AB Gaming amended the MA effective February 15, 2004. Under the amended MA, AB Gaming foregoes its entitlement to have its President designated as President and Chief Executive Officer of the Company although the scope of the services remains unchanged. Total management fees amounted to = P 35.2 million, = P 25.6 million and = P19.2 million in 2008, 2007 and 2006, respectively. Outstanding payable as of December 31, 2008 and Page 24 of 28 2007 amounted to P =3.4 million and = P2.2 million, respectively. c. The Company had noninterest-bearing advances from Belle Group (43% shareholder), Abacus (37% shareholder) and PASC (20% shareholder) totaling = P34.5 million as of December 31, 2005. In 2006, the advances were paid in full. d. The Company granted advances to TGTI which was covered by a Loan Agreement. The Company has indirect interest in TGTI. Under the terms of Loan Agreement, the Company shall provide short-term financial assistance credit of = P25.0 million to TGTI. Any outstanding loan shall be subject to simple interest calculated using the applicable shortterm placement rate with monthly repricing plus add-on rate of 0.50% and payable as soon as the increase in capitalization of TGTI is received or as soon as proper demand is made by the Company’s Board. As of December 31, 2007, total advances granted to TGTI and unpaid interest (included under “Investment and advances” account in the balance sheets) amounted to P =67.4 million. TGTI became an indirect subsidiary through Innovative in April 2008. Prior to obtaining control, the Parent Company accounted for its investment in Innovative using equity method. Given that Innovative is now classified as a subsidiary, the Group now prepares consolidated financial statements to include Innovative in its consolidation and accordingly, the related investments and advances were eliminated. e. In 2006, the Company granted interest-bearing advances to Abacus for working capital purposes. The advances were subject to an annual interest rate of 4.6%. Outstanding advances as of December 31, 2006 amounted to = P5.0 million. In 2007, these advances were fully paid. f. Compensation and benefits of key management personnel of the Company are as follows: 2008 Short-term employee benefits Post-retirement benefits Share-based payment Total = P7.2 0.8 0.9 P =8.9 2007 (in millions) = P6.4 0.6 P =7.0 2006 = P5.7 0.5 P =6.2 PART IV - CORPORATE GOVERNANCE Page 25 of 28 The Company remains focused on insuring the adoption of systems and practices of good corporate governance in enhancing value for its shareholders. In compliance with the initiative of the Securities and Exchange Commission (“SEC”) under Memorandum Circular No. 2, Series of 2002, the Company, upon the approval of its Board on February 21, 2007, submitted its Corporate Governance Manual (“the Manual) to the SEC. Even prior to the submission of its Manual, in a special joint meeting with the Board of Directors held on November 21, 2006, the Company’s stockholders approved the creation of various Board level committees. These committees were comprised of an Executive Committee, a Nomination Committee for selection and evaluation of qualifications of directors and officers, a Compensation and Remuneration Committee to look into an appropriate remuneration system, and an Audit Committee to review financial and accounting matters. A Compliance Officer was also appointed on that date. Members of various committees are expected to serve for a term one (1) year. The Company is not aware of any non-compliance with its Manual of Corporate Governance, by any of its officers or employees. PART V - EXHIBITS AND SCHEDULES Page 26 of 28 Item 13. Exhibits and Reports on SEC Form 17-C a. Exhibits There are no exhibits to be provided/are applicable to the Company. b. Reports on SEC Form 17-C DOCUMENT DATE FILED ITEM NO. MATTER SEC Form 17-C dated October 14, 2008 October 15, 2008 Item 9 (a) (13) / 9 (b)9 Extension of Buy-Back Program and Payment date for Cash Dividend SEC Form 17-C dated August 8, 2008 August 11, 2008 Item 9 (a) (13) / 9 (b) Payment date for Cash Dividend SEC Form 17-C dated June 26, 2008 June 26, 2008 Item 4 Annual Stockholders’ Meeting SEC Form 17-C dated May 7, 2008 May 7, 2008 Item 9 (a) (13) / 9 (b) Cash Dividend SEC Form 17-C dated March 12, 2008 March 14, 2008 Item 9 (a) (12) Postponement of Annual Stockholders’ Meeting SEC Form 17-C dated January 18, 2008 January 18, 2008 Item 9(4) (b) Appointment of Mr. Jerry C. Tiu as head of the Compensation and Remuneration Committee Page 27 of 28 SIGNATURES Pursuantto the requirements of Section17 of the SecuritiesRegulationCodeand Section141of the CorporationCode,this reportis signedon^[ehglflof the issuerby the undersigned,thereuntoduly authorized, in the of Pasigon By: President ChiefFinancialOffi-cer Vice President-Finance & -.-'.2 --="- . BavaniK. Tan rporate Secretary APR2e2!9J" SUBSCRIBEDAND SWORN to before me this affiants exhibiting to me their C_ommunityTax Certificates,as follows: NAME COMMI]NITY TAX CERTIFICATE NO. DATE OF ISSUE 2009, PLACE OF ISSUE Willy N. Ocier zJo44Zll Jarmary 28, 2009 Manila RhederickB. Inciong 13605962 January t2, 2009 Pasig City A. BayaniK. Tan r90L7579 January !2, 2oO9 lhnila -: [lTY.-DEtFtfP noc.No. f Book No. Z- PageNo. l/Y/ Seriesof 2009 ,t6T -,, R0Ltrfo.24 f s pl i s 7 5 4 + 3 *. n* rF " a E - 0 9 \{il*F il{i:qr'0f}!f, " o t f F v h t f ' lf l r n n B t . ' 3 9 'ia*fi Page 28 of 28 PACIFIC ONLINE SYSTEMS CORPORATION AND SUBSIDIARY INDEX TO FINANCIAL STATEMENTS AND SUPPLEMENTARY SCHEDULES Page No. Financial Statements Statement of Management's Responsibility for Financial Statements Report of Independent Public Auditors Balance Sheets as of December 31, 2008 and 2007 Statements of Income for the years ended December 31, 2008 and 2007 Statements of Changes in Stockholders' Equity for the years ended December 31, 2008 and 2007 Statements of Cash Flows for the years ended December 31, 2008 and 2007 Notes to Financial Statements ) See Attached ) FS ) ) ) ) ) ) ) ) Supplementary Schedules Report of Independent Public Auditors on Supplementary Schedules A. B. C. D. E. F. G. H. I. Short-term Cash Investments Amounts Receivable from Director's, Officers, Employees, Related Parties and Principal Stockholders (Other than Associates) Other Long-term Investments and Other Investments Indebtedness to Unconsolidated Subsidiaries and Associates Other Assets Long-term Debt Indebtedness to Affiliates and Related Parties (Long-term Loans from Related Companies) Guarantees of Securities of Other Issuers Capital Stock * SEE ATTACHED SEE ATTACHED SEE ATTACHED SEE ATTACHED SEE ATTACHED SEE ATTACHED * * SEE ATTACHED * These schedules, which are required by Part IV(e) of RSA Rule 48, have been omitted because they are either not required, not applicable or the information required to be presented is included in the Company's consolidated financial statements or the notes to consolidated financial statements. PAtrIFItr ENLINE STATEMENT OF MANAGEMENT'S RESPONSIBILITY FOR THE FINANCIAL STATEMENTS S E C U R I T I EA S N D E X C H A N G EC O M M I S S I O N SECBuilding,EDSA Greenhills City, Metro Manila Mandaluyong for all inlormationard representations The management of PacificOnline SystemsCorporationis responsible for theyearsendedDecember 31,2006,December 31, 2007,ald December containedin the financialstatements 31, 2008. The filancial statementshave beenpreparedin conformitywith PhilippineFinancialReporting Standardsard reflect amountsthat axebasedon the bestestimatesand informedjudgment of managementwith anappropriate consideration to materiality. In this regard,management maintainsa systemof accountingand reportingwhich providesfor the necessary intemal controlsto ensurethat transactionsare properly authorizedand recorded,assetsare safeguardedagainst unauthorizeduse or dispositionand liabilities are recognized.The managementlikewise disclosesto the company'sextemalauditors;(i) all significantdeficienciesin the designor operationof internalcontrolsthat in the could adverselyaffect its ability to record,process,and reportfinancialdata;(ii) materialweaknesses who exercisesignificantroles intemalcontrols;and(iii) any fraudthat involvesmanagement or otheremployees in internalcontrols. beforesuchstatements are approveda.ndsubmittedto The Boardof Directorsreviewsthe financialstatements ofthe company. thestockholders haveauditedthe financial auditorsappointedby the stockholders, SycipGorresVelayo& Co., the independent with auditing of the Companyas of andthe for the periodendedDecember31, 2008 in accordance statements presentation generallyacceptedin the Philippinesandhaveexpressed on the fairness of their opinion upon ofsuch audit in their reDortto stockholde$. oathby the following: C.4/TevAM//,, rNggNG RHEDERTCK RHEDERICK B. B. IN Chairman ofthe BoardandPresident ChiefFinanciallOffictrt' to me their AND SWORNto beforeme this APR Aagffi0$ril 2009affiantsexhibited SUBSCRIBED asfollows: andotheridentificationdocuments, respective CommunityTax Certificates WILLY N. OCIER RHEDERICKB. INC]ONG Date/PlaceIssued CTC No./Passport No./OtherI.D. 23644222 TT0034832/1 1360s962 / / 03-9232025-2'tSS$ z l.28.2009iManila 5.03.2006/Manila CiE 1.12.2009/Pasie wtr ?a\ -- /1 ATIY,0E[Fflt1 D o c . N o --lL . :l Pug"no. -i BookNo. LXX[/ I Sedesof2009 ; i'!''trdi{ffi l"Tf,If Jy-". f ! glalor.0.,_oc F_4 lpj HtJ t re-5r.-{is'_bi fto;tr'-oir'#j !LE fot{.EXprf;E0 {ri oegios 16/F MetrobankPlaza OsmefraBoulevard,CebuCity 6000 Tel.No. 032-255-0721 Fax No. 032-255-0635 sa[l[r PaciticOnlineSystemsCorporation 2201-A.22lFWestTower Centre StockExchange Philippine Ortigascenter,PasigCity,M.M.1605 Tel.No.02-636-5281 FaxNo.02-6361657 Pacific Online Systems Corporation and Subsidiaries Consolidated Financial Statements December 31, 2008 and 2007 and Years Ended December 31, 2008, 2007 and 2006 and Independent Auditors’ Report SyCip Gorres Velayo & Co. SyCip Gorres Velayo & C o. 6760 Ayala Av enue 1226 Makati City Philippines Phone: (632) 891 0307 Fax: (632) 819 0872 www.sgv.com.ph BOA/PRC Reg. No. 0001 SEC Accreditation No. 0012-FR-1 INDEPENDENT AUDITORS’ REPORT The Stockholders and the Board of Directors Pacific Online Systems Corporation We have audited the accompanying financial statements of Pacific Online Systems Corporation and Subsidiaries, which comprise the consolidated balance sheets as at December 31, 2008 and 2007, and the consolidated statements of income, consolidated statements of changes in equity and consolidated statements of cash flows for each of the three years in the period ended December 31, 2008, and a summary of significant accounting policies and other explanatory notes. We did not audit the 2008 and 2007 consolidated financial statements of Loto Pacific Leisure Corp. and subsidiary, a wholly owned subsidiary, and Innovative Solutions Consultancy Group, Corp. and subsidiary, an 87.38% subsidiary effective April 1, 2008 (previously a 50% joint-venture entity). These subsidiaries’ total assets included in the 2008 consolidated financial statements amounted to P =136.7 million (representing 17.52% of the 2008 consolidated assets), while their revenue amounted to P =68.4 million (which increased the 2008 consolidated revenue by 8.99%). The total assets of Loto Pacific Leisure Corp. and subsidiary included in the 2007 consolidated financial statements amounted to P =59.2 million (representing 7.93% of the 2007 consolidated assets), while their revenue amounted to P =13.2 million (which increased the 2007 consolidated revenue by 2.66%). Also in 2007, we did not audit the financial statements of Innovative Solutions Consultancy Group, Corp., a 50% joint-venture entity, the investment of which was reflected in the 2007 consolidated financial statements using the equity method of accounting. The balance of such investment represented 6.40% of the total assets as of December 31, 2007. The subsidiaries’ and the 50% joint-venture entity financial statements were audited by other auditors whose reports thereon have been furnished to us, and our opinion, insofar as it relates to the amounts included for such subsidiaries, is based solely on the reports of the other auditors. Management’s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in accordance with Philippine Financial Reporting Standards. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances. Auditors’ Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with Philippine Standards on Auditing. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement. *SGVMC211961* A member firm of Ernst & Young Global Limited -2An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor’s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained and the reports of other auditors are sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, based on our audits and the reports of the other auditors, the consolidated financial statements present fairly, in all material respects, the financial position of Pacific Online Systems Corporation and Subsidiaries as of December 31, 2008 and 2007 and their financial performance and their cash flows for each of the three years in the period ended December 31, 2008, in accordance with Philippine Financial Reporting Standards. SYCIP GORRES VELAYO & CO. Juanito A. Fullecido Partner CPA Certificate No. 25543 SEC Accreditation No. 0080-AR-1 Tax Identification No. 102-086-897 PTR No. 1566432, January 5, 2009, Makati City April 2, 2009 *SGVMC211961* PACIFIC ONLINE SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31 ASSETS Current Assets Cash and cash equivalents (Notes 10 and 28) Investments held for trading (Notes 11 and 28) Trade and other receivables (Notes 2, 12, 19 and 28) Other current assets - net (Notes 13 and 16) Total Current Assets Noncurrent Assets Investment and advances (Notes 8, 14, 19 and 28) Property and equipment - net (Notes 15, 16 and 24) Deferred tax assets - net (Note 23) Goodwill - net (Note 8) Other noncurrent assets Total Noncurrent Assets LIABILITIES AND EQUITY Current Liabilities Trade and other current liabilities (Notes 16, 19, 24 and 28) Withholding taxes payable Income tax payable Current portion of installment payable (Notes 15, 24 and 28) Current portion of obligations under finance lease (Notes 15, 24 and 28) Total Current Liabilities Noncurrent Liabilities Installment payable - net of current portion (Notes 15, 24 and 28) Obligations under finance lease - net of current portion (Notes 15, 24 and 28) Defined benefit liability (Note 26) Total Noncurrent Liabilities Equity Attributable to Equity Holders of the Parent Capital stock (Notes 17 and 18) Additional paid-in capital (Notes 17 and 18) Treasury shares (Note 17) Retained earnings (Note 17) Minority Interests (Note 8) Total Equity 2008 2007 P =103,424,773 54,810,517 116,796,975 52,569,459 327,601,724 =151,417,401 P 58,213,480 67,667,916 43,763,032 321,061,829 – 399,497,752 3,276,796 39,275,519 10,177,695 452,227,762 P =779,829,486 47,135,294 347,546,171 2,000,616 13,363,484 5,343,393 415,388,958 =736,450,787 P P =71,128,214 5,736,821 32,488,173 4,269,134 =20,609,359 P 3,973,747 26,924,515 2,326,433 62,471,714 176,094,056 55,849,197 109,683,251 2,349,000 – 196,462,736 4,716,198 203,527,934 228,244,156 2,485,398 230,729,554 199,715,000 198,223,654 (37,061,041) 47,797,006 408,674,619 (8,467,123) 400,207,496 P =779,829,486 199,098,000 190,371,690 – 6,568,292 396,037,982 – 396,037,982 =736,450,787 P See accompanying Notes to Consolidated Financial Statements. *SGVMC211961* PACIFIC ONLINE SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31 2007 2008 REVENUE Equipment rentals (Notes 2 and 24) Commission income Instant scratch ticket project with PCSO (net of prizes, share of PCSO and direct expenses) (Note 21) Maintenance and repair fees (Note 2) COSTS AND EXPENSES Operating expenses (Notes 15, 16, 18, 19, 20, 24 and 26) Finance charges (Notes 15 and 24) OTHER INCOME (CHARGES) Mark-to-market gain (loss) on investments held for trading (Note 11) Interest income (Notes 10, 19 and 22) Foreign exchange gain (loss) Gain (loss) on sale of: Property and equipment (Note 15) Investments held for trading Equity in net losses of a joint venture (Note 14) Provisions for: Impairment loss (Note 8) Probable losses (Note 13) Gain on condonation of liability (Notes 16 and 19) Others - net (Note 25) INCOME BEFORE INCOME TAX PROVISION FOR (BENEFIT FROM) INCOME TAX (Note 23) Current Deferred NET INCOME Attributable to: Equity holders of the parent (Note 27) Minority interests Basic/Diluted Earning Per Share Attributable to Equity Holders of the Parent (Note 27) 2006 P =642,598,196 65,239,995 =472,368,287 P 13,210,086 =402,042,400 P – 92,074,582 9,737,152 809,649,925 21,011,172 7,193,426 513,782,971 – 11,591,988 413,634,388 (497,400,296) (26,636,655) (524,036,951) (287,672,265) (25,345,169) (313,017,434) (321,812,304) (20,476,312) (342,288,616) (48,008,254) 3,294,967 388,143 (11,178,317) 5,484,443 (86,997) 2,623,862 3,171,489 1,496,537 1,655,770 – (5,927,929) (36,906,038) 1,131,030 (9,185,674) (142,832) – – 24,255,582 14,059,720 – (2,820,539) 39,156,556 10,562,753 9,229,976 8,928 – – – – – 10,488,887 (33,827,329) 251,785,645 214,825,257 80,575,748 113,639,678 (1,276,180) 112,363,498 79,167,719 1,065,769 80,233,488 24,995,623 5,113,572 30,109,195 P =139,422,147 =134,591,769 P =50,466,553 P P =140,597,374 (1,175,227) P =139,422,147 =134,591,769 P – =134,591,769 P =50,466,553 P – =50,466,553 P =0.73 P =0.40 P P =0.71 See accompanying Notes to Consolidated Financial Statements. *SGVMC211961* PACIFIC ONLINE SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY Additional Paid-in Capital Capital Stock (Notes 17 (Notes 17 and 18 and 18) P =199,098,000 P =190,371,690 Balance at December 31, 2007 Minority interest at date of acquisition of the controlling interest in a joint venture entity (subsidiary) – Additional subscription (Note 17) 617,000 Share-based payment (Note 18) – Cash dividends (Note 17) – Treasury shares acquired – Net income (loss) during the year – Balance at December 31, 2008 P =199,715,000 Balance at December 31, 2006 Subscriptions and conversion of deposit for stock subscriptions before initial public offering (IPO) IPO shares subscriptions Stock issuance costs Net income during the year Balance at December 31, 2007 =125,250,000 P Balance at December 31, 2005 Net income during the year Balance at December 31, 2006 =125,250,000 P – =125,250,000 P 62,048,000 11,800,000 – – =199,098,000 P Deposit for Stock Subscription (Note 17) P =– Treasury Shares (Note 17) P =– Retained Earnings (Deficit) (Note 17) P =6,568,292 – – – – (37,061,041) – (P =37,061,041) – – – (99,368,660) – 140,597,374 P =47,797,006 Minority Interests (Note 8) Total P =– P =396,037,982 – 4,855,960 2,996,004 – – – P =198,223,654 – – – – – – P =– =– P =124,750,000 P =– (P P =128,023,477) =– P =121,976,523 P (124,750,000) – – – =– P – – – – =– P – – – – =– P 54,000,000 104,784,000 (19,314,310) 134,591,769 =396,037,982 P =124,750,000 P – =124,750,000 P =– (P P =178,490,030) – 50,466,553 =– (P P =128,023,477) =– P – =– P =71,509,970 P 50,466,553 =121,976,523 P 116,702,000 92,984,000 (19,314,310) – =190,371,690 P =– P – =– P – – – 134,591,769 =6,568,292 P (7,291,896) (7,291,896) – 5,472,960 – 2,996,004 – (99,368,660) – (37,061,041) (1,175,227) 139,422,147 (P =8,467,123) P =400,207,496 See accompanying Notes to Consolidated Financial Statements. *SGVMC211961* PACIFIC ONLINE SYSTEMS CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS 2008 CASH FLOWS FROM OPERATING ACTIVITIES Income before income tax Adjustments for: Depreciation and amortization (Notes 15, 20 and 21) Unrealized mark-to-market loss (gain) on investments held for trading (Note 11) Finance charges (Notes 15 and 24) Minority interests of acquired subsidiary Interest income (Notes 19 and 22) Share-based compensation (Notes 18 and 20) Dividend income (Note 25) Loss (gain) on or sale of: Property and equipment (Note 15) Investments held for trading Gain on condonation of liability (Notes 16 and 19) Provisions for: Equity in net losses of a joint venture (Note 14) Impairment loss (Note 8) Probable losses (Note 13) Unrealized foreign exchange losses (gain) Operating income before working capital changes Increase in: Trade and other receivables Other current assets Increase (decrease) in: Trade and other current liabilities Withholding taxes payable Defined benefit liability Income tax paid Interest received Net cash provided by operating activities CASH FLOWS FROM INVESTING ACTIVITIES Additions to: Property and equipment (Notes 15 and 24) Investments held for trading (Note 11) Acquisition of a subsidiary, excluding cash (Notes 8 and 10) Increase (decrease) in other noncurrent assets Dividend received Proceeds from sale of: Property and equipment Investments held for trading (Note 11) Notes receivable issued and advances to Total Gaming Technologies, Inc. Net cash used in investing activities Years Ended December 31 2006 2007 P =251,785,645 =214,825,257 P =80,575,748 P 75,634,129 55,489,063 42,788,288 48,008,254 26,636,655 7,291,896 (3,294,967) 2,996,004 (903,100) 11,178,317 25,345,169 – (5,484,443) – (466,268) (2,623,862) 20,476,312 – (3,171,489) – (11,150) (8,928) – – (1,655,770) – – 36,906,038 (1,131,030) 39,156,556 – – – – 408,145,588 5,927,929 142,832 – 58,997 305,361,083 (48,767,870) (7,659,167) (46,158,325) (26,416,527) (2,834,176) (4,775,873) 23,138,741 1,763,074 2,230,800 (108,076,020) 3,387,853 274,162,999 3,187,240 (1,281,497) (3,242,398) (58,227,893) 5,660,878 178,882,561 (92,070,293) 585,579 1,313,364 (19,010,934) 3,105,798 109,788,552 (87,268,223) (44,605,291) (52,986,434) (58,841,397) (10,832,069) (10,380,953) 25,528,184 (3,171,657) 903,100 (17,913,696) (1,995,566) 466,268 8,928 – – (108,604,959) 1,655,770 – (10,814,570) (140,429,625) 9,185,674 – 2,820,539 (1,496,537) 223,475,087 – 21,310 11,150 3,250,880 9,864,565 (27,759,814) (35,824,931) (Forward) *SGVMC211961* -2Years Ended December 31 2007 2006 2008 CASH FLOWS FROM FINANCING ACTIVITIES Payments of: Cash dividends (Note 17) Obligations under finance lease Installment payable Loans Acquisition of treasury shares (Note 17) Interest paid Cash proceeds from issuance of shares of stock (net of issuance costs) Decrease in payable to stockholders Net cash provided by (used in) financing activities NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR CASH AND CASH EQUIVALENTS AT END OF YEAR (Note 10) (P =99,368,660) (53,630,839) (2,326,433) – (37,061,041) (26,636,655) P =– (41,537,761) (1,582,575) – – (25,353,390) P =– (29,891,974) – (825,825) – (18,289,634) 5,472,960 – (213,550,668) 139,469,690 – 70,995,964 – (34,452,122) (83,459,555) (47,992,628) 109,448,900 (9,495,934) 151,417,401 41,968,501 51,464,435 P =103,424,773 =151,417,401 P =41,968,501 P See accompanying Notes to Consolidated Financial Statements. *SGVMC211961* PACIFIC ONLINE SYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. General Information Corporate Information Pacific Online Systems Corporation (POSC or Parent Company) and the following subsidiaries (collectively referred to as “the Group”) are incorporated in the Philippines and registered with the Philippine Securities and Exchange Commission (SEC) on various dates: Subsidiaries Loto Pacific Leisure Corporation (LotoPac) Lucky Circle Corporation (Lucky Circle)* Innovative Solutions Consultancy Group Corp. (Innovative) Total Gaming Technologies, Inc. (TGTI)** ** ** Percentage of Ownership Direct Indirect 100.00 – – 100.00 87.38 – – 69.90 Indirectly owned through LotoPac (see Note 8) Indirectly owned through Innovative (see Note 8) The Parent Company with registered office address at 22nd Floor, West Tower, Philippine Stock Exchange (PSE) Centre, Exchange Road, Ortigas Center, Pasig City, is engaged in the development, design and management of online computer systems, terminals and software for the gaming industry. The Parent Company can also engaged in any lawful arrangement for sharing profits, union of interest, unitization or formal agreement, reciprocal concession, or cooperation, with any corporation, association, partnership, syndicate, entity, person or governmental, municipal or public authority, domestic or foreign. On November 11, 2006, the Parent Company’s Board of Directors (BOD) and stockholders authorized the Parent Company to conduct an IPO of 39,800,000 parent company common shares (the “offer shares”), which consist of 11,800,000 new common shares and 28,000,000 existing common shares owned by the selling shareholders of the Parent Company; and apply for the listing thereof on the PSE. On March 23, 2007, the SEC and PSE approved the Parent Company’s application for public listing and trading of its shares which commenced on April 12, 2007 (see Note 17). On March 16, 2007, LotoPac was incorporated primarily to acquire, establish, own, hold, lease, sell, conduct, operate, and manage amusement, recreational and gaming equipment facilities, and enterprise of every kind and nature, as well as places for exhibitions, recreation, gaming, amusement and leisure of the general public, and to acquire, hold, and operate any and all privileges, rights, franchises and concessions as may be proper, necessary, advantageous, or convenient in the conduct of its business. On August 29, 2007, LotoPac acquired Lucky Circle, an authorized agent of Philippine Charity Sweepstakes Office (PCSO) to operate several online lottery betting stations located at branches of the SM Supermalls nationwide. *SGVMC211961* -2In April 2008, the Parent Company acquired 37.38% ownership of the other venturer in Innovative. Innovative, a holding company whose primary purpose is to provide management counsel for business enterprises engaged in gaming business, has 80% interest in TGTI. TGTI has an Equipment Lease Agreement (ELA) with PCSO for its Online Keno Lottery Project. TGTI provides consultancy service and “Online Keno” equipment and necessary accessories to PCSO through its partnership with Intralot S.A. Integrated Lottery Systems and Services (Intralot). Approval for the Issuance of the Financial Statements The accompanying consolidated financial statements were approved and authorized for issuance by the BOD on April 2, 2009. 2. Agreement with PCSO Parent Company with PCSO ELA. The Parent Company has an ELA with PCSO which provides for the lease to PCSO of, among others, central computer, communications equipment including its accessories, 1,250 terminals, the right to use the application software and manuals for the central computer system and terminals and draw equipment for a period of eight years from April 1, 2005. A maintenance and repair agreement which runs concurrently with the ELA, was also entered into by the Parent Company with PCSO, whereby, the Parent Company will provide maintenance and repair services on the equipment leased by PCSO for a fee. The ELA also provides PCSO an option to purchase the equipment upon the expiration of the lease period for a sum of =25.0 million. P Rental billed to PCSO is based on a certain percentage of gross amount of lotto ticket sales from the operation of all PCSO’s lotto terminals in Visayas-Mindanao (VIS-MIN) to cover for equipment rental, maintenance and repairs fee, and communication and service fee. Total number of terminals installed as of December 31, 2008 and 2007 was 1,600 and 1,401, respectively. Rental income of the Parent Company amounted to P =639.4 million, P =472.4 million and =402.0 million in 2008, 2007 and 2006, respectively. Receivables from PCSO amounted to P =38.0 million and P P =26.4 million as of December 31, 2008 and 2007, respectively (see Note 12). Instant Scratch Ticket Project. On June 13, 2007, the BOD approved the Deed of Assignment entered into by the Parent Company with AB Gaming and Leisure Specialist, Inc. (AB Gaming), the assignor, to assume and undertake the sale of 10 million Instant Scratch Tickets (tickets) “Money Bags and Triple Cash” in the amount of P =200.0 million to be sold for a period of not more than six months at no cost to PCSO. All rights, interest and obligations of AB Gaming under the original Memorandum of Agreement (MOA) dated March 23, 2007 with PCSO were ceded, transferred, or assigned in favor of the Company, which resulted to the assumption of AB Gaming’s obligation amounting to P =39.2 million. On November 19, 2007, the Parent Company entered into another MOA with PCSO to undertake the printing, distribution and sale of 20 million tickets “Lucky 8, Payday, Fast Cash and Diamond Dash Promo” in the amount of P =400.0 million to be sold within six months to one year, and guaranty the sale of all tickets on “good-as-sold basis”, at no cost to PCSO. PCSO’s share is fixed at P =60.0 million payable in 12 equal monthly installments of P =5.0 million. *SGVMC211961* -3On June 11, 2008, the PCSO’s BOD authorized the amendment of the MOA dated November 19, 2007 to increase the number of scratch tickets from the initial 20 million tickets to 40 million tickets. The additional 20 million tickets “Mega Money, Red Hot 7, Gold Rush and Double Dollar” in the amount of P =400.0 million guarantees additional P =60.0 million share for PCSO. Refer to Note 21 for the financial performance. On February 5, 2009, the Parent Company entered a new MOA with PCSO to undertake the printing, distribution and sale of 30 million new batch of tickets comprising of a maximum of 8 game variants to be called the “Diamond Anniversary Series” in the amount of P =600.0 million to be sold within eighteen months, and guaranty the sale of all tickets on “good-as-sold basis,” and again at no cost to PCSO. PCSO’s share is also fixed at P =90.0 million in 18 equal monthly installments of P =5.0 million. Development and Delivery of the Game Software. In 2007, the PCSO’s BOD authorized the Parent Company to develop the game software for Powerlotto. In consideration for this service, an amount of P =9.9 million (net of output value added-tax (VAT)) was received in 2008 (see Note 25). TGTI Equipment Rental with PCSO TGTI has an ELA with PCSO which provides also for the lease of the necessary equipment for the “Online KENO” games. The term of the lease shall be for ten (10) years, commencing on the date of the establishment of at least two hundred (200) KENO outlets and shall mean the actual operation of at least 200 outlets. Rental billed to PCSO is based on certain percentage of the gross amount of the “Online KENO” game or a fixed annual rental of P =40,000 per terminal in commercial operation, whichever is higher, and maybe extended and/or renewed upon the mutual consent of the parties. On July 15, 2008, TGTI and PCSO agreed on certain amendments to the ELA. Under the terms of the amended ELA, TGTI shall provide the services of telecommunications integrator for the Online KENO operations in Luzon and VISMIN areas. In consideration of such services, PCSO shall pay a communication integration service fee based on certain percentage of the gross amount of ticket sales from all “Online KENO” operations. The amended ELA also provides that TGTI shall procure supplies for PCSO’s Online KENO operations in Luzon and VISMIN for a fee based on certain percentage of the gross amount of ticket sales from all “Online KENO” operations computed and payable bi-weekly. Rental income from “Online KENO” game amounted to P =3.2 million in 2008. 3. Basis of Preparation and Statement of Compliance Basis of Preparation The accompanying consolidated financial statements have been prepared on a historical cost basis, except for investments held for trading that have been measured at fair value. The consolidated financial statements are presented in Philippine peso, the Group’s functional and presentation currency, and all values are rounded to the nearest peso, except when otherwise indicated. *SGVMC211961* -4Statement of Compliance The accompanying consolidated financial statements have been prepared in compliance with Philippine Financial Reporting Standards (PFRS), which include Philippine Accounting Standards (PAS) and Philippine Interpretations from International Financial Reporting Interpretations Committee (IFRIC) interpretations issued by the Financial Reporting Standards Council. Basis of Consolidation The consolidated financial statements include the accounts of the Parent Company, LotoPac and Lucky Circle and in 2008, the accounts of Innovative and TGTI. The financial statements of the subsidiaries are prepared for the same reporting year as the Parent Company using consistent accounting policies. Adjustments are made to bring into line any dissimilar accounting policies that may exist. The subsidiaries are fully consolidated from the date of acquisition, being the date on which the Parent Company obtains control, and continue to be consolidated until the date that such control ceases. Where there is a loss of control of a subsidiary, the consolidated financial statements include the results for the part of the reporting year during which the Parent Company has control. Control is normally evident when the Parent Company owns, either directly or indirectly through its subsidiaries, more than 50% of the voting rights of a company’s capital stock, and is able to govern the financial and operating policies of a company so as to benefit from its activities. Minority interests represent the portion of profit or loss and net assets or liabilities not held by the Parent Company and are presented separately in the consolidated statements of income and within stockholders’ equity in the consolidated balance sheets, separately from equity attributable to equity holders of the Parent. Losses applicable to the minority in a consolidated subsidiary may exceed the minority interest in the subsidiary’s equity. The excess, and any further losses applicable to the minority, are allocated against the majority interest except to the extent that the minority has a binding obligation and is able to make an additional investment to cover the losses. If the subsidiary subsequently reports profits, such profits are allocated to the majority interest until the minority’s share of losses previously absorbed by the majority has been recovered. All intra-group balances, transactions, income and expenses and profits and losses resulting from intra-group transactions that are recognized in assets and liabilities, are eliminated in full. Unrealized losses are eliminated unless costs cannot be recovered. 4. Changes in Accounting Policies The accounting policies adopted in the preparation of the Group’s financial statements are consistent with those of the previous financial year, except for the adoption of the following Philippine Interpretations which became effective on January 1, 2008 and an amendment to an existing standard that became effective July 1, 2008: § Philippine Interpretation IFRIC 11, “PFRS 2, Group and Treasury Share Transactions” — This interpretation indicates how to account for circumstances where goods and services are received in return for an entity’s own equity instruments and how to account for circumstances *SGVMC211961* -5when a parent entity grants its own equity instruments to the employees of a subsidiary. As indicated in Note 18, the Parent Company has Stock Option Plan (the Plan) for its executives and employees and those of Lucky Circle. This interpretation however has no impact in the Group’s financial statements. § Philippine Interpretation IFRIC 12, “Service Concession Arrangements” — This interpretation covers contractual arrangements arising from private entities providing public services and is not relevant to the Group’s current operations. § Philippine Interpretation IFRIC 14, “PAS 19 — The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction” - This interpretation provides general guidance on how to assess the limit in PAS 19, “Employee Benefits,” on the amount of the surplus that can be recognized as an asset. It also explains how the pension asset or liability may be affected when there is a statutory or contractual minimum funding requirement. This interpretation has no impact on the Group’s financial statements as the defined benefit scheme is currently in deficit. § Amendments to PAS 39, “Financial Instruments: Recognition and Measurement”, and PFRS 7, “Financial Instruments: Disclosure” — The amendments to PAS 39 introduce the possibility of reclassification of securities out of the trading category in rare circumstances and reclassification to the loans and receivable category if there is intent and ability to hold the securities for the foreseeable future or to held-to-maturity if there is intent and ability to hold the securities until maturity. The amendments to PFRS 7 introduce the disclosures relating to these reclassifications. These amendments has no impact in the Group’s financial statements since the Group did not avail of the reclassification allowed under the amended standard. 5. Summary of Significant Accounting and Financial Reporting Policies Business Combination and Goodwill Business combinations are accounted for using the purchase method of accounting. This involves recognizing identifiable assets (including previously recognized intangible assets, if any) and liabilities (including contingent liabilities and excluding future restructuring of the acquired business at fair value). Goodwill acquired in the business combination is initially measured at cost being the excess of the cost of the business combination over the Parent Company’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities. Following initial recognition, goodwill is measured at cost less any accumulated impairment losses. Goodwill is reviewed for impairment annually or more frequently if events or changes in circumstances indicate that the carrying value may be impaired. *SGVMC211961* -6Impairment is determined by assessing the recoverable amount of the cash-generating unit (or group of cash-generating units), to which the goodwill relates. Where the recoverable amount of the cash-generating unit (group of cash-generating units) is less than the carrying amount, an impairment loss is recognized. Where goodwill forms part of a cash-generating unit (or group of cash-generating units), and part of the operation within that unit is disposed of, the goodwill associated with the operation disposed of is included in the carrying amount of the operation when determining the gain or loss on disposal of the operation. Goodwill disposed of in this circumstance is measured based on the relative values of the operation disposed of and the portion of the cash-generating unit retained. When subsidiaries are sold, the difference between the selling price and the net assets plus cumulative translation differences, if any, is recognized in the consolidated statement of income. PFRS 3, “Business Combination” provides that if the initial accounting for a business combination can be determined only provisionally by the end of the period in which the combination is effected because either the fair values to be assigned to the acquiree’s identifiable assets, liabilities or contingent liabilities or the cost of the combination can be determined only provisionally, the acquirer shall account for the combination using those provisional values. The acquirer shall recognize any adjustments to those provisional values as a result of completing the initial accounting within twelve months of the acquisition date as follows; (i) the carrying amount of the identifiable asset, liability or contingent liability that is recognized or adjusted as a result of completing the initial accounting shall be calculated as if its fair value at the acquisition date had been recognized from that date; (ii) goodwill or any gain recognized shall be adjusted by an amount equal to the fair value of the identifiable asset, liability or contingent liability being recognized or adjusted; and (iii) comparative information presented for the periods before the initial accounting for the combination is complete shall be presented as if the initial accounting had been completed from the acquisition. Cash and Cash Equivalents Cash includes cash on hand and cash in banks. Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash with original maturities of three months or less from the date of acquisition and that are subject to an insignificant risk of change in value. Financial Instruments Initial Recognition. Financial assets within the scope of PAS 39 are classified as financial assets at fair value through profit or loss (FVPL), loans and receivables, held-to-maturity (HTM) investments, available-for-sale (AFS) financial assets, or as derivatives designated as hedging instruments in an effective hedge, as appropriate. Financial liabilities are categorized as financial liabilities at FVPL or other financial liabilities. The Group determines the classification of its financial instruments at initial recognition. The Group has no financial assets classified as HTM investments and AFS investments and no financial liabilities at FVPL as of December 31, 2008 and 2007. Financial assets and liabilities are recognized initially at fair value plus, in the case of financial assets and liabilities not at FVPL, directly attributable transaction costs. *SGVMC211961* -7Purchases or sales of financial assets that require delivery of assets within a time frame established by regulation or convention in the marketplace (regular way purchases) are recognized on the trade date, i.e. the date that the Group commits to purchase or sell the asset. Subsequent Measurement. The subsequent measurement of financial assets depends on their classification as follows: Financial Assets at FVPL. Financial assets at FVPL include financial assets held for trading and financial assets designated upon initial recognition as at FVPL. Financial assets are classified as held for trading if they are acquired for the purpose of selling in the near term. Derivatives, including separated embedded derivatives, are also classified as held for trading unless they are designated as effective hedging instruments. Financial assets at FVPL are carried in the consolidated balance sheet at fair value with gains or losses recognized in the consolidated statement of income. Interest earned or incurred is recorded in interest income or expense, respectively, while dividend income is recorded in other income when the right to receive payment has been established. An embedded derivative is separated from the host contract and accounted for as a derivative if all of the following conditions are met: (a) the economic characteristics and risks of the embedded derivative are not closely related to the economic characteristics and risks of the host contract; (b) a separate instrument with the same terms as the embedded derivative would meet the definition of a derivative; and (c) the hybrid or combined instrument is not measured at fair value with changes in fair value reported in net profit or loss. The Group assesses whether embedded derivatives are required to be separated from the host contracts when the Group first becomes a party to the contract. Reassessment only occurs if there is a change in the terms of the contract that significantly modifies the cash flows that would otherwise be required. The Group’s investments held for trading consists mainly of investments in quoted securities (see Note 11). Loans and Receivables. Loans and receivables are nonderivative financial assets with fixed or determinable payments that are not quoted in an active market. Such financial assets are carried at amortized cost using the effective interest method less any allowance for impairment. Gains and losses are recognized in the consolidated statement of income when the loans and receivables are derecognized or impaired, as well as through the amortization process. Loans and receivables are included in current assets if maturity is within twelve months from balance sheet date. Otherwise, these are classified as noncurrent assets. This category includes the Group’s cash and cash equivalents, trade and other receivables and advances to previously held joint-venture (included as part of “Investments and advances” account in the 2007 consolidated balance sheet) (see Notes 10, 12 and 14). Other Financial Liabilities. This category pertains to financial liabilities that are not held for trading or designated as FVPL upon inception of the liability. These include liabilities arising from operations or borrowings. The financial liabilities are recognized initially at fair value and are subsequently carried at amortized cost, taking into account the impact of applying the effective interest method of amortization for any related premium, discount and any directly attributable transaction costs. These financial liabilities are included in current liabilities if maturity is within twelve months from the balance sheet date. Otherwise, these are classified as noncurrent liabilities. *SGVMC211961* -8This category includes trade and other current liabilities, installment payable and obligations under finance lease (see Notes 15, 16 and 24). Offsetting of Financial Instruments. Financial assets and financial liabilities are offset and the net amount reported in the consolidated balance sheet if, and only if, there is a currently enforceable right to offset the recognized amounts and there is intention to settle on a net basis, or to realize the asset and settle the liability simultaneously. “Day 1” Profit. Where the transaction price in a nonactive market is different from the fair value of other observable current market transactions in the same instrument or based on a valuation technique whose variables include only data from observable market, the Group recognizes the difference between the transaction price and fair value (a “Day 1” profit) in the consolidated statement of income unless it qualifies for recognition as some other type of asset. In cases where use is made of data which is not observable, the difference between the transaction price and model value is only recognized in the consolidated statement of income when the inputs become observable or when the instrument is derecognized. For each transaction, the Group determines the appropriate method of recognizing the “Day 1” profit amount. Derecognition of Financial Assets and Liabilities Financial Assets. A financial asset (or, where applicable a part of a financial asset or part of a group of similar financial assets) is derecognized when: § the right to receive cash flows from the asset have expired; § the Group retains the right to receive cash flows from the asset, but has assumed an obligation to pay them in full without material delay to a third party under a “pass-through” arrangement; or § the Group has transferred its right to receive cash flows from the asset and either (a) has transferred substantially all the risks and rewards of the assets, or (b) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset. Where the Group has transferred its rights to receive cash flows from an asset or has entered into a pass-through arrangement, and has neither transferred nor retained substantially all the risks and rewards of the asset nor transferred control of the asset, the asset is recognized to the extent of the Group’s continuing involvement in the asset. Continuing involvement that takes the form of a guarantee over the transferred asset is measured at the lower of original carrying amount of the asset and the maximum amount of consideration that the Group could be required to repay. Financial Liability. A financial liability is derecognized when the obligation under the liability is discharged, cancelled, or has expired. Where an existing financial liability is replaced by another from the same lender on substantially different terms, or the terms of an existing liability are substantially modified, such an exchange or modification is treated as a derecognition of the original liability and the recognition of a new liability, and the difference in the respective carrying amounts is recognized in the consolidated statement of income. *SGVMC211961* -9Impairment of Financial Assets The Group assesses at each balance sheet date whether there is any objective evidence that a financial asset or a group of financial assets is impaired. A financial asset or a group of financial assets is deemed to be impaired if, an only if, there is objective evidence of impairment as a result of one or more events that has occurred after the initial recognition of the asset (an incurred “loss event”) and that loss event has an impact on the estimated future cash flows of the financial asset of the group of financial assets that can be reliably estimated. Evidence of impairment may include indications that the debtors or a group of debtors is experiencing significant financial difficulty, default or delinquency in interest or principal payments, the probability that they will enter bankruptcy or other financial reorganization and where observable data indicate that there is a measurable decrease in the estimated future cash flows such as changes in arrears or economic conditions that correlate with defaults. Assets Carried at Amortized Cost. For assets carried at amortized cost, the Group first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If there is objective evidence that an impairment loss has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows discounted at the financial asset’s original effective interest rate. The carrying amount of the financial asset is reduced through use of an allowance account and the amount of the loss is recognized in the consolidated statement of income. Interest income continues to be accrued on the reduced carrying amount based on the effective interest rate of the asset. If it is determined that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, the asset is included in a group of financial assets with similar credit risk characteristics and that group of financial assets is collectively assessed for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognized are not included in a collective assessment of impairment. The Group provides an allowance for loans and receivables which they deemed to be uncollectible despite the Group’s continuous effort to collect such balances from the respective clients. The Group considered those past due receivables as still collectible if they become past due only because of a delay on the completion of the services to be rendered by the Group as agreed in the contract and not due to incapability of the clients to fulfill their obligation. However, for those receivables associated to pre-terminated contracts, the Group directly writes them off from the account since there is no realistic prospect of future recovery. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognized, the previously recognized impairment loss is reversed. Any subsequent reversal of an impairment loss is recognized in the consolidated statement of income, to the extent that the carrying value of the asset does not exceed its amortized cost at the reversal date. *SGVMC211961* - 10 In relation to trade receivables, a provision for impairment is made when there is objective evidence (such as probability of insolvency or significant financial difficulties of the debtor) that the Group will not be able to collect all of the amounts due under the original terms of the invoice. The carrying amount of the receivable is reduced through the use of an allowance account. The financial assets, together with the associated allowance accounts, are written off when there is no realistic prospect of future recovery and all collateral has been realized. Instant Scratch Tickets Supplies Instant scratch ticket supplies (included under “Other current assets” account in the consolidated balance sheet) are valued at cost, less any impairment loss. Spare Parts and Supplies Spare parts and supplies (included under “Other current assets” account in the consolidated balance sheets) are valued at the lower of cost or net realizable value. Cost, which includes all costs attributable to acquisition, is determined using the first-in, first-out method. Net realizable value of spare parts and supplies is its current replacement cost. Property and Equipment Property and equipment are stated at cost, excluding the costs of day-to-day servicing, less accumulated depreciation, amortization and any impairment in value. Such cost includes the cost of replacing part of such property and equipment when that cost is incurred if the recognition criteria are met. Depreciation and amortization are computed using the straight-line method over the following estimated useful lives: Lottery equipment Leasehold improvements Office furniture and fixtures Transportation equipment 4–8 years or term of the lease, whichever period is shorter 4 years or term of the lease, whichever period is shorter 4 years 4–5 years Equipment under installation are stated at cost, which includes purchase price and other direct costs. Such assets are not depreciated until such time when the relevant property and equipment are available for its intended use. The asset’s residual values, useful lives and depreciation and amortization method are reviewed, and adjusted if appropriate, at each financial year-end. When each major repairs and maintenance is performed, its cost is recognized in the carrying amount of the property and equipment as a replacement if the recognition criteria are satisfied. Fully depreciated property and equipment are retained in the accounts until they are no longer in use and no further depreciation is charged to current operations. *SGVMC211961* - 11 An item of property and equipment is derecognized upon disposal or when no future economic benefits are expected from its use or disposal. Any gain or loss arising on derecognition of the asset (calculated as the difference between the net disposal proceeds and the carrying amount of the asset) is included in the consolidated statement of income in the year the asset is derecognized. Impairment of Nonfinancial Assets The Group assesses at each balance sheet date whether there is an indication that an asset may be impaired. If any such indication exists and when annual impairment testing for an asset is required, the Group makes an estimate of the asset’s recoverable amount. An asset’s recoverable amount is the higher of an asset’s cash-generating unit’s fair value less costs to sell or its value in use and is determined for an individual asset, unless the asset does not generate cash inflows that are largely independent of those from other assets or groups of assets. Where the carrying amount of an asset exceeds its recoverable amount, the asset is considered impaired and is written down to its recoverable amount. In determining fair value less costs to sell, an appropriate valuation model is used. These calculations are corroborated by valuation multiples or other available fair value indicators. In assessing value in use, the estimated future cash flows are discounted to their present value using a pretax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. Impairment losses are recognized in the consolidated statement of income in the expense category consistent with the function of the impaired asset. For asset excluding goodwill, an assessment is made at each balance sheet date as to whether there is any indication that previously recognized impairment losses may no longer exist or may have decreased. If such indication exists, the Group makes an estimate of recoverable amount. A previously recognized impairment loss is reversed only if there has been a change in the estimates used to determine the asset’s recoverable amount since the last impairment loss was recognized. If that is the case, the carrying amount of the asset is increased to its recoverable amount. That increased amount cannot exceed the carrying amount that would have been determined, net of depreciation and amortization, had no impairment loss been recognized for the asset in prior years. Such reversal is recognized in the consolidated statement of income unless the asset is carried at revalued amount, in which case the reversal is treated as a revaluation increase. Treasury Shares Own equity instruments which are reacquired (treasury shares) are recognized at cost and deducted from equity. No gain or loss is recognized in the consolidated statement of income on the purchase, sale, issue or cancellation of the Group’s own equity instruments. Any difference between the carrying amount and the consideration upon reissuance or cancellation is recognized as part of “Additional paid-in capital” (APIC). Business Segments The Group’s operating businesses are organized and managed separately according to the nature of the products and services provided, with each segment representing a strategic business unit that offers different products. Segment Assets and Liabilities. Segment assets include all operating assets used by a segment and consist principally of operating cash, receivables, inventories, and property and equipment, net of allowances and provision. Segment liabilities include all operating liabilities and consist principally of accounts payable and other liabilities. Segment assets and liabilities do not include deferred income taxes, investments and advances, and borrowings. *SGVMC211961* - 12 Inter-segment Transactions. Segment revenue, segment expenses and segment performance include transfers among business segments. The transfers, if any, are accounted for at competitive market prices charged to unaffiliated customers for similar products. Such transfers are eliminated in consolidation. Revenue Revenue is recognized to the extent that it is probable that the economic benefits will flow to the Group and the revenue can be reliably measured. The following specific recognition criteria must also be met before revenue is recognized: Equipment Rentals and Maintenance and Repair Fees. Income from equipment rentals, consisting of central computer, communications equipment including its accessories, terminals, the right to use the application software and manuals for the central computer system and terminals and draw equipment, as well as maintenance and repair fees is recognized based on a certain percentage of gross sales of the lessee’s online lottery operations or a fixed annual rental per terminal in commercial operations, whichever is higher. Sale of Instant Scratch Tickets. Revenue is recognized upon distribution of Instant Scratch Tickets (tickets) to third parties. Interest. Revenue is recognized as the interest accrues, taking into account the effective yield on the asset. Dividends. Dividend is recognized when the Group’s right to receive payment is established. Commission Income. Commission is recognized by the subsidiaries as certain percentages of their sales of PCSO lottery, sweepstake and instant scratch tickets. Leases The determination of whether an arrangement is, or contains a lease is based on the substance of the arrangement at inception date of whether the fulfillment of the arrangement is dependent on the use of a specific asset or assets or the arrangement conveys a right to use the asset. A reassessment is made after inception of the lease only if one of the following applies: a. There is a change in contractual terms, other than a renewal or extension of the arrangement; b. A renewal option is exercised or extension granted, unless the term of the renewal or extension was initially included in the lease term; c. There is a change in the determination of whether fulfillment is dependent on a specified asset; or d. There is a substantial change to the asset. Where a reassessment is made, lease accounting shall commence or cease from the date when the change in circumstances gave rise to the reassessment for scenarios a, c or d and at the date of renewal or extension period for scenario b. *SGVMC211961* - 13 As a Lessor. Leases where the Group does not transfer substantially all the risks and benefits of ownership of the asset are classified as operating leases. Initial direct costs incurred in negotiating an operating lease are added to the carrying amount of the leased asset and recognized over the lease term on the same bases as rental income. Contingent rents are recognized as revenue in the period in which they are earned. As a Lessee. Finance leases, which transfer to the Group substantially all the risks and benefits incidental to ownership of the leased item, are capitalized at the inception of the lease at the fair value of the leased property or, if lower, at the present value of the minimum lease payments. Lease payments are apportioned between the finance charges and reduction of the lease liability so as to achieve a constant rate of interest on the remaining balance of the liability. Finance charges are charged in the consolidated statement of income. Operating lease payments are recognized as expense in the consolidated statement of income on a straight-line basis over the lease term or based on the term of the lease agreements, as applicable. Share-based Payment Transactions Under the Plan, employees and executives (including directors) of the Group and its affiliates receive remuneration in the form of share-based payment transactions, whereby employees and executives render services as consideration for equity instruments (“equity-settled transactions”) of the Group. Equity-Settled Transactions. Share-based payment transactions in which the Parent Company grants rights to equity on its instruments to the Parent Company’s employees and executives and to those of Lucky Circle are accounted for as equity-settled transactions. The cost of equity-settled transactions with executives and employees is measured by reference to the fair value at the date on which they are granted. The fair value is determined using an optionpricing model, further details of which are set forth in Note 18. In valuing equity-settled transactions, no account is taken of any performance conditions, other than linked to the price of the shares of the Parent Company (“market condition”), if applicable. The cost of the Plan is measured by reference to the market price at the time of the grant less subscription price. The cost of equity-settled transactions is recognized, together with a corresponding increase in “Additional paid-in capital” account, over the period in which the performance and/or service conditions are fulfilled, ending on the date on which the relevant employees become fully entitled to the award (the vesting date). The cumulative expense recognized on equity-settled transactions at each balance sheet date until the vesting date reflects the extent to which the vesting period has expired and the Group’s best estimate of the number of equity instruments that will ultimately vest. The stock compensation expense incurred for the period represents the expense recognized in the current period for stock option grants pertaining to Group’s executives and employees. No expense is recognized for awards that do not ultimately vest, provided that all other service conditions are satisfied. Where the terms of a share-based award are modified, as a minimum, an expense is recognized as if the terms had not been modified. In addition, an expense is recognized for any modification, which increases the total fair value of the share-based payment arrangement, or is otherwise beneficial to the employee as measured at the date of modification. *SGVMC211961* - 14 Where an equity-settled award is cancelled, it is treated as if it had vested on the date of cancellation, and any expense not yet recognized for the award is recognized immediately. However, if a new award is substituted for the cancelled award, and designated as a replacement award on the date that it is granted, the cancelled and new awards are treated as if they were a modification of the original award, as described in the previous paragraph. Retirement Cost The Parent Company has a funded, noncontributory defined benefit retirement plan covering substantially all of its qualified employees. The defined benefit plan requires contributions to be made to a separately administered fund. The obligation and costs of retirement benefits are actuarially computed by a professionally qualified independent actuary using projected unit credit method. This method reflects service rendered by employees to the date of valuation and incorporates assumptions concerning employees’ projected salaries. Past service costs, experience adjustments, and the effects of changes in actuarial assumptions are amortized over the average remaining working lives of employees participating in the plan. The past service cost is recognized as an expense on a straight-line basis over the average period until the benefits become vested. If the benefits are already vested immediately following the introduction of, or changes to, a pension plan, past service cost is recognized immediately. Actuarial gains and losses are recognized as income or expense when the net cumulative unrecognized actuarial gains and losses at the end of the previous reporting period exceeded 10% of the higher of the defined benefit obligation and the fair value of plan assets at that date. These gains or losses are recognized over the expected average remaining working lives of the employees participating in the plan. The defined benefit liability is the aggregate of the present value of the defined benefit obligation less past service cost not yet recognized and the fair value of plan assets out of which the obligations are to be settled directly. The value of any asset is restricted to the sum of any past service cost not yet recognized and the present value of any economic benefits available in the form of refunds from the plan or reductions in the future contributions to the plan. Actuarial valuations are made with sufficient regularity that the amounts recognized in the consolidated financial statement do not differ materially from the amounts that would be determined at balance sheet date. Foreign Currency-denominated Transactions Transactions denominated in foreign currency are recorded in Philippine peso by applying to the foreign currency amount the exchange rate between the Philippine peso and the foreign currency at the date of transaction. Monetary assets and liabilities denominated in foreign currencies are restated using the closing exchange rate at balance sheet date. All exchange rate differences including those arising from translation or settlement of monetary items at rates different from those at which they were initially recorded are recognized in the consolidated statement of income in the year such differences arise. *SGVMC211961* - 15 Taxes Current Tax. Current tax assets and liabilities for the current and prior years are measured at the amount expected to be recovered from or paid to the taxation authority. The tax rates and tax laws used to compute the amount are those that are enacted or substantively enacted at balance sheet date. Deferred Tax. Deferred tax is provided using the balance sheet liability method on all temporary differences at balance sheet date between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes. Deferred tax liabilities are recognized for all taxable temporary differences, except: § where the deferred tax liability arises from the initial recognition of goodwill or of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting income nor taxable income or loss; and § in respect of taxable temporary differences associated with investments in subsidiaries, associates and interests in joint ventures, where the timing of the reversal of the temporary differences can be controlled and it is probable that the temporary differences will not reverse in the foreseeable future. Deferred tax assets are recognized for all deductible temporary differences to the extent that it is probable that future taxable profit will be available against which the deductible temporary differences can be utilized except: § where the deferred tax asset relating to the deductible temporary difference arises from the initial recognition of an asset or liability in a transaction that is not a business combination and, at the time of the transaction, affects neither the accounting income nor taxable income or loss; and § in respect of deductible temporary differences associated with investments in subsidiaries, associates and interests in joint ventures, deferred tax assets are recognized only to the extent that it is probable that the temporary differences will reverse in the foreseeable future and taxable profit will be available against which the deductible temporary differences can be utilized. The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable income will be available to allow all or part of the deferred tax assets to be utilized. Unrecognized deferred tax assets are reassessed at each balance sheet date and are recognized to the extent that it has become probable that future taxable income will allow the deferred tax assets to be recovered. Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the year when the asset is realized or the liability is settled, based on tax rates and tax laws that have been enacted or substantively enacted at balance sheet date. Deferred tax assets and liabilities are offset, if a legally enforceable right exists to offset current tax assets against current tax liabilities and the deferred taxes relate to the same taxable entity and the same taxation authority. *SGVMC211961* - 16 Basic/Diluted Earnings Per Share (EPS) Basic EPS is computed by dividing the net income for the period attributable to equity holders of the Parent by the weighted-average number issued and outstanding common shares during the period. For the purpose of computing diluted EPS, the net income for the period attributable to equity holders of the Parent and the weighted-average number of issued and outstanding common shares are adjusted for the effects of all potential dilutive instruments. Provisions Provisions are recognized when the Group has a present obligation (legal or constructive) as a result of a past event; it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and a reliable estimate can be made of the amount of the obligation. If the effect of the time value of money is material, provisions are discounted using a current pretax rate that reflects, where appropriate, the risks specific to the liability. Where discounting is used, the increase in the provisions due to the passage of time is recognized as a finance cost. Contingencies Contingent liabilities are not recognized in the consolidated financial statements. They are disclosed in the consolidated notes to consolidated financial statements unless the possibility of an outflow of resources embodying economic benefits is remote. A contingent asset is not recognized in the consolidated financial statements but disclosed in the notes to consolidated financial statements when an inflow of economic benefits is probable. Events After the Balance Sheet Date Post balance sheet events that provide additional information about the Group’s financial position at balance sheet date (adjusting events) are reflected in the consolidated financial statements. Post balance sheet events that are not adjusting events are disclosed in the notes to consolidated financial statements when material. 6. Significant Accounting Judgments, Estimates and Assumptions The preparation of the Group’s consolidated financial statements requires management to make judgments, estimates and assumptions that affect the reported amounts of revenue, expenses, assets and liabilities, and the disclosure of contingent liabilities, at the reporting date. However, uncertainty about these assumptions and estimates could result in outcomes that could require a material adjustment to the carrying amount of the asset or liability affected in the future. Judgments In the process of applying the Group’s accounting policies, management has made judgments, apart from those involving estimations, which has the most significant effect on the amounts recognized in the consolidated financial statements. Leases. The evaluation of whether an arrangement contains a lease is based on its substance. An arrangement is, or contains a lease when the fulfillment of the arrangement depends on a specific asset or assets and the arrangement conveys a right to use the asset. *SGVMC211961* - 17 The Group has entered into operating lease agreements as a lessor and as a lessee. The Group, as a lessee, has determined that the lessor retains all significant risks and rewards of ownership of these properties which are on operating lease agreements. As a lessor, the Group retains substantially all the risks and benefits of ownership of the assets. The Group has also entered into finance lease agreements covering certain lottery equipment. The Group has determined that it bears substantially all the risks and benefits incidental to ownership of the said properties which are on finance lease agreements. The carrying value of lottery equipment under finance lease amounted to = P254.0 million and =280.7 million as of December 31, 2008 and 2007, respectively (see Notes 15 and 24). P Legal Contingencies. The estimate of the probable costs for the resolution of possible claims has been developed in consultation with outside legal counsel handling the Group’s defense in these matters and is based upon a thorough analysis of potential results. As of April 2, 2009, the Group is not involved in any legal cases. No provision for probable losses arising from legal contingencies was recognized in the consolidated financial statements as of December 31, 2008 and 2007. Estimates and Assumptions The key assumptions concerning the future and other key sources of estimation uncertainty at balance sheet date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below. Allowance for Doubtful Accounts. The Group maintains allowance for doubtful accounts at a level considered adequate to provide for potential uncollectible receivables. The level of this allowance is evaluated by the management on the basis of factors that affect the collectibility of the accounts. These factors include, but not limited to, the age and status of receivable, the length of relationship with the customers, the customer’s payment behavior and known market factors. The Group reviews the allowance on a continuous basis. Accounts that are specifically identified to be potentially uncollectible are provided with adequate allowance through charges to consolidated statement of income in the form of provision for doubtful accounts. A provision is also established as a certain percentage of receivables not provided with specific reserves. This percentage is based on a collective assessment of historical collection, current economic trends, changes in customer payment terms and other factors that may affect the Group’s ability to collect payments. As of December 31, 2008 and 2007, there were no provisions for doubtful accounts recognized in the consolidated financial statements. Trade and other receivables amounted to P =116.8 million and P =67.7 million as of December 31, 2008 and 2007, respectively (see Note 12). Impairment of Nonfinancial Assets (except Goodwill). PFRS requires that an impairment review be performed when certain impairment indicators are present. Determining the value of property and equipment requires the determination of future cash flows expected to be generated from the continued use and ultimate disposition of such assets, requires the Group to make estimates and assumptions that can materially affect the consolidated financial statements. Future events could cause the Group to conclude that the property and equipment are impaired. Any resulting impairment loss could have a material adverse impact on the Group’s financial condition and financial performance. *SGVMC211961* - 18 The net carrying values of property and equipment amounted to P =399.5 million and = P347.5 million as of December 31, 2008 and 2007, respectively (see Note 15). Impairment of Goodwill. The Parent Company’s management conducts an annual review for any impairment in value of the goodwill. The impairment on the goodwill is determined by comparing: (a) the carrying amount of the cash-generating unit; and (b) the present value of the annual projected cash flows for five years and the present value of the terminal value computed under the discounted cash flow method. The key assumptions used in the impairment test of goodwill are discussed in Note 8 to the consolidated financial statements. The carrying amount of goodwill amounted to = P39.3 million and P =13.4 million as of December 31, 2008 and 2007, respectively (see Note 8). Provision for impairment loss of goodwill amounted to = P0.1 million in 2007. No impairment loss was recognized in 2008 and 2006. Purchase Price Allocation in Business Combinations. The purchase method requires extensive use of accounting estimates and judgments to allocate the purchase price to the fair market values of the acquiree’s identifiable assets and liabilities at acquisition date. It also requires the acquirer to recognize goodwill. The Group’s acquisitions have resulted in goodwill (see Note 8). Net Realizable Value of Inventory. The Group provides an allowance for inventories whenever the value of inventories becomes lower than its cost due to damage, physical deterioration, obsolescence, changes in price levels or other causes. The lower of cost and net realizable value of inventories is reviewed at each reporting date to reflect the accurate valuation in the consolidated financial statements. Spare parts and supplies identified to be obsolete and unusable are written off and charged as expense for the period. As of December 31, 2008 and 2007, the aggregate carrying value of instant scratch tickets and spare parts and supplies (included under “Other current assets” account in the consolidated balance sheets) amounted to P =23.9 million and = P12.1 million, respectively (see Note 13). Allowance for Probable Losses. The Group provides an allowance for probable losses on input valueadded (VAT) tax based on amount recoverable from taxation authority. The allowance account is reviewed on an annual basis. An increase in the allowance for probable losses would increase the recorded expenses and decrease current assets. As of December 31, 2008 and 2007, the carrying value of input VAT (included under “Other current assets” account in the consolidated balance sheets) amounted to P =23.1 million and P =17.8 million, respectively (see Note 13). Estimated Useful Lives of Property and Equipment. The useful life of each of the Group’s property and equipment is estimated based on the period over which the asset is expected to be available for use. Such estimation is based on a collective assessment of industry practice, internal technical evaluation and experience with similar assets. The estimated useful life of each asset is reviewed periodically and updated if expectations differ from previous estimates due to physical wear and tear, technical or commercial obsolescence and legal or other limits on the use of the asset. It is possible, however, that future financial performance could be materially affected by changes in the amounts and timing of recorded expenses brought about by changes in the factors mentioned above. A reduction in the estimated useful life of any property and equipment would increase the recorded operating expenses and decrease noncurrent assets. *SGVMC211961* - 19 The carrying value of property and equipment as of December 31, 2008 and 2007 amounted to =399.5 million and P P =347.5 million, respectively (see Note 15). Share-based Payments. The Group measures the cost of equity-settled transactions with executives and employees by reference to the option value using the Black-Scholes Option Pricing Model. The valuation model requires determining the expected volatility, risk-free rate and dividend yield. The Group recognizes expenses based on the estimated number of grants that will ultimately vest and will receive settlement. The Group’s average turnover rate over the past few years is used to determine the attrition rate in computing the benefit expense and the estimated liability. Share-based compensation expense amounted to P =3.0 million in 2008 (see Note 18). Retirement Cost. The present value of the retirement obligation depends on a number of factors that are determined on an actuarial basis using a number of assumptions. The assumptions used in determining the net cost for pension include the discount rates and rate of future salary increase. In accordance with PFRS, actual results that differ from the Group’s assumptions are accumulated and amortized over future periods and therefore, generally affect the recognized expense and recorded obligation in such future periods. The Group determines the appropriate discount rate at the end of each year. This is the interest rate that is used to determine the present value of estimated future cash outflows expected to be required to settle the retirement obligation. In determining the appropriate discount rate, the Group considers the interest rates on government bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating the terms of the related retirement liability. Other key assumptions for retirement obligation are based in part on current market conditions. While it is believed that the Group’s assumptions are reasonable and appropriate, significant differences in actual experience or significant changes in assumptions may materially affect the Group’s retirement obligation. Defined benefit liability amounted to P =4.7 million and P =2.5 million as of December 31, 2008 and 2007, respectively (see Note 26). Deferred Tax Assets. The carrying amount of deferred tax assets is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred tax assets to be utilized. Management expects future operations will generate sufficient taxable income that will allow all or part of the deferred tax assets to be utilized. Deferred tax assets recognized in the consolidated balance sheets amounted to = P3.4 million and P2.0 million as of December 31, 2008 and 2007, respectively. There are no unrecognized deferred = tax assets as of December 31, 2008 and 2007 (see Note 23). *SGVMC211961* - 20 Fair Value of Financial Instruments. PFRS requires certain financial assets and liabilities to be carried and disclosed at fair value, which requires extensive use of accounting estimates and judgments. While significant components of fair value measurement were determined using verifiable objective evidence (i.e., foreign exchange rates, interest rates, volatility rates), the amount of changes in fair value would differ if the Group utilized a different valuation methodology. Any changes in fair value of these financial assets and liabilities would directly affect the statement of income and statement of changes in equity. The fair value of financial assets amounted to P =275.0 million and P =344.6 million as of December 31, 2008 and 2007, respectively. The fair value of financial liabilities amounted to =334.4 million and P P =304.8 million as of December 31, 2008 and 2007, respectively (see Note 28). 7. Future Changes in Accounting Policies The Group will adopt the following standards and interpretations enumerated below when these become effective. Except as otherwise indicated, the Group does not expect the adoption of these new and amended PFRS and Philippine Interpretations to have significant impact on its consolidated financial statements. Effective in 2009 § Revised PFRS 1, “First-time Adoption of Philippine Financial Reporting Standards - Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate” — This standard has been revised to allow an entity, in its separate financial statements, to determine the cost of investments in subsidiaries, jointly controlled entities or associates (in its opening PFRS financial statements) as one of the following amounts: (a) cost determined in accordance with PAS 27; (b) at the fair value of the investment at the date of transition to PFRS, determined in accordance with PAS 39; or (c) previous carrying amount (as determined under generally accepted accounting principles) of the investment at the date of transition to PFRS. § Amendments to PFRS 2, “Share-based Payment - Vesting Condition and Cancellations” — The amended standard clarifies the definition of a vesting condition and prescribes the treatment for an award that is effectively cancelled. It defines a vesting condition as a condition that includes an explicit or implicit requirement to provide services. It further requires non-vesting conditions to be treated in a similar fashion to market conditions. Failure to satisfy a non-vesting condition that is within the control of either the entity or the counterparty is accounted for as cancellation. However, failure to satisfy a non-vesting condition that is beyond the control of either party does not give rise to a cancellation. The Group is in the process of quantifying the impact of adoption of this amendment when it becomes effective on January 1, 2009. § PFRS 8, “Operating Segments” — This standard adopts a management approach to reporting segment information. PFRS 8 will replace PAS 14, “Segment Reporting,” and is required to be adopted only by entities whose debt or equity instruments are publicly traded, or are in the process of filing with the SEC for purposes of issuing any class of instruments in a public market. The Group is in the process of assessing the impact of the standard on its current manner of reporting segment information. *SGVMC211961* - 21 § Revised PAS 1, “Presentation of Financial Statements” — This standard has been revised to enhance the usefulness of information presented in the financial statements. Companies will need to consider whether to present the statement of comprehensive income as a single statement or two statements. This may also impact the information disclosed in the other announcements by the Group, such as press releases. Adoption of this amendment will not have significant impact on the Group except for the additional disclosures to be included in the consolidated financial statements. § PAS 23, “Borrowing Costs” — This standard requires capitalization of borrowing costs when such costs relate to a qualifying asset. A qualifying asset is an asset that takes a substantial period of time to get ready for its intended use or sale. In accordance with the transitional requirements of this standard, the Group will apply these prospectively upon adoption. No changes will be made for borrowing costs incurred to this date that have been expensed. § Amendments to PAS 27, “Consolidated and Separate Financial Statements – Cost of an Investment in a Subsidiary, Jointly Controlled Entity or Associate Amendments” — This standards has been amended in respect of the holding companies separate financial statements including (a) the deletion of “cost method”, making the distinction between pre- and postacquisition profits no longer required; and (b) in cases of reorganizations where a new parent is inserted above an existing parent of the group (subject to meeting specific requirements), the cost of the subsidiary is the previous carrying amount of its share of equity items in the subsidiary rather than its fair value. All dividends will be recognized in profit or loss. However, the payment of such dividends requires the entity to consider whether there is an indicator of impairment. The Group expects significant changes in its accounting policies when it adopts the foregoing accounting changes effective January 1, 2009. § Amendments to PAS 32, “Financial Instruments: Presentation” and PAS 1 - Puttable Financial Instruments and Obligations Arising on Liquidation — These amendments specify, among others, that puttable financial instruments will be classified as equity if they have all of the following specified features: (a) The instrument entitles the holder to require the entity to repurchase or redeem the instrument (either on an ongoing basis or on liquidation) for a pro rata share of the entity’s net assets, (b) The instrument is in the most subordinate class of instruments, with no priority over other claims to the assets of the entity on liquidation, (c) All instruments in the subordinate class have identical features (d) The instrument does not include any contractual obligation to pay cash or financial assets other than the holder’s right to a pro rata share of the entity’s net assets, and (e) The total expected cash flows attributable to the instrument over its life are based substantially on the profit or loss, a change in recognized net assets, or a change in the fair value of the recognized and unrecognized net assets of the entity over the life of the instrument. § Philippine Interpretation IFRIC 13, “Customer Loyalty Programmes” — This interpretation addresses accounting by entities that grant loyalty award credits (such as “points” or travel miles) to customers who buy other goods or services. Specifically, it explains how such entities should account for their obligations to provide free or discounted goods or services (“awards”) to customers who redeem award credits. *SGVMC211961* - 22 § Philippine Interpretation IFRIC 16, “Hedges of a Net Investment in a Foreign Operation” — This interpretation provides guidance on identifying foreign currency risks that qualify for hedge accounting in the hedge of net investment; where within the group the hedging instrument can be held in the hedge of a net investment; and how an entity should determine the amount of foreign currency gains or losses, relating to both the net investment and the hedging instrument, to be recycled on disposal of the net investment. Improvements to PFRS In May 2008, the International Accounting Standards Board issued its first omnibus of amendments to certain standards, primarily with a view to removing inconsistencies and clarifying wording. These improvements will be effective for annual periods beginning on or after January 1, 2009. The Group has not yet adopted the following amendments and anticipates that these changes will have no material effect on the consolidated financial statements. § PAS 1, “Presentation of Financial Statements” — The improvement clarifies that assets and liabilities classified as held for trading are not automatically classified as current in the balance sheet. § PAS 16, “Property, Plant and Equipment” — The improvement replaces the term “net selling price” with “fair value less costs to sell”, to be consistent with PFRS 5, “Noncurrent Assets Held for Sale and Discontinued Operations” and PAS 36, “Impairment of Asset.” Items of property, plant and equipment held for rental that are routinely sold in the ordinary course of business after rental, are transferred to inventory when rental ceases and they are held for sale. Proceeds of such sales are subsequently shown as revenue. Cash payments on initial recognition of such items, the cash receipts from rents and subsequent sales are all shown as cash flows from operating activities. § PAS 19, “Employee Benefits” — The improvement revises the definition of “past service costs” to include reductions in benefits related to past services (“negative past service costs”) and to exclude reductions in benefits related to future services that arise from plan amendments. It also provided amendment to plans that result in a reduction in benefits related to future services are accounted for as a curtailment. The improvement further revises the definition of “return on plan assets” to exclude plan administration costs if they have already been included in the actuarial assumptions used to measure the defined benefit obligation. It also revises the definition of “short-term” and “other long-term” employee benefits to focus on the point in time at which the liability is due to be settled. And, it deletes the reference to the recognition of contingent liabilities to ensure consistency with PAS 37, “Provisions, Contingent Liabilities and Contingent Assets.” § PAS 20, “Accounting for Government Grants and Disclosures of Government Assistance” — The improvement clarifies that loans granted with no or low interest rates will not be exempt from the requirement to impute interest. The difference between the amount received and the discounted amount is accounted for as a government grant. § PAS 23, “Borrowing Costs” — The improvement revises the definition of borrowing costs to consolidate the types of items that are considered components of “borrowing costs,” i.e., components of the interest expense calculated using the effective interest rate method. *SGVMC211961* - 23 § PAS 28, “Investment in Associates” — The improvement clarifies if an associate is accounted for at fair value in accordance with PAS 39, only the requirement of PAS 28 to disclose the nature and extent of any significant restrictions on the ability of the associate to transfer funds to the entity in the form of cash or repayment of loans applies. An investment in an associate is a single asset for the purpose of conducting the impairment test. Therefore, any impairment test is not separately allocated to the goodwill included in the investment balance. § PAS 29, “Financial Reporting in Hyperinflationary Economies” — The improvement revises the reference to the exception that assets and liabilities should be measured at historical cost, such that it notes property, plant and equipment as being an example, rather than implying that it is a definitive list. § PAS 31, “Interest in Joint Ventures” — The improvement clarifies if a joint venture is accounted for at fair value, in accordance with PAS 39, only the requirements of PAS 31 to disclose the commitments of the venturer and the joint venture, as well as summary financial information about the assets, liabilities, income and expense will apply. § PAS 36, “Impairment of Assets” — The improvement clarifies when discounted cash flows are used to estimate “fair value less cost to sell,” additional disclosure is required about the discount rate, consistent with disclosures required when the discounted cash flows are used to estimate “value in use.” § PAS 38, “Intangible Assets” — The improvement clarifies that expenditure on advertising and promotional activities is recognized as an expense when the Group either has the right to access the goods or has received the services. Advertising and promotional activities now specifically include mail order catalogues. It also deletes references to there being rarely, if ever, persuasive evidence to support an amortization method for finite life intangible assets that results in a lower amount of accumulated amortization than under the straight-line method, thereby effectively allowing the use of the unit of production method. § PAS 39, “Financial Instruments: Recognition and Measurement” — The improvement clarifies that changes in circumstances relating to derivatives, specifically derivatives designated or de-designated as hedging instruments after initial recognition, are not reclassifications. When financial assets are reclassified as a result of an insurance company changing its accounting policy in accordance with paragraph 45 of PFRS 4 “Insurance Contracts,” this is a change in circumstance, not a reclassification. It removes the reference to a “segment” when determining whether an instrument qualifies as a hedge. And it requires the use of revised effective interest rate (rather than the original effective interest rate) when remeasuring a debt instrument on the cessation of fair value hedge accounting. § PAS 40, “Investment Properties” — The improvement revises the scope (and the scope of PAS 16) to include property that is being constructed or developed for future use as an investment property. Where an entity is unable to determine the fair value of an investment property under construction, but expects to be able to determine its fair value on completion, the investment under construction will be measured at cost until such time as fair value can be determined or construction is complete. *SGVMC211961* - 24 § PAS 41, “Agriculture” — The improvement removes the reference to the use of a pre-tax discount rate to determine fair value, thereby allowing use of either a pre-tax or post-tax discount rate depending on the valuation methodology used. It further removes the prohibition to take into account cash flows resulting from any additional transformations when estimating fair value. Instead, cash flows that are expected to be generated in the ‘most relevant market’ are taken into account. Effective in 2010 § Revised PFRS 3, “Business Combinations” and PAS 27, “Consolidated and Separate Financial Statements” — The revised PFRS 3 introduces a number of changes in the accounting for business combinations that will impact the amount of goodwill recognized, the reported results in the period that an acquisition occurs, and future reported results. The revised PAS 27 requires, among others, that (a) change in ownership interests of a subsidiary (that do not result in loss of control) will be accounted for as an equity transaction and will have no impact on goodwill nor will it give rise to a gain or loss; (b) losses incurred by the subsidiary will be allocated between the controlling and non-controlling interests (previously referred to as “minority interests”); even if the losses exceed the non-controlling equity investment in the subsidiary; and (c) on loss of control of a subsidiary, any retained interest will be remeasured to fair value and this will impact the gain or loss recognized on disposal. The changes introduced by the revised PFRS 3 must be applied prospectively and will affect future acquisitions and transactions with non-controlling interests. Revised PAS 27 must be applied retrospectively subject to certain exceptions. § Amendment to PAS 39, “Financial Instruments: Recognition and Measurement - Eligible hedged items” — This amendment addresses only the designation of a one-sided risk in a hedged item, and the designation of inflation as a hedged risk or portion in particular situations. The amendment clarifies that an entity is permitted to designate a portion of the fair value changes or cash flow variability of a financial instrument as a hedged item. Improvement to PFRS § PFRS 5, “Noncurrent Assets Held for Sale and Discontinued Operations” The improvement clarifies when a subsidiary is held for sale, all of its assets and liabilities will be classified as held for sale under PFRS 5, even when the entity retains a non-controlling interest in the subsidiary after the sale. Effective in 2012 § Philippine Interpretation IFRIC 15, “Agreement for Construction of Real Estate” (effective for annual periods beginning on or after January 1, 2012) — This interpretation covers accounting for revenue and associated expenses by entities that undertake the construction of real estate directly or through subcontractors. This interpretation requires that revenue on construction of real estate be recognized only upon completion, except when such contract qualifies as construction contract to be accounted for under PAS 11, “Construction Contracts,” or involves rendering of services in which case revenue is recognized based on stage of completion. Contracts involving provision of services with the construction materials and where the risks and reward of ownership are transferred to the buyer on a continuous basis, will also be accounted for based on stage of completion. *SGVMC211961* - 25 - 8. Goodwill Acquisition of Additional Shares of Innovative In April 2008, the existing Parent Company’s interest in Innovative increased by 37.38% from 50% in 2007 to 87.38% in 2008. Indirect ownership in TGTI also increased from 40% to 69.90%. The Parent Company acquired from Intralot additional 574,885 shares of Innovative for a contract price of P =4.3 million. The total cost of the acquisition was comprised of a cash outlay amounting to P =2.9 million advanced in 2007 and P =1.4 million paid in 2008. The provisional values of the identifiable assets and liabilities of Innovative as of the acquisition and the corresponding carrying amounts immediately before the acquisition were as follows: Cash Receivables Other current assets Property and equipment Other noncurrent assets Accounts payable Due to related parties Net assets Net assets acquired Provisional goodwill Total consideration Previous Provisional Value Carrying Value =383,852 P =383,852 P 1,214,755 1,214,755 1,109,179 1,109,179 7,092,627 7,092,627 6,407,946 6,407,946 16,208,359 16,208,359 (6,427,048) (6,427,048) (67,561,501) (67,561,501) (57,780,190) (57,780,190) 37.38% 37.38% (21,598,235) (P =21,598,235) 25,912,035 =4,313,800 P The Group recorded its share in the identifiable assets and liabilities of Innovative at provisional values as of balance sheet date because the Company is still in the process of determining the fair values of net liabilities acquired and intangible asset that might arise with the ELA with PCSO of the acquired company. As permitted by PFRS 3, “Business Combinations” the Company will recognize any adjustment to those provisional values to goodwill upon determination of final fair values of identifiable assets and liabilities within 12 months from the date of acquisition. Provisional goodwill is not subjected to impairment testing. From the date of acquisition to December 31, 2008, Innovative and TGTI reduced the net income of the Group by P =9.3 million. If the business combination had taken place at the beginning of 2008, the net income for the Group would have been P =135.2 million (reduced by P =3.6 million). The goodwill of = P25.9 million comprises the fair value of the ELA with PCSO of the acquired company and expected synergies arising from the acquisition. *SGVMC211961* - 26 Minority Interest Minority interest is the 12.62% share of the other venturer in the previous joint venture. Losses applicable to the minorities in the 2008 consolidated financial statements may exceed the minority interests in the subsidiary’s equity since the minorities have binding obligation to provide securities or guarantee of any loan or financing to be obtained on behalf of Innovative proportionally to its shareholding percentage. Acquisition of Lucky Circle by LotoPac LotoPac was incorporated on March 16, 2007, and on August 29, 2007, acquired Lucky Circle, an authorized agent of PCSO to operate several online lottery betting stations located at branches of the SM Supermalls nationwide. The goodwill arising from the acquisition of Lucky Circle in 2007 follows: Cash Receivables Other current assets Property and equipment Other noncurrent assets Accounts payable Net assets Goodwill Total consideration Previous Fair Value Carrying Value =1,690,454 P =1,690,454 P 4,009,365 4,009,365 5,847,700 5,847,700 1,541,314 1,541,314 2,062,000 2,062,000 15,150,833 15,150,833 (9,052,999) (9,052,999) 6,097,834 =6,097,834 P 13,506,316 =19,604,150 P From the date of acquisition (August 29, 2007) to December 31, 2007, Lucky Circle contributed =1.3 million to the net income of the Group. If the business combination had taken place at the P beginning of 2007, the 2007 net income for the Group would have been P =135.4 million (increased by P =0.4 million). The goodwill of = P13.5 million comprises the fair value of expected synergies arising from the acquisition. Based on management’s cash flow projections in 2007, the present value of the expected cash flows from operations of Lucky Circle is P =19.5 million; thus, provision for impairment loss of P =0.1 million is recognized in the 2007 consolidated statement income. Key Assumptions on Impairment Testing of Goodwill The Company performs impairment testing annually or more frequently when there are indications of impairment for goodwill. The Company performed impairment testing of these assets at December 31. Following are the key assumptions on which management has based its cash flow projections to undertake impairment testing of goodwill: Gross Revenue. Gross revenue of the subsidiaries over the next five years were projected to grow in line with the economy or with nominal Gross Domestic Product. This assumes that the market share of the subsidiaries in their respective industries will be flat on the assumption that the industries also grow at par with the economy. *SGVMC211961* - 27 Operating Expenses. Operating expenses were projected to increase at a single-digit growth rate and at a slower pace than revenue. Gross Margins. Increased efficiencies over the next five years are expected to result in margin improvements. Discount Rate. The discount rate used to arrive at the present value of future cash flows was the Weighted Average Cost of Capital (WACC). WACC was based on the appropriate weights of debt and equity, which were multiplied with the assumed costs of debt and equity. The movements in goodwill are as follows: Cost Balance at beginning of year Additions (Provisional) Balance at end of year Less accumulated impairment loss Net book value 2008 2007 P =13,506,316 25,912,035 39,418,351 142,832 P =39,275,519 =– P 13,506,316 13,506,316 142,832 =13,363,484 P 9. Segment Information The primary segment reporting format is presented based on business segments in which the Group’s risks and rates of return are affected predominantly by differences in the products and services provided. The operating businesses are organized and managed separately according to the nature of the products and services provided, with each segment representing a strategic business unit that offers different products and serves different markets. The Group is engaged in the businesses of leasing gaming equipment to PCSO (leasing activity) and sale of lottery, sweepstake and instant scratch tickets (distribution and retail activities), among others. Financial information about the Group’s business segments are shown below: Leasing Activity Revenue Equipment rentals Commission income Instant scratch ticket project with PCSO Maintenance and repair fees Total Revenue P =642,598,196 – – 9,737,152 P =652,335,348 2008 Distribution and Retail Activities P =– 65,239,995 92,074,582 – P =157,314,577 Eliminations P =– – – – P =– Consolidated P =642,598,196 65,239,995 92,074,582 9,737,152 P =809,649,925 *SGVMC211961* - 28 - Leasing Activity 2008 Distribution and Retail Activities Eliminations P =5,627,019 2,426,472 P =3,200,547 P =8,026,574 – P =8,026,574 P =251,785,645 112,363,498 P =139,422,147 P =779,829,486 (3,276,796) P =776,552,690 Segment Results: Income before income tax Provision for income tax Net income P =238,132,052 109,937,026 P =128,195,026 Segment assets Deferred tax Segments assets (excluding deferred tax) P =666,673,818 (3,276,796) P =663,397,022 P =119,222,217 – P =119,222,217 (P =6,066,549) – (P =6,066,549) Segment liabilities P =171,000,134 P =115,665,645 (P =172,008,374) P =87,268,223 26,682,506 73,760,142 P =– – 1,873,987 Other Information Capital expenditures Capitalized assets Depreciation and amortization Leasing Activity Revenue Equipment rentals Commission income Instant scratch ticket project with PCSO Maintenance and repair fees Total Revenue Segment assets Investments and advances Deferred tax Segments assets (excluding deferred tax and investments and advances) Segment liabilities Segment Results: Income (loss) before income tax Provision for income tax Net income (loss) Other Information Capital expenditures Capitalized assets Depreciation and amortization P =114,657,405 P =– – – P =87,268,223 26,682,506 75,634,129 Eliminations Consolidated =– P – – – =– P =472,368,287 P 13,210,086 21,011,172 7,193,426 =513,782,971 P =472,368,287 P – – 7,193,426 =479,561,713 P =– P 13,210,086 21,011,172 – =34,221,258 P =724,956,835 P – (2,000,616) =48,983,680 P – – (P =37,489,728) – – =736,450,787 P (47,135,294) (2,000,616) =722,956,219 P =48,983,680 P (P =37,489,728) =687,314,877 P =42,087,261 P =64,687,408 P (P =52,783,650) =53,991,019 P (P =142,831) – (P =142,831) =214,825,257 P 80,233,488 =134,591,769 P =215,070,497 P 80,066,921 =135,003,576 P =48,162,545 P 89,888,207 55,190,762 Leasing Activity Revenue Equipment rentals Maintenance and repair fees Total Revenue 2007 Distribution and Retail Activities Consolidated =402,042,400 P 11,591,988 =413,634,388 P (P =102,409) 166,567 (P =268,976) =4,823,889 P – 298,301 2006 Distribution and Retail Activities =– P – =– P =– P – – Eliminations =– P – =– P =52,986,434 P 89,888,207 55,489,063 Consolidated =402,042,400 P 11,591,988 =413,634,388 P *SGVMC211961* - 29 2006 Distribution and Retail Activities =– P – =– P Segment assets Deferred tax Segments assets (excluding deferred tax) Leasing Activity =394,881,393 P (3,066,385) =391,815,008 P Segment liabilities =272,904,870 P =– P =– P =272,904,870 P Segment Results: Income before income tax Provision for income tax Net income =80,575,748 P 30,109,195 =50,466,553 P =– P – =– P =– P – =– P =80,575,748 P 30,109,195 =50,466,553 P Other Information Capital expenditures Capitalized assets Depreciation and amortization =10,832,069 P 64,806,938 42,788,288 =– P – – =– P =10,832,069 P 64,806,938 42,788,288 Eliminations =– P – =– P – Consolidated =394,881,393 P (3,066,385) =391,815,008 P There were no sales and transactions between internal parties. 10. Cash and Cash Equivalents This account consists of: Cash on hand and in banks Cash equivalents 2008 P =93,005,632 10,419,141 P =103,424,773 2007 =57,397,448 P 94,019,953 =151,417,401 P Cash in banks earn interest at the respective bank deposit rates. Cash equivalents are short-term investments which are made for varying periods within one day to three months depending on the immediate cash requirements of the Group and earn interest at the respective short-term investment rates. Interest income from cash and cash equivalents amounted to P =2.6 million in 2008, P =3.0 million in 2007 and P =0.9 million 2006 (see Note 22). 11. Investments Held for Trading This account consists mainly of investments in quoted shares of stock of Leisure and Resorts World Corporation, iVantage Corporation, Belle Corporation, Sinophil Corp. and Philippine Long Distance Telecommunications Company. *SGVMC211961* - 30 Movement in investments held for trading related to additions and fair value changes are as follows: Carrying value of investments, beginning of year Additions during the year Mark-to-market loss Carrying value of investments, end of year 2008 P =58,213,480 44,605,291 (48,008,254) P =54,810,517 2007 =10,550,400 P 58,841,397 (11,178,317) =58,213,480 P The Group determines the cost of investments sold using specific identification method. 12. Trade and Other Receivables This account consists of: Trade (see Note 2) Advances to: Officers and employees (see Note 19) Contractors and suppliers Others § § § § 2008 P =38,010,276 2007 =26,436,779 P 28,726,468 21,768,816 28,291,415 P =116,796,975 7,537,085 27,509,183 6,184,869 =67,667,916 P Trade receivables are noninterest-bearing and generally collected within a month. Advances to contractors and suppliers are noninterest-bearing and generally have 30 days term. Advances to officers and employees are noninterest-bearing and are normally liquidated within a year. Other receivables, which pertain mainly to advances to third party, are noninterest-bearing and generally have 30-60 days term. 13. Other Current Assets This account consists of: Input VAT (net of allowance for probable losses amounting P =2.8 million) Instant scratch ticket supplies Spare parts and supplies - at cost Prepaid expenses and others (see Note 16) 2008 2007 P =23,078,541 21,122,825 2,817,776 5,550,317 P =52,569,459 =17,790,283 P 10,260,667 1,828,975 13,883,107 =43,763,032 P *SGVMC211961* - 31 Input VAT amounting to P =4.3 million were applied for tax credit and is pending approval from the Bureau of Internal Revenue (BIR). On September 1, 2005, the Commissioner of BIR has signed Revenue Regulations (RR) No. 16-2005, which took effect on November 1, 2005. The RR, among others, introduces the following changes: a. The government or any of its political subdivisions, instrumentalities or agencies, including government-owned or controlled corporations (GOCCs) shall, before making payment on account of each purchase of goods and/or of services taxed at 12% VAT pursuant to Sections 106 and 108 of the Tax Code, deduct and withhold a final VAT due at the rate of 5% of the gross payment thereof. b. The 5% final VAT withholding rate shall represent the net VAT payable of the seller. The remaining 7% effectively accounts for the standard input VAT for sales of goods or services to government or any of its political subdivisions, instrumentalities or agencies including GOCCs, in lieu of the actual input VAT. Should actual input VAT exceed 7% of gross payments, the excess may form part of the seller’s expense or cost. On the other hand, if actual input VAT is less than 7% of gross payment, the difference must be closed to expense or cost. Difference between standard input VAT and actual input VAT is presented as “Other charges” in 2008 amounted to P =4.0 million and “Other income” in 2007 and 2006 amounted to P =13.5 million and P =10.6 million, respectively (see Note 25). 14. Investment and Advances The details and movement of the Parent Company’s interest in Innovative, a joint venture, and advances to TGTI, 80%-owned by Innovative as of December 31, 2007, are as follows: Acquisition cost Accumulated equity in net losses: Balance at beginning of year Equity in net losses for the year Balance at end of year Advances to TGTI (see Notes 19 and 28) =7,689,740 P 21,977,710 5,927,929 27,905,639 (20,215,899) 67,351,193 =47,135,294 P As discussed in Note 8, Innovative became a subsidiary in 2008. Prior to obtaining control, the Parent Company accounted for its investment in Innovative using equity method. Given that Innovative is now classified as a subsidiary, the Group now prepares consolidated financial statements to include Innovative in its consolidation and accordingly, the related investments and advances were eliminated. *SGVMC211961* - 32 - 15. Property and Equipment This account consists of: Cost Balance at beginning of year Business combination (see Note 8) Capital lease during the year (see Notes 24 and 29) Additions Reclassifications/disposals Balance at end of year Accumulated Depreciation and Amortization Balance at beginning of year Depreciation and amortization Disposals Balance at end of the year Net Book Value Cost: Balance at beginning of year Business combination (see Note 8) Capital lease during the year (see Notes 24 and 29) Additions Disposals Balance at end of year Accumulated Depreciation and Amortization Balance at beginning of year Depreciation and amortization Disposals Balance at end of year Net Book Value Lottery Equipment Leasehold Improvements P = 394,106,132 3,914,110 P = 16,439,244 2,221,795 2008 Office Furniture Transportation and Fixtures Equipment Equipment Under Installation Total P = 27,382,603 956,721 P = 23,918,055 – P = 484,454,659 7,092,626 P = 22,608,625 – 26,682,506 37,948,187 23,918,055 486,568,990 – 33,791,176 (111,295) 52,340,920 – 9,552,655 (600,613) 37,291,366 – 12,594,339 (1,549,200) 33,653,764 93,199,627 63,469,312 – 156,668,939 P = 329,900,051 16,096,142 1,789,660 (111,295) 17,774,507 P = 34,566,413 16,936,109 5,452,537 (581,404) 21,807,242 P = 15,484,124 10,676,610 4,922,620 (1,492,630) 14,106,600 P = 19,547,164 – – – – P =– 136,908,488 75,634,129 (2,185,329) 210,357,288 P = 399,497,752 2007 Office Furniture Transportation and Fixtures Equipment Equipment Under Installation Total =– P – =341,649,879 P 1,541,314 Lottery Equipment Leasehold Improvements =290,379,332 P – =16,057,639 P 369,101 =19,243,871 P 1,031,884 =15,969,037 P 140,329 – – (23,918,055) – 26,682,506 93,886,357 (2,261,108) 609,855,040 89,888,207 13,853,138 (14,545) 394,106,132 – 12,504 – 16,439,244 – 7,162,757 (55,909) 27,382,603 – 10,366,413 (3,867,154) 22,608,625 – 23,918,055 – 23,918,055 89,888,207 55,312,867 (3,937,608) 484,454,659 43,742,054 49,472,118 (14,545) 93,199,627 =300,906,505 P 16,057,638 38,504 – 16,096,142 =343,102 P 15,044,559 1,947,459 (55,909) 16,936,109 =10,446,494 P 10,512,782 4,030,982 (3,867,154) 10,676,610 =11,932,015 P – – – – =23,918,055 P 85,357,033 55,489,063 (3,937,608) 136,908,488 =347,546,171 P In 2005, the Parent Company acquired certain lottery equipment to replace its existing equipment. Accordingly, replaced lottery equipment were decommissioned in 2006. The decommissioned lottery equipment in 2006 and 2005 were disposed in 2006. Loss recognized from the disposal amounted to P =36.9 million. Certain lottery equipment were acquired under finance lease agreements. The carrying amount of the equipment under finance lease agreements amounted to P =254.0 million and P =280.7 million as of December 31, 2008 and 2007, respectively (see Note 24). The Parent Company acquired additional transportation equipment amounting to P =11.5 million in 2008 and P =10.4 million in 2007. The net carrying value of the transportation equipment amounted to P =19.5 million and P =11.9 million as of December 31, 2008 and 2007, respectively. The related liability, presented separately as “Installment payable” amounted to P =6.6 million and = P2.3 million as of December 31, 2008 and 2007, respectively. *SGVMC211961* - 33 Installment payable arising from the purchase of transportation equipment is subject to interest ranging from 7.26% to 9.33% in 2008 and 2.0% to 7.3% in 2007. The outstanding balance in 2008 will be fully settled in September 2010. 16. Trade and Other Current Liabilites This account consists of: Trade payable Consultancy and software and license fees payable (see Note 24) Accrued expenses: Management fees (see Note 19) Communication Rental and utilities Others Others 2008 P =17,827,803 2007 =9,021,730 P 13,924,658 4,763,614 6,430,542 2,472,465 11,528 20,410,971 10,050,247 P =71,128,214 2,166,580 – 2,433,933 521,633 1,701,869 =20,609,359 P Below are the terms and conditions of the above financial liabilities: § Trade payable, which are noninterest-bearing and normally settled on 15 to 30 days’ terms, consists of payable to PCSO for unremitted cash receipts from the sale of lotto tickets (on-line lottery) and payable to suppliers of sweepstakes and other tickets. § Consultancy and software and license fees and other current liabilities are noninterest-bearing and are normally settled on 15 to 30 days’ terms. Consultancy and software and license fees payable arose from the following agreements. a. Consultancy Agreements Company Arwen Gaming Consultancy, Inc. (AGC) Blackberry Gaming and Leisure Corporation (BGLC) Scope of Service AGC, a Philippine company, renders consultancy services relative to the telecommunication requirements of lottery operations of PCSO. BGLC, a Philippine Company, renders consultancy services to the online lottery venture of the Company particularly the 2-Digit Lotto. Fee Monthly commission of 0.5% of the gross amount of PCSO's lottery ticket sales, net of all taxes 1.5% of the gross amount of ticket sales from PCSO's 2-Digit Lotto game Consultancy Fees =30.5 million P 13.4 million 43.9 million Consultancy Fees Payable =2.7 million P 2008 2007 7.1 million 1.0 million – – 2006 – – Term Termination is upon mutual agreement of both parties Year 2008 2007 2006 Until the termination or expiry of the ELA – 4.7 million *SGVMC211961* - 34 - Company Golden Link Consultancy Group, Inc. (Golden Link) Scope of Service Golden Link, a Philippine company, renders advice and consulting services particularly the 2-Digit Lotto. Fee 1.5% of the gross amount of ticket sales from PCSO's 2-Digit Lotto game MRS Solutions Trading, Inc. (MRS) MRS, a Philippine company, renders comprehensive consultancy services involving the development of new game variations which are intended to generate additional revenues. STC, a Philippine company, renders comprehensive consultancy services involving the development and approval of game format variations and equipment upgrade for the on-line lottery operations which are intended to generate additional revenues. 1.5% of the gross amount of ticket sales from PCSO’s 3-Digit Game or Suertres Sign of the Times Consulting, Inc. (STC) Monthly commission of 1.5% of the gross amount of PCSO's lottery ticket sales Term Until the termination or expiry of the ELA or upon mutual agreement of both parties Until the termination or expiry of the ELA or upon mutual agreement of both parties Year 2008 2007 2006 Consultancy Fees =0.9 million P 2.5 million 2,121 Consultancy Fees Payable 2008 2007 2006 – 9.4 million 18.4 million – – Until the termination or expiry of the ELA or upon mutual agreement of both parties 2008 2007 2006 23.5 million 60.6 million =– P 0.3 million 1,803 1.5 million – – – 2.3 million On January 23, 2007, the BOD approved the pre-termination of the consultancy agreements of the Company with MRS and STC. Termination fees paid amounted to P =19.6 million and =7.8 million for MRS and STC, respectively. P On January 31, 2008, the Company and Golden Link mutually agreed to the pre-termination of the consultancy agreement. Advance payment to AGC amounted to P =26.0 million and is being amortized over 2 years based on amended agreement where AGC will continue rendering consultancy services until 2008 only. Unamortized portion amounting to P =13.4 million was included under “Other current assets” account in the 2007 consolidated balance sheet. However, in May 2008, the Company agreed to retain AGC and avail of the latter’s expertise and services to work out and monitor the necessary technical, operational, business, and legal arrangements needed in connection with the implementation of lottery draw in the VISMIN region. *SGVMC211961* - 35 b. Scientific Games On February 15, 2005, the Parent Company entered into a contract with Scientific Games, a company incorporated under the laws of the Republic of Ireland, for the supply of computer hardware and operating system software necessary for the operation of a new online lottery system effective November 20, 2005. Under the terms of the “Contract for the Supply of the Visayas-Mindanao Online Lottery System,” Scientific Games will provide the Parent Company with 900 online lottery terminal and terminal software necessary for its operation. In consideration, the Parent Company shall pay Scientific Games a pre-agreed percentage of its revenue from the conduct of online lottery games running under the system provided by Scientific Games. The total number of terminals delivered as of December 31, 2006 was 965. The additional 65 terminals are intended as replacement for defective terminals. Software and license fees amounted to P =10.4 million, P =1.7 million and P =0.3 million in 2008, 2007 and 2006, respectively (see Note 20). As of December 31, 2008 and 2007, software and license fees payable amounted P =3.6 million and P =1.4 million, respectively. c. Intralot On March 13, 2006, the Parent Company entered into a contract with Intralot, a company incorporated under the laws of the Greece, for the supply of online lottery system necessary for the operation of a new online lottery system effective December 8, 2006. Under the terms of the “Contract for the Supply of the Visayas-Mindanao Online Lottery System,” Intralot will provide the Parent Company the hardware, operating system software and terminals (collectively referred to as the System) and the training required to operate the System. Based on the amended contract signed on July 7, 2006, Intralot will provide the Parent Company with 600 online lottery terminals. In consideration, the Parent Company shall pay Intralot a pre-agreed percentage of the revenue generated by the terminals from the conduct of online lottery games running on the System, including without limitation, the revenue from the ELA contract or a fixed amount of US$110 per terminal per month, whichever is higher. The Parent Company received 200 terminals on October 13, 2006. In 2007, the Parent Company received 487 additional terminals. In 2008, there are 188 additional terminals installed. On July 10, 2006, Intralot entered into an agreement with its 85% subsidiary, Intralot Inc., a company domiciled in Atlanta, Georgia, wherein Intralot assigned whole of the contract, including all its rights and obligations arising from it, to Intralot Inc. Software and license fees amounted to P =8.4 million, P =0.6 million and P =0.1 million in 2008, 2007 and 2006, respectively (see Note 20). As of December 31, 2008 and 2007, software and license fees payable amounted to P =6.6 million and P =3.1 million, respectively. d. PMP Management Services Sdn Bhd (PMP) and Pacific Automated Systems Corporation (PASC) On April 16, 1996, the Parent Company entered into a Consultancy Agreement with PMP for the support in the operation and development of the leased online lottery equipment and accessories and the provision of maintenance and repair services. *SGVMC211961* - 36 The Parent Company also entered into Operational Support Services Agreement (OSSA) with PASC on April 23, 1996. The scope for this agreement is similar to the consultancy agreement with PMP. As of December 31, 2005, the recorded liability to PMP and PASC amounted to P =56.6 million (US$1.1 million). In 2006, the Parent Company terminated its agreements with PMP and PASC. Termination of the said agreements resulted in the recognition of gain on condonation of liability of P =39.2 million in the 2006 consolidated statement of income. There is no related outstanding payable as of December 31, 2008 and 2007. 17. Equity 2007 Amount Number of Shares 2008 Number of Shares Amount Capital Stock Authorized - par value of = P1/share 500,000,000 P =500,000,000 500,000,000 =500,000,000 P Issued and outstanding: Balance at beginning of period Issuance during the period Balance at end of period 199,098,000 617,000 199,715,000 P =199,098,000 617,000 P =199,715,000 125,250,000 73,848,000 199,098,000 =125,250,000 P 73,848,000 =199,098,000 P As discussed in Note 1, on November 11, 2006, the Parent Company’s BOD and stockholders authorized the Parent Company to conduct an IPO of common shares owned by the selling shareholders of the Parent Company; and apply for the listing thereof on the PSE. Furthermore, the BOD approved the following amendments to the Articles of Incorporation: (a) denial of preemptive rights; (b) removal of sub-classifications of the common shares; (c) grant of stock options, issuances of warrants, etc.; and (d) removal of right of first refusal. On March 23, 2007, the SEC and PSE approved the Parent Company’s application for public listing and trading of shares which commenced on April 12, 2007. IPO offer price is at =8.88. APIC arising from IPO amounted to P P =190.4 million (net of stock issuance costs of =19.3 million). P On May 19, 2008, grantees of the stock options exercised 617,000 shares of the Company’s stock at P =8.88 per share resulting to APIC amounting to P =4.9 million. In 2008, the BOD, upon recommendation of management, declared the following cash dividends: Date Approved May 6, 2008 July 11, 2008 July 11, 2008 Record May 23, 2008 August 8, 2008 November 17, 2008 Amount Payment June 19, 2008 September 3, 2008 December 8, 2008 Per Share =0.25 P 0.08 0.17 =0.50 P Total =49,928,750 P 15,956,880 33,483,030 =99,368,660 P *SGVMC211961* - 37 On July 11, 2008, the BOD authorized the Parent Company to buyback up to 2,000,000 shares from the public as a means of preserving the value of the Company’s shares and maintaining investor confidence and on another board meeting on October 14, 2008 approved to extend its share buy back program up to a maximum of 10% of the Company’s outstanding capital stock. As of December 31, 2008, the Company has acquired and paid 4,414,000 shares of capital stock at a weighted average price of P =8.40 for a total of P =37.1 million. 18. Stock Options Plan On April 11, 2007, the BOD approved the Parent Company’s Plan which provides an incentive and mechanism to employees and officers to become stockholders of the Parent Company, as well as to qualified directors, officers and employees, who are already stockholders, to increase their equity in the Parent Company and thereby increase their concern for the Parent Company’s wellbeing. All such full-time and regular employees of the Group and its affiliates, their officers and directors, and such other qualified persons who may be recommended from time to time by the Executive Committee or the BOD to the Committee as qualified, are eligible to participate in the Plan. The Plan is being administered by a Committee organized and appointed by the BOD. The Committee, in its sole discretion, shall determine from among those recommended by the Executive Committee or the BOD those to whom options are to be granted, the time or times when such options shall be granted, the effectivity dates thereof, and the number of shares to be allocated to each participant at a given time. Five percent of the Parent Company’s total outstanding common stock is reserved for the Plan. Any unexercised option lapsed or terminated for any reason shall revert back to the pool of shares reserved for the whole Plan, and may be offered to other qualified participants. The shares covered by any one grant shall be offered for subscription over a period of three years from and after the effectivity date of each grant that may be determined by the Committee. The participants may exercise their right to subscribe to shares under the Plan in accordance with the following schedule: § § § 1/3 of total grant immediately after the grant up to and until three years from the effectivity date of each grant 1/3 of total grant after one year from the effectivity date of each grant up to and until two years thereafter 1/3 of total grant after two years from the effectivity date of each grant up to and until a year thereafter The purchase price of the shares shall not in any case be less than the fair market value of the Parent Company’s shares at the time of grant, and, in no case, be less than the offer price at which the Parent Company’s shares are initially offered for sale to the public. Further, the purchase price shall be subject to adjustment for subsequent stock dividends or splits. On February 15, 2008, SEC approved the Parent Company’s application requesting that its proposed issuance on 9,954,900 common shares is exempt from the registration requirements of the Securities Regulation Code. *SGVMC211961* - 38 On May 6, 2008, the BOD approved the Committee’s allocation of 2,174,000 shares to its executives and employees and to the officers of Lucky Circle under the Plan which is exercisable over a period of three years from May 6, 2008 until May 6, 2011. The exercise price of the option was fixed at P =8.88 per share. The following table illustrates the number and weighted average exercise prices (WAEP) of, and movements in share options during the year: 2008 Number 2,174,000 (746,000) 1,428,000 – Granted during the year Exercised during the year Outstanding at end of year Exercisable at end of year WAEP =8.88 P 8.88 8.88 – The options outstanding at December 31, 2008 had an exercise price of P =8.88, and a weighted average remaining contractual life of 1.65 years. The fair values of the stock options are estimated on the date of grant using the Black-Scholes option-pricing model. The fair value of stock options granted under the Plan at grant date and the assumptions used to determine the fair value of the stock options are as follows: Vesting date Share price Exercise price Vesting period (days) Expected volatility Risk-free rate Dividend yield Fair value of stock options May 6, 2008 =9.20 P =8.88 P – 42% 7.89% 5% =2.00 P May 6, 2009 =9.20 P =8.88 P 310 42% 7.99% 5% =2.25 P May 6, 2010 =9.20 P =8.88 P 675 42% 7.97% 5% =2.44 P The risk-free rate used to get the time value of the option was determined with reference to the Philippine Dealing Exchange rates as of grant date corresponding to the estimated terms of the options and adjusted to zero-coupon basis. The volatility is an assumption regarding the variability of the stock price during the option period and computed using the the daily volatility of the Company's closing prices and adjusted to annual basis. The 5% assumption was based on the projected dividend of P =0.50 and an average price P =9.78 (actual average closing price from January 1 to May 6, 2008) for the year. Share-based compensation expense recognized in 2008 amounted to P =3.0 million. *SGVMC211961* - 39 - 19. Related Party Transactions Parties are considered to be related if one has the ability, directly or indirectly, to control the other party or exercise significant influence over the party in making financial and operating decisions. Parties are also considered to be related if they are subject to common control or common significant influence. Outstanding balances as of December 31, 2008 and 2007 are unsecured, interest free and settlement occurs in cash. There have been no guarantees provided or received for any related party receivables or payables. For the years ended December 31, 2008 and 2007, the Group has not made any provision for doubtful accounts relating to amounts owed by related parties. This assessment is undertaken each financial year through examining the financial position and the amount and timing of future cash flows of the related parties. The Parent Company has significant transactions with related parties in the normal course of business. The amounts included in the financial statements with respect to these transactions are as follows: a. AB Gaming manages the day-to-day operations of the Parent Company as provided in a Management Agreement (MA) entered into on June 10, 2002. Under the terms of the MA, the Parent Company shall elect the president of AB Gaming as the President, Chief Executive Officer (CEO) and Administrative Officer of the Parent Company. The MA shall be effective for five years until June 10, 2007 and shall be automatically renewed for a similar period unless terminated by either party. In March 2004, the Parent Company and AB Gaming amended the MA effective February 15, 2004. Under the amended MA, AB Gaming foregoes its entitlement to have its President designated as President and CEO of the Parent Company although the scope of the services remains unchanged. Also, the term of the MA shall continue as long as the Parent Company’s ELA with the PCSO is in effect. Total management fees amounted to P =35.2 million, P =25.6 million and P =19.2 million in 2008, 2007 and 2006, respectively. Outstanding payable as of December 31, 2008 and 2007 amounted to P =3.4 million and = P2.2 million, respectively (see Note 16). Also, in 2008, the Parent Company entered in management contract with AB Gaming for the management of the instant scratch ticket project with PCSO. Management fees for the instant scratch ticket project amounted to P =5.6 million in 2008 (see Note 21). Outstanding payable as of December 31, 2008 amounted to P =3.1 million (see Note 16). b. The Parent Company granted advances to TGTI which was covered by a Loan Agreement. In 2007 and prior years, the Parent Company has indirect interest in TGTI (see Note 14). Under the terms of Loan Agreement, the Parent Company shall provide short-term financial assistance credit of P =25.0 million to TGTI. Any outstanding loan shall be subject to simple interest calculated using the applicable short-term placement rate with monthly repricing plus add-on rate (MART 1) of 0.50% and payable as soon as the increase in capitalization of TGTI is received or as soon as proper demand is made by the Parent Company’s BOD. *SGVMC211961* - 40 As of December 31, 2007, total advances granted to TGTI and unpaid interest (included under “Investment and advances” account in the consolidated balance sheets) amounted to =67.4 million. Interest income amounted to P P =2.5 million in 2007 and P =2.3 million in 2006 (see Note 22). c. The Parent Company granted interest-bearing advances to one of its officers amounting to =20.0 million which is payable within one year subject to simple interest calculated using the P applicable short-term placement rate with monthly repricing plus add-on rate of 0.50%. Outstanding balance of receivables amounted to P =19.0 million as of December 31, 2008 (included under “Trade and other receivables” account in the consolidated balance sheet) (see Note 12). d. PMP, an affiliate of PASC (a 20% shareholder of the Parent Company) provides consultancy support in the operation and development of the leased online lottery equipment and accessories and the provision of maintenance and repair services. No services were rendered by PMP and PASC starting 2004. Agreements with PMP and PASC were terminated on March 16, 2006 and April 6, 2006, respectively. As discussed in Note 16, termination of service agreements resulted in the recognition of gain on condonation of liability of =39.2 million in the 2006 consolidated statement of income. P e. In May 2008, the BOD approved the advances made by the Parent Company to its executives and employees and to those of Lucky Circle amounting to P =3.3 million and P =0.4 million, respectively, as full payment of shares exercised the Company’s stock option plan. f. Compensation and benefits of key management personnel of the Group are as follows: 2007 2008 2006 (In Millions) Short-term employee benefits Post-retirement benefits Share-based payment =6.4 P 0.6 – =7.0 P P =7.2 0.8 0.9 P =8.9 =5.7 P 0.5 – =6.2 P 20. Operating Expenses This account consists of: Depreciation and amortization (see Note 15) Personnel costs (see Notes 18 and 26) Travel and accommodation Communication 2008 2007 2006 P =75,634,129 71,527,030 65,777,616 42,763,930 =55,489,063 P 35,606,417 16,678,121 40,478,336 =42,788,288 P 23,633,648 17,001,238 47,567,595 (Forward) *SGVMC211961* - 41 - Management fees (see Note 19) Consultancy fees (see Note 16) Rent and utilities (see Note 24) Professional fees Software and license fees (see Notes 16 and 24) Operating supplies Taxes and licenses Repairs and maintenance Entertainment, amusement and recreation Others 2008 P =40,709,338 38,521,104 28,570,189 25,178,753 2007 =25,620,349 P 50,637,864 11,856,321 8,257,321 2006 P19,204,440 = 122,917,073 7,321,413 14,866,579 18,788,804 17,677,559 11,476,483 11,031,736 9,947,972 39,795,653 P =497,400,296 2,298,762 3,794,344 5,618,652 10,551,026 7,391,155 13,394,534 =287,672,265 P 332,092 2,328,736 3,000,423 6,465,408 4,564,604 9,820,767 =321,812,304 P 2008 P =54,144,913 12,155,313 2,996,004 2,230,800 P =71,527,030 2007 =26,663,681 P 7,429,595 – 1,513,141 =35,606,417 P 2006 =15,724,872 P 6,358,443 – 1,550,333 =23,633,648 P Personnel costs consist of: Salaries and wages Employee benefits Share-based compensation (see Note 18) Retirement expense (see Note 26) 21. Instant Scratch Ticket Project with PCSO Presented below is the result of instant scratch ticket project with PCSO for the years ended December 31, 2008 and 2007: Sales Direct expenses: Prizes for winning tickets Share of PCSO Costs of printing Others Gross income 2008 P =430,738,446 2007 =176,724,880 P 232,830,177 70,000,000 27,671,260 8,162,427 338,663,864 P =92,074,582 101,158,400 39,197,978 11,876,560 3,480,770 155,713,708 =21,011,172 P *SGVMC211961* - 42 - 22. Interest Income This account consists of: Income from bank and short-term deposits (see Note 10) Others (see Note 19) 2008 2007 2006 P =2,560,512 734,455 P =3,294,967 =2,992,843 P 2,491,600 =5,484,443 P =917,749 P 2,253,740 =3,171,489 P 23. Income Tax The components of the Group’s net deferred tax assets follow: 2008 P =1,414,859 1,592,497 373,691 Defined benefit liability Accrual of prizes for winning tickets Share-based payment Excess of rental under operating lease on a straight-line basis Others 3,458 (107,709) P =3,276,796 2007 =869,889 P – – 129,744 1,000,983 =2,000,616 P The current provision for income tax represents RCIT in 2008, 2007 and 2006. A reconciliation of provision for income tax computed at the applicable statutory income tax rate to provision for income tax shown in the consolidated statements of income is as follows: Provision for income tax at statutory income tax rate Income tax effects of permanent differences: Nondeductible expenses Interest income subjected to final tax Others Change in tax rate 2008 2007 2006 P =88,124,976 =75,188,840 P =28,201,512 P 23,864,135 (872,852) (315,945) 1,563,184 P =112,363,498 6,239,587 (1,031,745) (163,194) – =80,233,488 P 1,907,683 – – – =30,109,195 P The deferred taxes and the provision for current income tax include the effect of the change in tax rates. Under Republic Act No. 9337, RCIT rate for domestic corporations and resident and nonresident foreign corporations is increased to 35% (from 32%) beginning November 1, 2005 and the rate will be reduced to 30% beginning January 1, 2009. The deferred tax assets were measured using the appropriate corporate income tax rate on the year it is expected to be reversed or settled. *SGVMC211961* - 43 - 24. Lease Commitments a. Finance Lease Lottery equipment. The contracts for the supply of online lottery system entered into by the Parent Company with Scientific Games and Intralot contain a lease which is accounted for as finance lease. These are included as part of lottery equipment under “Property and equipment” account in the consolidated balance sheets. The details are as follows: Property and equipment under finance lease Less accumulated depreciation 2008 P =383,357,899 129,405,650 P =253,952,249 2007 =356,675,393 P 75,991,428 =280,683,965 P The present value of future annual minimum lease payments under the lease agreements as of December 31, 2008 and 2007 follows: Year Ending December 31 Within one year After one year but not more than five years Total minimum lease payments Less amount representing interest Present value of lease payments Less current portion of obligations under finance lease Noncurrent portion of obligations under finance lease 2008 P =86,510,679 229,147,470 315,658,149 56,723,699 258,934,450 2007 P86,324,497 = 273,646,059 359,970,556 75,877,203 284,093,353 62,471,714 55,849,197 P =196,462,736 =228,244,156 P The contracts remain effective until March 31, 2013, the expiration date of the ELA. Payment to Scientific Games is based on a pre-agreed percentage of the Parent Company’s revenue from the conduct of online lottery games running under the system provided by Scientific Games. Payment to Intralot is based on a pre-agreed percentage of the revenue generated by the terminals from the conduct of online lottery games running on the System, including without limitation, the revenue from the ELA contract or a fixed amount of US$110 per terminal per month, whichever is higher. Payments to Scientific Games and Intralot include the non-lease elements which are presented as “Software and license fees” account in the consolidated statements of income (see Notes 16 and 20). The Company initially recognized the loans liability based on the fair value of the equipment or the sales price since the minimum lease payments cannot be established, as the monthly payment varies depending on the revenue generated by the leased equipment. *SGVMC211961* - 44 Transportation Equipment. The Parent Company has finance leases covering its transportation equipment subject to two-year term (see Note 15). Future minimum lease payments under these finance leases together with the present value of the minimum lease payments are as follows: Within one year After one year but not more than five years Total future minimum lease payments Less amount representing interest Present value of minimum lease payments Less current portion 2008 P =4,683,341 2,577,284 7,260,625 642,491 6,618,134 4,269,134 P =2,349,000 2007 =2,473,777 P – 2,473,777 147,344 2,326,433 2,326,433 =– P The liability relating to finance leases is shown as “Installment payable” account in the consolidated balance sheets. b. Operating Lease As Lessor The Parent Company leases to PCSO online lottery equipment and accessories for a period of eight years until March 31, 2013 as provided in the ELA. Rental payment is based on certain percentage of gross amount of lotto ticket sales from the operation of all PCSO’s lotto terminals in VISMIN or a fixed annual rental of P =35,000 per terminal in commercial operation, whichever is higher (see Note 2). Rental income amounted to P =639.4 million in 2008, = P472.4 million in 2007 and P =402.0 million in 2006. Future minimum rental income for the remaining lease terms are as follows: Year Within one year After one year but not more than five years Amount P56,000,000 = 182,000,000 TGTI leases to PCSO online KENO games for a period of 10 years from the time the ELA will run in commercial operations. Rental payment is based on certain percentage of gross amount of Online KENO games from the operation of all PCSO’s terminals or a fixed annual rental of P =40,000 per terminal in commercial operation, whichever is higher (see Note 2). Rental income amounted to P =3.2 million in 2008. Should TGTI meet the 200 terminals as required in the ELA, future minimum rental income for the remaining lease terms should have been as follow: Year Within one year After one year but not more than five years Beyond five years Amount P8,000,000 = 32,000,000 40,000,000 *SGVMC211961* - 45 As Lessee The Parent Company leases certain office spaces for periods of one to five years up to January 14, 2011. The lease agreements provide for minimum rental commitments with annual rental escalation rate of 5%. Rent expense charged to operations amounted to =2.8 million in 2008, P P =3.3 million in 2007 and P =3.9 million in 2006. Future minimum lease expense under the lease agreements are as follows: Year Within one year After one year but not more than five years Amount =2,674,727 P 2,698,814 25. Other Income (Charges) This account consists of: 2008 Excess (deficiency) input VAT (see Note 13) Rental income Income from winning tickets Dividend income Bank charges Others (see Note 2) (P =4,004,125) 1,923,414 1,899,448 903,100 (122,279) 9,889,329 P =10,488,887 2007 2006 =13,476,718 P 4,280,914 1,989,275 466,268 – 4,042,407 =24,255,582 P =10,551,603 P – – 11,150 – – =10,562,753 P 26. Retirement Plan The Group has a funded, noncontributory defined benefit plan covering substantially all of its regular employees. Total retirement costs charged to operations amounted to P =2.2 million in 2008, P =1.5 million in 2007 and P =1.6 million in 2006. The following tables summarize the components of the Group’s retirement expense recognized in the consolidated statements of income and defined benefit liability recognized in the consolidated balance sheets. Retirement Expense (recorded under “Operating Expenses”) Current service cost Interest cost Expected return on plan assets Amortization for actuarial loss Retirement expense (see Note 20) 2008 P =1,432,500 996,400 (248,700) 50,600 P =2,230,800 2007 =838,307 P 620,408 – 54,426 =1,513,141 P 2006 =1,020,601 P 529,732 – – =1,550,333 P *SGVMC211961* - 46 Defined Benefit Liability 2008 P =5,677,700 (4,718,200) 959,500 3,756,698 P =4,716,198 Present value of defined benefit liability Fair value of plan assets Unfunded obligation Unrecognized actuarial gain (loss) Defined benefit liability 2007 P9,636,733 = (4,973,765) 4,662,968 (2,177,570) =2,485,398 P Changes in the present value of the defined benefit liability are as follows: Balance at beginning of year Current service cost Interest cost Actuarial loss (gain) on obligations Balance at end of year 2008 P =9,636,733 1,432,500 996,400 (6,387,933) P =5,677,700 2007 =7,755,105 P 838,307 620,408 422,913 =9,636,733 P 2008 P =4,973,765 – 248,700 (504,265) P =4,718,200 2007 =– P 4,755,539 – 218,226 =4,973,765 P (P =255,565) =218,226 P Movement in the fair value of plan assets Balance at beginning of year Contributions Expected return on plan assets Actuarial (loss) gain Balance at end of year Actual return on plan assets Movement of Defined Benefit Liability 2008 P =2,485,398 2,230,800 – P =4,716,198 Balance at beginning of year Retirement expense Contributions paid Balance at end of year 2007 =5,727,796 P 1,513,141 (4,755,539) =2,485,398 P The principal assumptions used in determining the defined benefit liability of the Group are shown below: Discount rate Future salary increase Expected rate of return on assets 2008 18.45% 10.00% 5.00% 2007 10.34% 10.00% 5.00% 2006 8.00% 10.00% 5.00% The overall expected return on plan assets is determined based on market prices prevailing on that date, applicable to the period over which the obligation is to be settled. Experience adjustments on benefit obligation amounted to P =0.6 million in 2008 and P =0.4 million in 2007. *SGVMC211961* - 47 - 27. EPS The following table presents information necessary to calculate basic and diluted EPS: 2008 2007 Net income attributable to equity holders of the Parent P134,591,769 P =140,597,374 = Outstanding capital stock at beginning of year 125,250,000 199,098,000 Effect of issuance of shares during the year 73,848,000 382,033 Effect of purchase of treasury shares during the year (1,098,497) – Weighted average number of shares outstanding during the year 184,941,333 198,381,536 Basic/Diluted EPS =0.73 P P =0.71 2006 =50,466,553 P 125,250,000 – – 125,250,000 =0.40 P Basis EPS is calculated by dividing the net income for the period by the weighted average number of shares outstanding during the period. Diluted EPS is calculated in the same manner assuming that, at the beginning of the year or at the time of issuance during the year, all outstanding options are exercised. Outstanding stock options will have a dilutive effect only when the average market price of the underlying share during the year exceeds the exercise price of the option. Option shares totaling to 1,428,000 shares granted in May 6, 2008 were not considered in the calculation of the diluted EPS because they are anti-dilutive for the year. 28. Financial Instruments Financial Risk Management Objectives and Policies The Group’s principal financial instruments are composed of cash and cash equivalents and obligation under finance lease. The main purpose of these financial instruments is to finance the Group’s operations. The Group has various other financial assets and liabilities such as trade and other receivables, trade and other current liabilities and advances to related parties, which arise directly from its operations. The main risks arising from the Group’s financial instrument are foreign currency risk, credit risk, liquidity risk and equity price risk. The Group’s BOD and management review and agree on the policies for managing each of these risks as summarized below: Foreign Currency Risk The Group has transactional currency exposures. Such exposure arises from consultancy payable with certain suppliers which are denominated in U.S. dollar (US$). The Group’s financial instrument which is denominated in foreign currency includes cash and cash equivalents and consultancy and software and license fees payable. The Group maintains a U.S. dollar account to match its foreign currency requirements. *SGVMC211961* - 48 As of December 31, 2008 and 2007, asset and liability denominated in foreign currencies include cash and cash equivalents amounting to P =3.3 million ($69,467) and P =1.0 million ($23,341), respectively; and consultancy and software and license fees payable amounting to P =8.7 million ($182,774) and P =3.1 million ($73,747), respectively. In translating foreign currency-denominated monetary assets and liabilities into peso amounts, the exchange rate used were P =47.52 to US$1.0 and P =41.28 to US$1.0, the Philippine peso to U.S. dollar exchange rates as of December 31, 2008 and 2007, respectively. The following table demonstrates the sensitivity to a reasonably possible change in the Philippine peso (Php)-US$ exchange rates, with all other variables held constant, of the Group’s consolidated income before tax. There is no other impact on the Company’s equity other that those already affecting the consolidated statement of income. Change in foreign currency rate Effect on income before income tax 2008 Increase in US$ Decrease in US$ P =1.98 P =1.07 (224,349) 121,239 Change in foreign currency rate Effect on income before income tax 2007 Increase in US$ Decrease in US$ =1.02 P =0.70 P (51,666) 3,528 The increase in US$ rate means stronger US$ against peso while the decrease in US$ means stronger peso against the US$. Credit Risk The Group’s trade receivable arises from equipment lease agreement with PCSO, the Company’s sole customer. Since the Group has significant concentration of credit risk on its receivable with PCSO, it is the Group‘s policy that all terms specified in the ELA with PCSO are complied with and ensure payment terms as agreed. With respect to other receivables, the Company manages credit risk by transacting only with recognized, credit worthy third parties and selected PCSO provincial district offices on their sale of instant scratch tickets. It is the Company’s policy that the BOD approves on major transactions with third parties. Receivable balances are monitored on an ongoing basis with the result that the Group’s exposure to bad debts is not significant. With respect to credit risk arising from the other financial assets of the Group, which are composed of cash and cash equivalents and investments in held for trading, the Group’s exposure to credit risk arises from default of the counterparty, with a maximum exposure equal to the carrying amount of these instruments. *SGVMC211961* - 49 The table below shows the maximum exposure to credit risk for the Group’s financial assets, as of December 31, 2008 and 2007, without taking account any collateral and other credit enhancements: Cash and cash equivalents Investments held for trading Trade and other receivables: Trade receivables Advances to officers and employees Advances to contractors and suppliers Other receivables Advances to TGTI (included as part of “Investment and advances” account in the consolidated balance sheets) Total credit risk exposure 2008 P =103,424,773 54,810,517 2007 =151,417,401 P 58,213,480 38,010,276 28,726,468 21,768,816 28,291,415 26,436,779 7,537,085 27,509,183 6,184,869 – P =275,032,265 67,351,193 =344,649,990 P As discussed in Note 8, TGTI became an indirectly owned subsidiary in 2008. The table below shows aging analysis of receivables as of December 31, 2008 and 2007: Trade receivables Advances to officers and employees Advances to contractors and suppliers Other receivables Trade receivables Advances to officers and employees Advances to contractors and suppliers Advances to TGTI Other receivables Neither Past Due nor Impaired P = 38,010,276 1,561,064 15,939,226 20,900,880 P = 76,411,446 Neither Past Due nor Impaired =26,436,779 P 4,129,280 26,735,237 5,402,299 804,485 =63,508,080 P 2008 Past Due but not Impaired 91–120 Days P =– 2,983,081 778,417 380,326 P = 4,141,824 121–150 Days P =– 27,615 603,900 457,638 P = 1,089,153 151–180 Days P =– 31,494 – 150,000 P = 181,494 Over 180 Days P =– 24,123,214 4,447,273 6,402,571 P = 34,973,058 Subtotal =– P 27,165,404 5,829,590 7,390,535 P = 40,385,529 Total P = 38,010,276 28,726,468 21,768,816 28,291,415 P = 116,796,975 Subtotal =– P 3,407,805 773,946 61,948,894 5,380,384 =71,511,029 P Total =26,436,779 P 7,537,085 27,509,183 67,351,193 6,184,869 =135,019,109 P 2007 Past Due but not Impaired 91–120 Days =– P 2,011 – 2,350,270 66,632 =2,418,913 P 121–150 Days =– P 22,729 – 1,241,844 31,489 =1,296,062 P 151–180 Days =– P 3,383,065 – 226,413 – =3,609,478 P Over 180 Days =– P – 773,946 58,130,367 5,282,263 =64,186,576 P Receivables that are past due but not impaired are still collectible based on the assessment of debtor’s ability to pay and collection agreement. The table below shows the credit quality of the Group’s neither past due nor impaired financial assets based on their historical experience with the corresponding third parties. Cash and cash equivalents Investments held for trading Receivables: Trade receivables Advances to officers and employees Advances to contractors and suppliers Other receivables Grade A P =103,424,773 54,810,517 2008 Grade B P =– – Grade C P =– – Total P =103,424,773 54,810,517 38,010,276 – – – – 1,561,064 38,010,276 1,561,064 – – P =196,245,566 15,939,226 – P =15,939,226 – 20,900,880 P =22,461,944 15,939,226 20,900,880 P =234,646,736 *SGVMC211961* - 50 - Cash and cash equivalents Investments held for trading Receivables: Trade receivables Advances to officers and employees Advances to contractors and suppliers Advances to TGTI Other receivables 2007 Grade B =– P – Grade A =151,417,401 P 58,213,480 Grade C =– P – Total =151,417,401 P 58,213,480 26,436,779 – – 26,436,779 – – 4,129,280 4,129,280 – – – =236,067,660 P 26,735,237 – – =26,735,237 P – 5,402,299 804,485 =10,336,064 P 26,735,237 5,402,299 804,485 =273,138,961 P Grade A financial assets pertain to those cash and cash equivalents that are deposited in a reputable bank, investments with reputable publicly listed companies and receivables from PCSO which are consistently collected before the maturity date. Grade B includes receivables that are collected on their due dates even without an effort from the Group to follow them up, while receivables which are collected on their due dates provided that the Group made a persistent effort to collect them are included under Grade C receivables. Liquidity Risk Liquidity risk is the risk that the Group will be unable to meet its payment obligations when they fall due under normal and stress circumstances. To limit this risk, the Company closely monitors its cash flows and ensures that credit facilities are available to meet its obligations as and when they fall due. The Group also has a committed line of credit that it can access to meet liquidity needs. The Group maintains sufficient cash to finance its operations. Any excess cash is invested in short-term money market placements. These placements are maintained to meet the requirements for additional capital expenditures, maturing obligations and cash dividends. The table below summarizes the maturity profile of the Group’s financial liabilities based on contractual undiscounted payments: 2008 Trade and other current liabilities* Installment payable (inclusive of current portion): Principal Interest Obligations under finance lease Less than 3 Months P =71,060,677 3–6 Months P =– 6–12 Months P =– More than 12 Months P =– Total P =71,060,677 1,117,934 107,230 23,859,868 P =96,145,709 1,050,400 102,326 21,292,714 P =22,445,440 2,100,800 204,652 41,358,097 P =43,663,549 2,349,000 228,284 229,147,470 P =231,724,754 6,618,134 642,492 315,658,149 P =393,979,452 * Excluding other current liabilities representing statutory payables and other liabilities to the government. 2007 Trade and other current liabilities* Installment payable: Principal Interest Obligations under finance lease Less than 3 Months =20,579,316 P 3–6 Months =– P 6–12 Months =– P More than 12 Months =– P Total =20,579,316 P 1,470,500 85,183 20,243,021 =42,378,020 P 527,133 38,281 20,062,983 =20,628,397 P 328,800 23,880 46,018,493 =46,371,173 P – – 273,646,059 =273,646,059 P 2,326,433 147,344 359,970,556 =383,023,649 P * Excluding other current liabilities representing statutory payables and other liabilities to the government. *SGVMC211961* - 51 Equity Price Risk Equity price risk is the risk that the fair value of quoted investments held for trading decreases as the result of changes in the value of individual stocks. The Group’s exposure to equity price risk relates primarily to the Group’s quoted investments held for trading. The Group monitors the equity investment based on market expectations. Material investments within the portfolio are managed on an individual basis and all buy and sell decisions are approved by the BOD. The following table demonstrates the sensitivity to a reasonably possible change in equity price, with all other variables held constant, of the Group’s consolidated income before income tax. There is no other impact on the Group’s equity other than those already affecting the consolidated statements of income. 2008 Increase (Decrease) in Equity Price 0.34 (0.34) Effect on Consolidated Net Income P =1,194,099 (1,194,099) 2007 Increase (Decrease) in Equity Price 0.28 (0.28) Effect on Consolidated Net Income =743,333 P (743,333) Capital Management The primary objective of the Group’s capital management is to safeguard the entity’s ability to continue as a going concern, so that it can provide returns for shareholders and benefits for others stakeholders and to maintain an optimal capital structure to reduce the cost of capital. The Group manages its capital structure and makes adjustments to it, in light of changes in economic conditions. To maintain or adjust the capital structure, the Group may adjust the dividend payment to shareholders, return capital to shareholders or issue new shares. The Group monitors capital on the basis of current ratio and debt-to-equity ratio. Debt-to-equity ratio is calculated as total liabilities over equity. The Group’s strategy, which was unchanged from prior year, was to maintain debt-to-equity ratio and current ratio at manageable levels. The Group’s current ratio and debt-to-equity ratio as of December 31, 2008 and 2007 are as follows: Current Ratio Current assets Current liabilities 2008 P =327,601,724 176,094,056 1.86 2007 =321,061,829 P 109,683,251 2.93 *SGVMC211961* - 52 Debt-to-Equity Ratio 2008 P =379,621,990 400,207,496 0.95 Total liabilities Total equity 2007 =340,412,805 P 396,037,982 0.86 Fair Value of Financial Instruments Set out below is a comparison by category of carrying values and fair values of all the Group’s financial instruments as of December 31, 2008 and 2007. 2007 2008 Financial Assets Loans and receivables Cash and cash equivalents Trade and other receivables: Trade receivables Advances to contractors and suppliers Advances to officers and employees Other receivables Advances (included as part of “Investment and advances” account in the consolidated balance sheets)* Investments held for trading Financial Liability Other liabilities Trade and other current liabilities: Trade Consultancy and software and license fees payable Accrued expenses and others** Others Installment payable (inclusive of current portion) Obligations under finance lease (including current portion) Carrying Value Fair Value Carrying Value Fair Value P =103,424,773 P =103,424,773 =151,417,401 P =151,417,401 P 38,010,276 21,768,816 28,726,468 28,291,415 38,010,276 21,768,816 28,726,468 28,291,415 26,436,779 27,509,183 7,537,085 6,184,869 26,436,779 27,509,183 7,537,085 6,184,869 – 220,221,748 54,810,517 P =275,032,265 – 220,221,748 54,810,517 P =275,032,265 67,351,193 286,436,510 58,213,480 =344,649,990 P 67,351,193 286,436,510 58,213,480 =344,649,990 P P =17,827,803 P =17,827,803 =9,021,730 P =9,021,730 P 13,924,658 29,257,969 10,050,247 13,924,658 29,257,969 10,050,247 4,763,614 5,092,103 1,701,869 4,763,614 5,092,103 1,701,869 6,618,134 6,577,217 2,326,433 2,326,433 258,934,450 P =336,613,261 256,766,992 P =334,404,886 284,093,353 =306,999,102 P 281,892,574 =304,798,323 P ** Advances to a subsidiary in 2007 pertain to advances to a previously held joint venture. ** Excluding other current liabilities representing statutory payables and other liabilities to the government. The carrying values of cash and cash equivalents, trade and other receivables, and trade and other current liabilities approximate their fair values due to the short-term nature of the transactions. The carrying value of interest-bearing advances to related parties approximates fair value due to recent and regular repricing (i.e., monthly) based on market conditions. The fair value of investments held for trading is based on quoted prices. *SGVMC211961* - 53 The fair value of installment payable and obligations under finance lease with fixed interest rate is based on the discounted net present value of cash flows using the prevailing MART 1 rates ranging from 5.64% to 6.81% in 2008 and 4.18% to 6.14% in 2007. 29. Note to Consolidated Statements of Cash Flows The Group’s noncash investing and financing activities in 2008 and 2007 pertain to the acquisition of lottery equipment through finance lease amounting to P =26.7 million and P =89.9 million in 2008 and 2007, respectively and acquisition of transportation equipment through car loans amounting to =11.5 million in 2008 and P P =10.4 million in 2007 with outstanding “Installment payable” amounting to P =6.6 million and P =2.3 million as of December 31, 2008 and 2007, respectively (see Note 15). *SGVMC211961* PACIFIC ONLINE SYSTEMS CORPORATION Schedule A. Short-term Cash Investment For the Year Ended December 31, 2008 Name of Issuing Entity and Description of each Issue Union Bank of the Philippines Number of Shares or Principal Amount of Bonds and Notes Amount Shown in the Balance Sheet Value Based on Market Quotations at Balance Sheet Date P 10,419,141 P 10,419,141 P 10,419,141 P 10,419,141 PACIFIC ONLINE SYSTEMS CORPORATION Schedule B. Amounts Receivable from Directors, Officers, Employees, Related Parties and Principal Stockholders (Other than Associates) For the Year Ended December 31, 2008 Beginning Balance Name and Designation of Debtor Advances to officers and employees TOTAL Additions Amount Collected Deductions Amount Written-off Ending Balance P 7,537,085 P 25,691,199 P 4,501,816 P P 28,726,468 P 7,537,085 P 25,691,199 P 4,501,816 P P 28,726,468 PACIFIC ONLINE SYSTEMS CORPORATION Schedule C. Other Long-term Investments and Other Investments - at Cost For the year Ended December 31, 2008 BEGINNING BALANCE Name of Issuing Entity and Description of Investment Number Shares of Principal Amount of Bonds and Notes ADDITIONS DEDUCTIONS Equity in Earnings (Losses) of Investees for the Period Amount Pesos ENDING BALANCE Distribution of Earnings by Investees Others Number Shares of Principal Amount of Bonds and Notes Others Dividends Received Accured from Investments Not Accounted for by the Equity Method Amount in Pesos At Cost P P P P P P NONE - - - - Less: Allowance for decline in value of investmnerts P - P P - P P - P - PACIFIC ONLINE SYSTEMS CORPORATION Schedule C. Other Long-Term Investments and Other Investments - at Equity For the Year Ended December 31, 2008 BEGINNING BALANCE Name of Issuing Entity and Description of Investment At Equity Innovative Solutions Consultancy Group Accumulated equity in net losses Number Shares of Principal Amount of Bonds and Notes 7,689,740 Amount in Pesos ADDITIONS Equity in Earnings (Losses) of Investees for the Period DEDUCTIONS Others Distribution of Earnings by Investees ENDING BALANCE Others Number Shares of Principal Amount of Bonds and Notes Amount in Pesos 7,689,740 (27,905,639) (20,215,899) - (20,215,899) - Allowance for impairment in value PACIFIC ONLINE SYSTEMS CORPORATION Schedule D. Indebtedness to Unconsolidated Subsidiaries and Associates December 31, 2008 Beginning Balance Name of Affiliate Ending Balance P P NONE P - P - PACIFIC ONLINE SYSTEMS CORPORATION Schedule E. Other Assets For the Year Ended December 31, 2008 Beginning Balance Description P Refundable deposits Addition At Cost P Deductions Charged to Other Accounts Charged to Costs and Expenses P P Other Changes Additions (Deductions) P 5,045,793 Others 5,343,393 P 4,834,302 297,600 P Ending Balance - P P P P 4,834,302 P 9,880,095 297,600 10,177,695 PACIFIC ONLINE SYSTEMS CORPORATION Schedule F. Long Term Debt December 31, 2008 Amount Authorized by Indenture Name of Issuer and Type of Obligation Peso: Amount Shown as Current P P - Amount Shown as Long-Term P 66,740,848.00 P 198,811,736.00 P 66,740,848.00 P 198,811,736.00 Remarks PACIFIC ONLINE SYSTEMS CORPORATION Schedule G. Indebtedness to Affiliates and Related Parties (Long-term Loans from Related Companies) December 31, 2008 Beginning Balance Name of Affiliate Ending Balance P P NONE P P PACIFIC ONLINE SYSTEMS CORPORATION Schedule H: Guarantees of Securities of Other Issuers December 31, 2008 Name of Issuing Entity of Securities Guaranteed by the Company for which Statement is Filed Title of Issue of Each Class of Securities Guaranteed Amount Owned by the Company for which Statement is Filed Total Amount Guaranteed and Outstanding P P NONE P P Nature of Guarantee PACIFIC ONLINE SYSTEMS CORPORATION Schedule I. Capital Stock December 31, 2008 Title of Issue Common Shares Number of Shares Authorized Number of Shares Issued and Outstanding Number of Shares Reserved for Options, Warrants, Conversions and Other Rights 500,000,000 195,566,000 617,000 500,000,000 195,566,000 617,000 Number of Shares Held By Affiliates - Directors, Officers and Employees Others 16,901,600 178,664,400 16,901,600 178,664,400